Why Bar and Restaurant Operators Should Use Activity-Based Costing

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Should bar and restaurant operators replace traditional costing with activity-based costing?

Traditional costing—also known as product-based costing or cost of goods sold (COGS) accounting—is regarded as more simplistic than activity-based costing, also referred to as ABC.

Accounting for indirect costs, overhead and activities, ABC is considered more accurate.

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We asked industry leaders to weigh in on what metrics they were tracking to ensure proper cash flow, increased profit margins, and operations setup for future growth.

An activity, in terms of ABC, is any task or event related to making a product or completing a goal. This type of costing is most closely associated with manufacturing but can be used in bars and restaurants as well.

Consider why many manufacturers use ABC:

  1. They make a multitude of products via different processes and equipment.
  2. They serve a range of customers that are different from one another.

The same can be said of many bars and restaurants. Focusing just on food, many products produced in a kitchen are prepared using different equipment: fryers, griddles, ranges, oven, etc. And we all know that each guest is different, visiting bars and restaurants for their own reasons, seeking personalized experiences.

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Adapting an example from manufacturing, let’s compare a high-volume item (A) and low-volume item (B). The operator and kitchen team know they’re going to sell a lot of item A. Based on data and experience, there are times when item A is prepared nearly continuously. Item B doesn’t sell in the same numbers as item A and requires a different process and equipment to prepare.

Some operators would allocate much more overhead cost to item A because it saw more in the way of prep hours than item B. But item B incurred its own costs for research, development, testing, equipment, and prep. Applying only COGS or overhead to item B doesn’t paint a full picture of cost.

Other operators apply overhead costs evenly across their entire menu. This can also lead to inaccurate costing. Again, different items are produced using different equipment. If overhead is spread evenly, that means items prepared in the oven aren’t differentiated from items prepared using the fryer. That means the operator doesn’t have an accurate idea of what it costs to run each piece of equipment each month. ABC would apply all the costs of each menu item only to the equipment used to prepare them.

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Strategic menu development and programming that leverages cross-utilization can help reduce costs. However, some items cost more than others in terms of overhead and the use of specialized equipment (and other indirect factors). Therefore, spreading overhead cost evenly across menu items is inaccurate. ABC is more accurate because it uses overhead and indirect costs for each item.

Using ABC, operators can much more strategically manage costs, program menus, and approach menu price changes with greater agility. Integrating ABC is, at present, more complex and not considered a "generally accepted accounting practice" (GAAP), but that complexity is what produces more accurate information. When considering accounting software, operators may benefit from platforms that use ABC and can integrate seamlessly with bar and restaurant POS systems.

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