COST ANALYSIS AND CONTROL
6.10 OTHER COSTS AND PRO FORMA INCOME
All other expenses besides the prime costs also must be forecasted applying the same technique. If everything works out as forecast described, the result of the annual operations during the second year (Y-2) will be as presented in the following pro forma Income Statement (Table 6.6). It shows the list of all expenses in group names such as Restaurant Operating Expenses, Marketing Expenses, Energy (Utility) Expenses, Administrative Expenses, Repair and Maintenance Expenses, Rent, Depreciation, and fi nally Interest Expenses. It must be noticed that the titles of some expenses are slightly altered. The Insurance Expenses have been included into the Administrative Expenses. It is common practice in the restaurant industry to put multiple expense items into a representative group for simplicity in their presentation of the opera- tional results.
Table 6-06 Pro Forma Income State of the Y-2 R&B Grill Y-1 Actual Y-2 Forecast Y-1V.A. %FCVC/custY-2V.A. % Customer # 58,604 Revenues14,444,195100.0%Avg. Check*$ 29.60 1,734,678100.0% Cost of Sales484,3003.4%Cost %33.5%581,11733.5% Gross Profit13,959,89596.6%1,153,56166.5% Operating Expenses FC (annual)VC/cust Labor Expense401,8002.8% per labor schedule**506,82329.2% Restaurant Operating Expense63,2950.4% *** $ 1.25 73,2554.2% Marketing Expense16,7700.1%$ 20,000 **** 20,0001.2% Energy (Utility) Expense33,7500.2%$ 11,652 $ 0.41 35,6802.1% Administrative Expense (*****)97,5550.7%$ 58,980 $ 0.72 101,1755.8% Repair & Maintenance Expense14,8200.1% *** $ 0.30 17,5811.0% Rent Expense180,0001.2%$ 180,000 $ – 180,00010.4% Depreciation – FF&E24,0000.2%$ 24,000 $ – 24,0001.4% Depreciation – Leasehold improve.24,0000.2%$ 24,000 $ – 24,0001.4% Depreciation – Smallware24,0000.2%$ 24,000 $ – 24,0001.4% Total Operating Expenses879,9906.1%1,006,51458.0%
Operating Profits13,079,90590.6%147,0478.5% Interest Expense (income)18,0000.1%18,0001.0% Income before Income Taxes13,061,90590.4%129,0477.4% Income Taxes (35%)4,571,66745,167 Net Income (loss)8,490,23858.8%83,8814.8% * Average check price has been adopted from the customer forecast (Table 6-01). ** Labor costs were adopted from the labor schedule total (Table 6-04). *** The negative amount of the fi xed cost is not used; and the variable cost per customer is adjusted. **** Marketing expenses is adjusted to the same percentage (1.2%) of the revenues of the Y-2. ***** Administrative expenses include the Insurance of $18,000.
The pro forma Income Statement in Table 6.6 shows the results of the 2 years (Y-1 and Y-2) side by side to compare the operational results. The following is the explanation of how individual items have been forecast.
1. Revenues have been calculated by multiplying the average check price of $29.60 to the expected customer count of 58,604. According to our forecast, the customer traffi c would increase by 15% in the Y-2 from the fi rst year (Table 6.1). It was a nạve forecast, but in the beginning stage of a restaurant business, it is considered reasonable to achieve. The average check price was also naively estimated to increase by 10%. The average check price has been estimated to be $29.60. Since these calculations have been conducted using Excel, readers may come up with slightly different numbers. Personal discretions are recommended when there is small dis- crepancy. This increase is also acceptable to expect if R&B Grill tries to upsell their products with enhanced services. When these two numbers are multiplied, the expected revenues turn out to be $1,734,678 ($29.60 x 58,604). This result shows an acceptable increase of 20.1% from Y-1.
2. The Cost of Sales, as a true VC, was set at 33.5% of the revenues fol- lowing the result of Y-1 to be conservative. In our forecast, the ideal cost was 32.41% (Refer to Table 5.2). The actual cost of sales per- centage of 33.5% during the fi rst year (Y-1) is quite close to the ideal condition. This result means that R&B Grill’s inventory control system – purchasing and receiving, portion control, and waste control, and oth- ers – are implemented very effi ciently. The company must maintain the same effi ciency this way, if not better. When 33.5% of the food cost is applied to the expected revenues, the amount is $581,117 as presented in the pro format statement.
3. The Labor Expenses picked up the amount estimated through the employee work schedules as presented in Table 6.4. This expense is con- sidered a mixed cost composed of a fi xed amount and variable amounts.
To accommodate unexpected situations, the labor cost includes $50,000 for contingency spending. The total labor cost will be 29.2% of the rev- enues. This is slightly higher than that of the Y-1 but still the overall per- centage is relatively low. The prime costs are still maintained at 62.7% of the revenues in the forecast.
