There are a number of nuances to restaurant accounting that do not apply to other industries. Tips are a large part of that, as well as uniform expenses (if you require workers to wear uniforms) and the natural cost variations that occur between dishes. Not to mention the day-to-day differences in supply costs, depending on where and when you source your food.
One choice restaurateurs need to make is which accounting process to use — the cash method or the accrual method. With pros and cons to both, it helps to better understand either method before locking down your restaurant’s accounting plan. So let’s start with their definitions.
What is the cash method and the accrual method?
The cash method, also called “cash-basis accounting,” recognizes revenue only when money is received, and expenses only when they are paid. Accounts receivable and accounts payable are not acknowledged.
The accrual method or “accrual accounting” takes a different approach. In this case, revenue and expenses are recorded when they are earned or billed, regardless of when the money is actually received or paid.
Here’s an example: Say you do a job for a client and send them an invoice for $100. If you were using the accrual method, you’d say you had $100 the minute the invoice was in their hands. If you were using the cash method, you wouldn’t count that $100 as income until the client’s money was in your bank account.
Both accounting methods have their merits — and their downsides. Here’s a quick rundown.
The pros and cons of cash basis accounting
If you’re someone who prefers to count their chickens once they’ve hatched, you’ll probably prefer the cash method for your accounting.
Transparency: You know exactly how much money you have — it’s what’s in your bank account right now. That means you also know how much you can spend.
Simplicity: If you have money in the bank, you know your business is profitable.
Taxes: You only pay taxes on money you’ve actually received; ideally that means you also have the funds in your account to pay those taxes.
Planning: If you’re not keeping track of future business — either what’s been billed but not yet received, or what’s coming up as an expense — it can be difficult to know where your business will be in six months. That’s a problem if you plan to woo investors or sell your business.
The pros and cons of accrual accounting
The majority of businesses use accrual accounting — mostly because so many industries bill their clients and receive payments at a later date.
Projections: Businesses can see their income and expenses during a specific period of time, which allows them to create a long-term picture of the business that cash accounting can’t provide.
Credit: With the cash method, money is only spent once it’s earned; with the accrual method, businesses only need to know money is on its way before handling important expenses.
Obscurity: Because accrual accounting uses accounts receivable to inform profitability, rather than the amount of money in the bank, a business can appear more financially stable than it really is. Businesses that use the accrual method should keep a watchful eye on cash flow to ensure they are seeing their finances accurately.
Taxes: If the business views an invoice as revenue, so does the IRS, which means taxes could be due even before cash is in hand.
Which accounting process is right for your restaurant?
Typically, accrual accounting is better for those who deal with large businesses (and contracts) and don’t get paid very quickly. Cash-basis accounting, on the other hand, is better for businesses that deal directly with customers and have lots of transactions.
Typically, restaurants fall under the cash basis accounting method, though some (particularly franchise owners), may use both. But what are the elements of accounting that restaurant owners need to consider?
The 4 basic elements of restaurant accounting
There are four basic elements of restaurant accounting:
Chart of accounts: This is a list of all the accounts related to your business, including assets, liabilities, revenue, expenses, and equity.
Restaurant expenses: You’ll need to create a clear record of costs relative to sales.
Prime cost: The four factors included here are cost of goods sold (CoGS), cost of labor, occupancy expenses, and operating expenses. (More on this in a minute!)
Prime cost-to-sales ratio: This varies by restaurant size and type and is calculated by dividing the restaurant’s prime cost by its total sales. In general, the prime cost of a financially healthy restaurant is 55-65% of its total food and beverage sales.
Calculating prime cost can feel a little overwhelming, but it helps to break each section into parts.
Cost of goods sold is the food and drink portion — in other words, the total cost of your restaurant’s ingredients/supplies during a specific period of time.
Cost of labor means employee expenses, including payroll, payroll taxes, and employee benefits.
Occupancy expenses are fixed costs like rent, property taxes, utilities, internet, and property insurance.
Finally, operating expenses are everything else, including laundry, equipment repairs, marketing costs, and legal fees.
Just remember that in order to calculate your business’s prime cost-to-sales ratio, you need to measure both elements over the same period of time. It’s not unusual for a restaurant’s sales to fluctuate throughout the year, but a sustainable business must be able to anticipate those fluctuations and make arrangements to hold its prime cost-to-sales ratio steady.
How tips affect restaurant accounting
If you’re new to the restaurant business, you may wonder how tips factor into your business’s accounting.
Tips are considered employee income, not wages. As such, they are not subject to withholding. That said, employees are required to report tips to their employers. Both the employee and the restaurant must pay taxes on that money, even though it’s not considered revenue.
Automatic gratuities are different. Because they are added to the customer’s check automatically, it is considered a service charge, not a tip. Unlike typical tips, automatic gratuities are considered restaurant revenue.
Service charges are like automatic gratuities. Whether they’re added as a result of catering or some other reason, they are considered revenue. Disbursements of service charges to staff count as part of staff wages and — unlike tips — are subject to withholding.
Restaurant accounting made easy
Like any industry, restaurants have their own particular accounting nuances that can be more easily navigated with the help of industry-specific software. MarginEdge is a restaurant management software that integrates with QuickBooks to make your restaurant’s accounting as uncomplicated as possible.
About the author
Danielle Higley is a freelance writer, editor, and children’s book author. Over the past decade, she’s written for Firm of the Future, SCORE, Costco Magazine, hr.com, and others. In 2022, her book The Stories Behind the Stories: The Remarkable True Tales Behind Your Favorite Children’s Books was celebrated at the National Books Festival, hosted by the Library of Congress.