A Guide to Accounting for Restaurants

Restaurants run differently from other types of businesses, so accounting for restaurants looks different. Here’s how to build an accounting system for a restaurant.

You’d never want me to be your sous chef; I’ve been known to burn toast, and I recently left the lid to a butter container on a hot burner. Still, I’m hoping you’ll join me as the guest chef in my figurative accounting kitchen.

Overview: What is restaurant accounting?

When you’re sitting at a table waiting for your appetizer to arrive, it’s easy to think restaurants are businesses just like any other. Those who own and run restaurants know the fire they face in the kitchen, both literally and figuratively.

Accounting for restaurants entails managing narrow margins and accurately paying tipped employees. Restaurants face challenges unseen in other industries, so restaurants must keep impeccable accounting records.

Cost accounting for restaurants is a prized field of expertise. Between pricing new menu items and figuring out the right amount of food to order, there’s plenty of analysis required to maintain a restaurant’s financials.

4 considerations specific to restaurant accounting

Restaurant owners not only worry about all the things other business owners worry about, but they also have to manage unique payroll and inventory issues. Keep these four considerations in mind as you build your restaurant accounting system.

1. Inventory inspections

A restaurant’s inventory is food and beverages, both of which have expiration dates. While many industries experience spoilage -- when their inventory is no longer usable -- restaurants must actively assess their inventory at least once a week.

When you throw out food that’s gone bad, you should note it in your accounting records by debiting a spoilage expense account and crediting an inventory account.

Keeping a record of spoilage should help you ascertain the right amount of food and beverages to order in the future. Spoilage cuts into your profits, so you want to keep it low. However, running out of inventory is just as problematic for your bottom line.

2. Tips

Servers and other restaurant workers in the U.S. generally earn a portion of their income through customer tips, with the rest covered by their employers. Build your restaurant chart of accounts and payroll process to account for tips.

Most states have a tip credit that effectively lowers the state minimum wage for tipped workers. For example, employers in Ohio must pay non-tipped workers at least $8.70 per hour in 2020. Because of the Ohio tip credit, tipped workers in the state may earn as little as $4.35 per hour from their employers, provided that tips can bring their average hourly earnings up to $8.70 per hour for the pay period.

Tips raise the question: Are employers responsible for payroll taxes on wages received from customers? The answer is yes, although restaurants can get reimbursed for employer-paid Federal Insurance Contributions Act (FICA) taxes through the FICA tip tax credit.

Before you pay employees their earned tips, you’re required to have a tips payable account in your chart of accounts to recognize the obligation. Tips are not revenue to your business, as you’ll see in the journal entry in the next category.

3. Food and beverage costs

When a non-restaurant business sells its inventory, you debit the expense account cost of goods sold and credit inventory. The same concept applies to restaurants, but the expense account is called food and beverage cost.

For example, let’s say your restaurant sold $50 worth of food and beverage for $100 last night. You’d record two journal entries: one to recognize revenue and another to reduce your inventory balance. The revenue journal entry would show:

Then, you would record the adjustment to your inventory account:

Restaurant accounting software can automatically record these journal entries.

4. Financial performance measures

You know how to julienne carrots, but do you know how to calculate your restaurant’s prime costs?

The restaurant business is challenging. It’s normal for even popular restaurants to eke out razor-thin profit margins, making it even harder for the industry to bounce back from setbacks caused by pandemics or economic downturns. Restaurants need to keep a hawkish eye on their financial indicators and regularly adjust their spending to stay in the black.

Restaurants treat prime costs as a key financial performance measure. Also seen in the manufacturing industry, prime costs refer to the expenses incurred for direct materials and direct labor. A restaurant’s direct materials are ingredients and beverages, while direct labor is wages for servers, bussers, hosts, and cooks.

Total Food and Beverage Costs + Labor Costs = Prime Costs

You want prime costs to be low relative to your net sales. Toast POS, a restaurant software, suggests that a healthy prime cost to sales ratio is less than 60%.

Prime Costs ÷ Net Sales = Prime Costs to Sales Ratio

Ratios are most insightful when compared to your business’s past and industry benchmarks. Continually analyze your business’s financial health and track its progress.

Which type of restaurant accounting is right for your business?

You can track restaurant expenses and revenues using the cash or accrual accounting method.

1. Cash accounting

Restaurants that use the cash method recognize revenue when cash comes in and expenses when cash departs.

Unless your business has a dine-and-dash problem, you shouldn’t have to worry about accounts receivable, or the balance customers owe for already-rendered goods and services. The cash method of accounting is ideal for small restaurants because it tracks revenue only as cash goes in the register.

You may only use the cash accounting method when your business’s average gross receipts (a fancy word for average total revenue) for the past three years is less than $25 million.

Cash accounting doesn’t recognize accounts payable, or bills you owe but have not yet paid. You can use an Excel spreadsheet to track accounts payable.

2. Accrual accounting

Accrual accounting provides more precision but requires more bookkeeping. Instead of recognizing revenue and expenses when cash changes hands, accrual accounting matches revenue and expenses when they’re incurred.

Say you buy $1,000 in food from a restaurant supplier. An accrual business would record a payable in its accounting software once it receives the invoice. A cash-basis business would wait to recognize the inventory purchase until it paid the bill.

The accrual method of accounting gives you a truer sense of your restaurant’s financial position. Any business teetering on profitability -- which many restaurants do -- should use the accrual method of accounting to know where it stands.

3 must-have restaurant financial statements

Like businesses in all industries, restaurants produce balance sheets, income statements, and cash flow statements to communicate their financial position.

Balance sheet

Think of the balance sheet as a picture of your business on a specific date. It proves the essential accounting equation:

Assets = Liabilities + Equity

Investors and lenders will ask for your restaurant balance sheet to see its cash position, accounts receivable, and debts. The difference between assets and liabilities is equity, also called the net book value of a company.

Income statement

The income statement compares your restaurant’s revenue and expenses. They come in multiple formats, but the best income statement for restaurants is the multi-step income statement.

Multi-step income statements separately state a restaurant’s gross profit margin, or the difference between net sales and food and beverage costs.

Cash flow statement

The cash flow statement shows the revolving door of cash in your business. It breaks down your cash spending and receipts into operating, investing, and financing categories.

Accrual-basis businesses rely on the cash flow statement to analyze their cash position. Accrual-basis income statements reflect revenue and expenses the company has recognized, which can differ from the cash that has come in or left the business.

Potential investors pay attention to cash flow statements to see whether your business has enough cash to cover its expenses.

There’s no cooking in accounting, but there’s accounting in cooking

Running a restaurant is no small job, even before you consider accounting responsibilities. Consider how restaurant software can lighten your administrative burden.