How Understanding the Contribution Margin Contributes to Your Restaurant’s Success

Written by Justine Nightingale
Wednesday, June 14, 2023 at 08:00am CDT

Your restaurant’s contribution margin is a vital key to your restaurant’s success and longevity. Have you heard about it, but you really aren’t sure what that means? You definitely aren’t alone, as many people in the restaurant industry have no idea what it is.

Would you like to learn more?

You’re in luck, as we’re going to talk about how understanding the contribution margin contributes to your restaurant’s success. You’ll learn what it is, how it’s different from profit margin, and how you can leverage it to reach your goals.

What is the Contribution Margin?

The most important takeaway for you to know is that the contribution margin affects every piece of your restaurant. This includes things like how you price your menu, how you order paper goods, and even how you manage your labor costs. (tweet this)

There is good news: once you understand the concept, you are well-poised to have a very successful restaurant.

When we talk about this concept, we’re talking about the percentage of every dollar you make that pays your business expenses (not including variable costs and labor costs).

In order to figure out your margin, you first need to know your prime cost. This represents your food costs plus your labor costs. A prime cost is the total of all the costs that go into making your menu items. It includes the ingredients you use to make the item and your labor costs.

For example, let’s say your food cost is 25% of the money you are bringing in, and your labor cost is 35% of the money you’re bringing in. This equals a prime cost of 60%. So, your contribution margin is 40%.

Your contribution margin equals the fixed costs of everything you use to support your business. This includes rent, salaries, computer systems, loan payments, and more.

Once you know your contribution margin, you can use it to set your financial goals for your restaurant.

Do note that it’s different from your profit margin as this number includes all the costs your restaurant incurs to sell your food.

How to Calculate Your Contribution Margin

Take your total sales minus your total variable expenses and divide it by your total sales to calculate your contribution margin.

For example, let’s say you sold $200,000 in April, and your variable expenses were $50,000. Your formula looks like this:

Contribution margin ratio = ($200,000-$50,000)/$200,000
Contribution margin ratio = .75 or 75%

The higher your number, the higher your restaurant’s profit. Your contribution margin is the percentage of profit you reached after you paid your variable expenses.

If you’d like a template for working with this number, you can download one here.

How Can You Use Your Contribution Margin?

It’s very useful for big picture people. And it helps to use it to stay knowledgeable about whether you’re making enough to pay yourself, your employees, your rent, and your essential expenses.

It’s a good idea to keep track of these numbers on a daily basis and monitor them.

Remember that your prime costs are basically just the reverse of the contribution margin. So, many restaurants know when they need to cut staff for the day based on both the prime cost and the contribution margin.

You want to ensure your point of sale (POS) system is able to work through these numbers for you. It will help you grow your restaurant on a daily basis.

You can also use this knowledge for individual menu items.

Use the Contribution Margin for Your Menu

You can also use this number to learn how profitable each of your menu items is for your restaurant. It can help you know how to price your menu and even whether or not to get rid of a menu item.

When figuring your margin for individual items, you use this formula: contribution margin equals the selling price minus the food costs. You are now using the tool to figure out your variable costs. So, you use your margin to figure out how to set menu prices based on the amount of profit you want each day or month.

Ultimately, you want your food cost percentages to be between 25%-40% (the lower, the better). You want your contribution margin to be consistently moving higher, while you want your food cost percentage to be lower.

Use this knowledge to:

• Take low-performing dishes off the menu. Low sales and a low contribution margin mean low sellers need to go.
• Re-price menu items.
• Modify dishes so your customers are happy, and you make more money. You can do this when you introduce new items. Consider the ingredients and ways to cut costs without sacrificing quality.
• See where trends lie. You want to look at your contribution on an ongoing basis so you can check food trends. For example, you may have a low-performing dish, but your social media manager has really been pushing it on Facebook, and your sales have increased. This might tell you the only way to sell the dish is to advertise it.
• Change up your menu if you see there are dishes that really shine when it comes to your margin.

Use Your Contribution Margin for Success

Once you know the difference between your restaurant’s sales and the variable expenses for a specified time period, you know your contribution margin.

Ultimately, you can use this ratio to decide whether or not you should raise or lower your individual menu item prices. You can use it to see how any change in your sales numbers will impact your profit.

If you want to raise your margin, you want to think about things like reducing your labor costs, reducing your variable costs, or increasing the prices of your menu items.

Finally, always remember that you are looking for a higher contribution margin, not a lower one, to position your restaurant for success. (tweet this)

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Images: Godefroy Boutet and Keith Tanner on Unsplash