The previous article explored various types of beverages, their processing, and preparation. This article focuses on the concept of “cost,” its elements, and components in food and beverage operations. Effective costing of food and beverages requires a clear understanding of what cost entails and its application in the hospitality industry.
Concept of Cost in Hospitality
Cost accounting focuses on understanding costs to manage expenditures effectively. Cost refers to the amount of expenditure (actual or notional) incurred on or attributable to a specific item or activity. However, the term “cost” lacks a precise definition, as its interpretation depends on:
1. Nature of the Business or Industry: In businesses with minimal selling and distribution expenses, costs may exclude these overheads. Conversely, in industries where products require significant selling and distribution efforts, excluding these expenses can lead to inaccurate costing, impacting profitability.
2. Context of Use: Costs vary by purpose. For instance, work-in-progress is valued at factory cost, while finished goods are valued at office cost. The term “cost” may also refer to specific expenses like materials (cost of materials) or labor (cost of labor). Using the term without context can be misleading.
Different costs serve different purposes. For example, depreciation varies based on the method used, affecting the cost of a product or service. Despite such variations, efforts should aim to achieve accurate costing while adhering to accepted cost accounting principles.
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Elements of Cost in Food and Beverage Operations
Costs in food and beverage operations are categorized into three broad elements:
1. Material Costs in Hospitality
Materials are substances used to create a product, available in raw or manufactured states, and can be direct or indirect.
i. Direct Material: Materials integral to the finished product and traceable to specific units, such as components purchased or produced, primary packing materials (e.g., cartons, wrappings, cardboard, boxes), and partly produced components. These are also known as process material, prime cost material, production material, stores material, or constructional material.
ii. Indirect Material: Materials used for ancillary purposes, not easily assigned to specific units, such as consumable stores, oil, waste, printing, and stationery. These may apply to factory, office, or selling and distribution divisions.
2. Labor Costs in Hospitality
Labor involves human effort to convert materials into finished goods, categorized as direct or indirect.
i. Direct Labor: Labor directly involved in production, traceable to specific products, such as process labor, productive labor, or operating labor.
ii. Indirect Labor: Labor supporting tasks incidental to production, not altering the product’s composition, such as wages for storekeepers, foremen, timekeepers, directors’ fees, or salesmen’s salaries. These apply to factory, office, or selling and distribution divisions.
3. Expenses in Hospitality Operations
Expenses can be direct or indirect.
i. Direct Expenses: Expenses wholly allocated to specific cost centers or units, such as hiring special machinery for a contract or costs of defective work tied to a specific job. These are also called chargeable expenses.
ii. Indirect Expenses: Expenses not directly allocable to specific units, such as rent, lighting, or insurance charges.
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Overhead Costs in Hospitality
Overheads encompass indirect material, indirect labor, and indirect expenses, categorized by the operational division:
i. Factory Overheads: Include indirect materials (e.g., lubricants, oil, consumable stores), indirect labor (e.g., gatekeeper, timekeeper, works manager’s salary), and indirect expenses (e.g., factory rent, insurance, lighting).
ii. Office and Administration Overheads: Include indirect materials (e.g., printing, stationery, brooms), indirect labor (e.g., salaries for office manager, accountant, clerks), and indirect expenses (e.g., office rent, insurance, lighting).
iii. Selling and Distribution Overheads: Include indirect materials (e.g., packing, printing, stationery), indirect labor (e.g., salaries for salesmen, sales manager), and indirect expenses (e.g., rent, insurance, advertising).
Cost Structure in Food and Beverage Operations
The cost of operating a catering unit is typically analyzed under three headings:
2. Material Costs: Costs of food, beverages, and additional items like tobacco, minus the cost of staff meals (deducted and added to labor costs). The formula is:
Opening stock + Cost of purchases – Closing stock – Cost of staff meals = Material cost.
2. Labor Costs: Wages, salaries, employer contributions to government taxes, bonuses, staff meals, and pension funds.
3. Overhead Costs: All other costs, such as rent, rates, insurance, depreciation, repairs, printing, stationery, china, glassware, and capital equipment.
A typical cost structure might be:
- Materials: 30%
- Labor: 30%
- Overheads: 20%
- Net Profit: 20%
As catering operations experience fluctuating sales volumes, costs and net profit are often expressed as percentages of sales to reflect changes in business activity.
Components of Total Cost in Food and Beverage
The components of total cost are:
1. Prime Cost: Includes direct materials, direct labor, and direct expenses, also known as basic, first, or flat cost.
2. Factory Cost: Prime cost plus factory overheads (indirect materials, labor, and expenses), also called works cost, production cost, or manufacturing cost.
3. Office Cost: Factory cost plus office and administration overheads, also termed total cost of production or administration cost.
4. Total Cost: Office cost plus selling and distribution overheads, also known as cost of sales.
These components can be summarized as:
| Components of Total Cost | Description |
|---|---|
| Direct Material, Labor, Expenses | Prime cost or direct cost or first cost |
| Prime Cost + Works Overheads | Works or factory cost or production cost |
| Works Cost + Office Overheads | Office cost or total cost of production |
| Office Cost + Selling Overheads | Cost of sales or total cost |
Cost Behavior in Relation to Sales Volume
Costs are also classified by their behavior relative to sales volume:
1. Fixed Costs: Remain constant regardless of sales volume, e.g., rent, rates, insurance, management labor costs.
2. Semi-Fixed Costs: Vary with sales volume but not proportionally, e.g., fuel, telephone, laundry.
3. Variable Costs: Vary directly with sales volume, e.g., food, beverage, and tobacco costs.
4. Total Costs: Sum of fixed, semi-fixed, and variable costs.
Profit Metrics in Catering Operations
Three main profit types are used in catering:
1. Gross Profit: Total sales – Cost of materials (often called “kitchen profit” for food or “bar profits” for beverages; room hire is treated as 100% gross profit).
2. After-Wage Profit (Net Margin): Total sales – (Material + Labor costs).
3. Net Profit: Total sales – Total costs (Material + Labor + Overheads).
These metrics evaluate performance against past results and budgeted targets.
Cost represents the expenditure incurred for a specific item or activity, varying by business type and context. The primary elements are material, labor, and expenses, with total cost comprising prime cost, factory cost, office cost, and selling costs.
Operating costs in catering are divided into material, labor, and overhead costs. Costs are further classified by behavior (fixed, semi-fixed, variable, total) and linked to sales volume. Profits include gross profit, after-wage profit, and net profit.
A thorough understanding of these elements and components ensures accurate costing in food and beverage operations.
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