4. The Restaurant Operating Expense is also a mixed cost. It includes many different cost items. The breakdown of this cost into its FC and VC (refer
to Table 6.5) shows a negative FC (−$3,778). As pointed out, this is just the result of the calculation process of the regression analysis technique.
Practitioners must use their own discretion to determine their most rea- sonable amount to forecast when statistical parameters turn out this way.
In our forecasting, the negative FC amount is ignored. Instead, $1.25 has been applied to the per capita expense for each customer served. The result is $73,255 in the Y-2. Compared with the total revenues, it is 4.2%.
This should be considered acceptable because it is almost the same as last year’s percentage.
5. The Marketing Expense, in the breakdown process, shows a large amount of the FC and a negative amount of VC per customer (refer to Table 6.5).
Due to the unique nature of this expense, the result like this should be explained. Simply, the result means that the marketing expense must be set at the highest amount. Out of the fi xed highest amount, when the busi- ness serves more customers, the spending of this expense per customer will gradually go down. This is the interpretation of this outcome. In the budgeting process, it is recommended to set aside a fi xed amount each month. In the second year (Y-2), it is expected that R&B Grill must do more to advertise their products and services. So, the marketing expenses are slightly increased to $20,000 for the year.
6. The next is Energy (Utility) Expense, which is also a mixed cost. The breakdown has yielded the FC amount of $971 per month, and an addi- tional cost of $0.41 per customer served. These fi ndings are directly applied to the total number of customers expected at the annual base. So, the entire amount of this expense is estimated at $35,680. When com- pared with the previous year’s record, it is slightly lower than last year’s 2.3%. This is acceptable considering that increased number of customers may and will enhance the energy effi ciency.
7. Below the Energy Expense is the Administrative Expenses. This is also a composite expense item that includes many similar sub-expense accounts.
As pointed out, this expense includes the Insurance Expense. This cost in Table 6.5 shows the FC amount of $4,915 per month and an additional cost that incurs per customer of $0.72. When these records are annual- ized and applied to the total number of customers, the result of the Y-2 is $101,175. The vertical analysis shows that it is 5.8% of the revenues.
The same logic as in the Energy Expense applies to this situation. That is, increased number of customers enhances the cost effi ciency.
8. The last mixed cost is the Repair and Maintenance. Table 6.5 shows the negative amount of the FC and $0.53 of additional cost per customer served. As we did in the case of the Restaurant Operating Expenses, the negative FC is ignored, and the additional cost per customer is adjusted to $.30, which has yielded $17,581 for the entire year. The amount is slightly higher than it was in Y-1, but the cost percentage remains the same. In the earlier days of the business, it is acceptable. However, as times go by, R&B Grill may have to increase its forecast in this expense due to the wear and tear of its properties.
9. The following items are all FCs – rent, depreciation, and interest expense.
Annualized amount of the monthly expenses is applied.
10. The Income Tax is added in this forecast as the last expense to be safe and to be more conservative. Tax is neither a FC nor a VC. It is simply charged on the Income before Income Taxes (also known as Earnings before taxes, or EBT). The common tax rate of 35% is applied to the Income before Income Taxes.
11. Finally, after deducting all projected expenses, R&B Grill will earn
$83,881 for the net profi t. This will be added to the owners’ equity. The projected net profi t is 4.8% of the revenues. Its ROS is increasing accord- ing to this forecast.
As presented so far, revenues and expense are forecast based on the projected number of customers. It is reasonable because, in restaurant businesses, revenues and expenses are directly related to the number of customers served. In this context, the customers are the infl uencing fac- tor (independent variable), and the revenues and expenses are the results (dependent variable). For each item (such as revenues and individual expense items), necessary parameters (intercept “a” and slope “b”) have been identifi ed using the Regression Analysis technique built in a spread- sheet program. In this process, profi ts (or losses) are calculated from the result of the forecast of the revenues and expenses. Profi ts are the result of the operations, and as such, they can only be estimated by forecasting the revenues and expenses fi rst. The Table 6-07 below presents the progress of the business during the past two years in a summarized format. The table shows the changes of the company’s assets, liabilities, and equity, supported by its operating activities. Major ratios are also presented.
Table 6-07 R&B Grill Ratio Analysis
Year Y-0 Y-1 Y-2
Assets $ 1,128,300 $ 1,135,705 $ 1,135,705
Liabilities $ 475,500 $ 421,000 $ 421,000
Equity $ 652,800 $ 714,705 $ 714,705
Revenues $ 1,444,795 $ 1,736,026
Oper. Profit $ 80,505 $ 147,944
E.B.T $ 62,050 $ 129,944
Net Profit $ 21,877 $ 84,463
Ratios
Asset Turnover 1.28 1.53
Return on
Sales 1.5% 4.9%
Return on Assets 1.9% 7.4%
Return on Equity 3.2% 11.8%
Figure 6.1 Business activities presented in time.