When it comes to running a profitable QSR these days, how you count your inventory counts more than ever. It’s increasingly competitive in the entire restaurant field, but especially so for quick-service concepts which are being pushed and pulled to provide their speedy service and products under increasing demands for locally produced, organic-certified and responsibly sourced ingredients.
Since the profitability of any QSR is calculated using the cost of the good sold, the accuracy and “fit” of the method you choose to value inventory is critical because the financial health of your brand is in great measure based on the goods you’re holding in stock.
But how do you determine this cost? In order to do this, you’ll need to know how much each good is worth. As it turns out, business owners actually have a few options for this. These include the first-in, first-out method, as well as the last-in, first-out and weighted-average cost methods. Keep reading to find out which technique is right for your business.
The majority of restaurants operate according to the first-in, first-out principle of inventory valuation. This technique, often referred to as FIFO, assumes that the goods purchased first are the ones sold first. As a result, the remaining inventory consists of the most recent purchases and is accounted for at the good’s current cost.
FIFO is best for cases where inventory has a short demand cycle or is perishable, as is often the case in QSR operation. This is because prioritizing the oldest goods will maximize the use of inventory before items go to obsolescence.
At restaurants, chefs will use the ingredients purchased earliest with the nearest expiration date in order to avoid spoilage. QSR and other restaurants businesses therefore often prefer FIFO because it syncs with the actual flow of food in the kitchen.
As costs continue to rise, restaurants find themselves in an inflationary environment. But for those using the first-in, first-out method, the financial hit is minimized. FIFO directs restaurants to use the older, lower-priced goods first and theoretically leave more expensive goods as inventory.
Altogether, this adds up to a lower cost of goods sold and higher net income. While a higher yield is attractive to owners and investors, it also indicates an increased income tax liability.
Of all valuation methods, FIFO is the most reliable indicator of inventory value for restaurants. Since inventory measured this way corresponds with its original cost, the calculated value of remaining goods is most accurate. Managers even can access real-time depletion and inventory counts instantly through restaurant management software.
Cautionary note: One thing to consider with this method, however, is that there is not always proper revenue and cost matching. With FIFO, older and often lower costs are calculated with current revenues, which can result in some misappropriation.
Another approach to valuing inventory is less frequently used in restaurant management. LIFO or last-in, first-out essentially reverses FIFO and works on the assumption that goods purchased last are sold first at their original cost.
This leaves the oldest goods remaining in ending inventory, which in QSR management would often leave food products to expire before being, explaining why this method is typically practiced with non-perishable commodities. ‘
When the price of goods increases, it's those newer and more expensive goods that are used first, according to the LIFO method. This increases the overall cost of goods sold and leaves the cheaper, earlier-purchased goods as inventory.
But, those goods may not even be used in the next period as they come second to QSR inventory purchases. A higher cost of goods sold will ultimately yield lower gross margins and net income, but one benefit of LIFO is that it can result in a reduced tax burden as a result of less profit.
Likewise, unlike FIFO, LIFO does not always provide an accurate valuation of ending inventory because the oldest goods tend to be stored repeatedly as inventory. As a result, many of these items obsolete before use. LIFO does, however, correctly match the current revenue with the current costs of a given period.
Cautionary note: Remember also that when it comes to financial accounting, LIFO is usually not the preferred method because it is banned by International Financial Reporting Standards and it has restricted use under Generally Accepted Accounting Principles.
Weighted average cost
If the aforementioned methods don’t fit the demands of your brand, a third method, QSR operators may want to consider WAC or weighted average costing. Under this approach, goods are assigned the same valuation regardless of when each was purchased and how much was paid. Instead, the total cost of all inventory items is divided by the number of all items, yielding a weighted average cost per unit.
WAC generates a valuation that falls between FIFO and LIFO because values assigned with this method represent cost that fall between the first and last purchased goods in inventory. This approach is often taken when businesses use lots of individual items that are impossible to assign value because they are so integrated and commoditized.
The increasing competition, as well as growing emphasis on local and organic sourcing of ingredients may make WAC worth investigating for some QSR operators. But the bottom line on this as in everything operational is that each brand must choose the method that best fits their reporting and management styles.
Back-office software can make whichever approach is selected easier and more meaningful on a day-to-day basis thanks to live inventory tracking which enhances the already inherent value of good inventory valuation. But, use wisely because haphazard or ill-informed approaches to this critical business task can result in very costly consequences.
Niall Keane Niall Keane, CEO of SynergySuite Restaurant Management Software, has over 15 years of experience in the hospitality industry. His clients include top restaurant companies and many of the nation's fastest growing and well-respected brands. www