One of the first orders of business for any new entrepreneur? A thoughtful business plan that introduces your mission, provides a high-level concept for generating profits, and — of course — accounts for overhead costs.
For new restaurateurs, calculating overhead is an important part of laying the groundwork for your business's success in a competitive market. But between building a tasty menu, enticing new customers to try your offerings, and planning day-to-day operations, figuring out how to calculate overhead can get lost in the mix — especially if restaurateurs aren't familiar with the process.
While it can seem daunting, knowing how to calculate overhead is essential for businesses looking to hit the ground running and increase their profit margins. Why? Because for some industries, the margins are so thin. In fact, the average profit margin for full-service restaurants is somewhere between 3% and 5%.
From rent and utilities to advertising and salaries, overhead expenses include all things operational that are necessary for your business to stay up and running. While many of these costs are fixed, using an overhead rate formula can help business owners manage current and future costs while analyzing opportunities for wiggle room.
Once you know how to calculate overhead, your business is better positioned to make strategic decisions that can increase your staff's efficiency, grow sales, and lower overhead costs overall. Learn how to set the table for success by understanding how to calculate and analyze overhead costs.
Identify monthly overhead expenses
First things first: any business owner needs to identify their monthly expenditure before using the overhead rate formula. Begin by outlining your monthly operational expenses with a comprehensive list. For most food and retail establishments, this includes:
Rent
Utilities
Insurance
Materials and equipment
Advertising and marketing expenses
Accounting and legal expenses
Salaries and wages
Depreciation
Government fees and licenses
Property taxes
While many expenses on this list are fixed, like rent, taxes, and insurance, other areas are in constant flux — like advertising, marketing, and equipment. For example, you may spend more on advertising and marketing costs in the months leading up to opening day, but over time, the expense will drop significantly. Or, if your business invests in modern, high-tech equipment, such purchases can increase operational efficiency and potentially lower staffing costs. For this reason, it's important to reevaluate your overhead costs each month, as they continue to evolve with your business's changing needs.
Other costs, like inventory, raw materials, and production labor, are direct costs, which are not considered overhead and should not be factored into how you calculate overhead costs.
Calculate overhead as a percentage of sales
Once you have a comprehensive list of monthly overhead expenses, add all of these costs up to calculate your aggregate overhead cost. As a new business owner, knowing the percentage of money that goes towards overhead is a helpful measure for determining your pricing and budget. What's more, knowing how these overhead costs compare to your monthly sales is critical to measuring your restaurant's efficiency, profitability, and overall success.
The next step? Divide your monthly overhead costs by your monthly sales, and multiply that total by 100 to find the percentage of overhead cost.
For example, if your business brings in $500,000 monthly and your overhead is $200,000 per month, you would divide 200,000 by 500,000 to get .4, then multiply by 100 to arrive at an overhead percentage of 40 percent. And there you have it! Though it may have seemed intimidating at first, you just figured out how to calculate overhead in a few simple steps.
Analyze overhead percentage
Now that you have this calculation, what does it tell you about your business? As a rule of thumb, if your overhead percentage is below 35%, that's a good indicator that your restaurant is running efficiently. However, the above example of 40% overhead means there is room to think more strategically about operational expenses and reduce overhead costs — without compromising guests' experience.
Knowing your overhead percentage can also help you strategize to increase restaurant sales by optimizing menu pricing, improving table turnover, and creating more efficient processes for delivery, pickup, and on-premise dining. In tandem, reducing overhead costs and finding creative ways to increase sales lends to a stronger, more successful business model.
Be strategic about lowering overhead costs
Considering that most restaurants only begin turning a profit within three to five years, it's not unexpected if your business isn't profitable right away. That being said, the path to profitability will certainly be quicker if overhead costs are lower.
One effective way to reduce overhead costs is by investing in user-friendly technologies. While buying expensive, modern tech doesn't seem like an intuitive solution to keeping costs down, the long-term effects on productivity and efficiency are often worth the upfront investment.
Kitchen display systems, for example, are increasingly popular as modern restaurants continue finding new ways to optimize their operations using technology. This digital screen allows the kitchen staff to track incoming orders and communicate more effectively with front-of-house staff, helping to avoid errors, improve accuracy, and increase table turnover. When your staff is more efficient, you need fewer people to get the job done — and less money to put towards salaries and wages. What's more, increased table turnover means more people in the door and more profits.
Another opportunity to reduce overhead costs is to offer a delivery service for your guests. In fact, 67% of restaurants say they were able to increase their profits in the past year due to DoorDash's delivery, pickup, and online ordering solutions. Delivery can be more profitable than dine-in too, considering orders are incremental sales that don't require increased labor or significant overhead expenses.
DoorDash can help restaurants reach new customers with Self-Delivery, which allows you to feature your restaurant on DoorDash while fulfilling deliveries in-house for a reduced commission. If you're looking to get access to on-demand Dashers to deliver orders placed on your own online ordering system, consider Drive On-Demand. Our white-label delivery solution includes an innovative logistics platform that allows you to request a driver at any time, track your orders, and maintain your branding. These cost-effective solutions can help you sustain a reliable delivery service without overwhelming costs.
Extract insights from the numbers
While any business owner has a long list of responsibilities and expenses to consider when getting their business off the ground, one of the most important places to start is with a calculator, keeping your overhead cost formula handy.
By learning how to calculate overhead costs, you'll set your business up for success with insight into your regular monthly expenses, a plan for your budget, and opportunities to reduce costs. As your business inevitably changes, you can reevaluate overhead costs each month and calculate a new overhead percentage as your reference point. Maybe you will be able to renegotiate your monthly rent, invest in cost-effective equipment, or reduce your marketing budget as your business gains popularity — so be sure to account for these changes when you revisit your overhead percentage.
At the beginning of each month, create a total of your monthly expenses, calculate the overhead percentage, and analyze how it stacks up against your profits. From there, be strategic about how you reduce costs by remaining attentive to your most pressing business needs. Open a dialogue with your staff to see what pain points they think need to be addressed — and make sure this conversation is ongoing. Equipped with these insights, your business can watch the orders roll in and keep delivering the highest level of service.
