Prime Costs, Operating Expenses, and Profit

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Prime Costs, Operating Expenses, and Profit are three of the four parts of a Profit and Loss Statement.

In a previous blog, I talked about the Importance of a Profit and Loss Statement (P&L).  In this blog, I’ll walk through a P&L and look at it from a perspective of the prime cost and the operating expenses that you look at to manage your business. The P&L is a critical tool to guide you through your plan to make your business profitable.

Here’s the example of a P&L:

P & L Example

On the left-hand side, you see the  three major categories that we will look at when we’re working through a Profit and Loss. For this example we’re going to say that our business does $1M million in annual sales. That, of course, equates to 100 percent of the revenue that you had to use to drive down to your profit. Now, let’s take a look at the items that impact that 100 percent.

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Cost of Goods

First,  Cost of Goods; and for this example,  Cost of Goods (COG) is 35 percent. So what’s in that Cost of Goods category? The definition of Cost of Goods is all the direct expenses necessary to deliver the product to the customer. It’s food, it’s beverage, it’s packaging, it’s condiments, it’s anything directly related to the product you’re serving to the customer, whether it’s takeout or in-store.

Labor

Next is Labor. This is the cost of managing the business through your staff and your management to deliver that product to the customer, so what’s included there? As I mentioned, direct wages for management and staff, and those things related to that payroll, such as taxes, insurance, workman’s comp, and again, anything else that might be directly related to the labor.

Prime Costs

What are Prime Costs? This is a term that it’s very important that people in the industry understand. Prime Cost is Cost of Goods plus Labor; and in our example above, it’s 25 percent plus 35 percent, or 60 percent. That means that 60 percent of that 100 percent dollar amount  is eaten up by Cost of Goods and Labor, so you now have 40 percent of that initial $1 million, or $400,000, to manage to your profit.

Operating Expenses

With Operating Expenses you have limited control over your expenditures. Examples of operating expenses are: rent, utilities(water, electric, gas), marketing costs, royalties, and outside services, such as a laundry service. There are other items in Operating Expenses, but the ones I listed are some of the main ones.

Managing Prime Costs and Operating Expenses

What’s important to understand, that any expenditures in the Operating Expenses category are directly related to sales. Any money spent in this category has to impact your sales positively.

I’m going to give you two examples of how you manage your business with your operating expenses:

Example 1

Let’s say  you want to add money to your budget for marketing. So you add a certain amount of dollars in the Operating Expenses category for marketing. The extra marketing should drive revenue (your annual sales).  If you add dollars in the Operating Expenses category, you should see an incremental bump in sales.  This means that you have more dollars to manage down to, so that may mean that even if the percentage goes up, you’re going to get an incremental dollar value in your profit.

Example 2

Conversely, let’s say that your staff is doing all your cleaning. You decide that you want to go out and hire outside services for somebody to come in and clean the business for you. Well, that’s more dollars in the Operating Expenses category to clean your unit. If that dollar amount does not cut the Labor (the Prime Cost category), it’s considered additional cost to manage the business. This will to drive Operating Expenses  up and drive Profit down.

Prime Costs, Operating Costs, and Profit are all things that you need to understand when you manage your business. I hope that this post gives you a general overview of how you manage a P&L to a Profit.

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