Let’s not beat around the bush — inventory costing is complicated, but it’s also a necessity.
Why?
Because it gives you a real-time understanding of your financial health. You can figure out the cost of goods sold (COGS), identify your most profitable menu items, and pinpoint areas to increase profitability. All of this paints a picture of your financial health.
So how exactly do you perform inventory costing for a restaurant?
Keep reading to find out! In this article, we’ll break down the three restaurant inventory costing techniques. We’ll also give you some best practices for improving your inventory costing going forward, and answer some FAQs.
But first, let’s expand on why inventory costing is important in the first place.
Why inventory costing matters in restaurant management
Inventory costing involves assigning value to your inventory. For restaurants, this includes menu items such as ingredients for meals and beverages. It’s an important part of restaurant management because it directly impacts profitability and operational efficiency.
Think about it — by accurately valuing your inventory, you can assess your profitability. This helps you make strategic decisions to maximise profits across your restaurant.
It also helps you improve your inventory management systems, identifying the best ways to store and use your ingredients before they perish. And when you minimise your food waste, you can reduce your food costs (because you only order items you actually need). It’s a win-win!
3 costing techniques that all restaurant managers need to know
Before we get into our tips for inventory costing, let’s outline the three main ways to calculate the cost of inventory:
- First-in, first-out (FIFO)
- Last-in, first-out (LIFO)
- Weighted average costing (WAC)
#1. First-in, first-out (FIFO)
FIFO is the most popular inventory costing method because it’s easy to understand, accurate, and reliable. It assumes that items purchased first are the first to be sold or used in production.
When inventory arrives, you mark it with the date and store it behind your existing stock. Chefs then use the older items at the front of the shelf that are more likely to perish sooner. It minimises food waste and ensures that you use fresh ingredients before they expire.
For this reason, FIFO is a useful technique for perishable goods like vegetables, fruits, and dairy products.
Inventory items are then valued at the current cost of your most recent purchases. If your supplier hikes prices, you apply the new prices to items even if you bought them at a lower price initially.
This helps you keep on top of inflation. Older items were purchased at lower prices before inflation took effect, so the FIFO technique results in a lower cost of goods sold (COGS).
#2. Last-in, first-out (LIFO)
Unlike FIFO, LIFO assumes that the last acquired inventory items are used first. This means that the COGS is based on the cost of the most recent inventory purchases because you’re assuming that these items sell first.
It’s less common in the restaurant industry because of the amount of perishable goods. If you want to use LIFO, it’s best applied to items like canned goods or dry ingredients with less time-sensitive expiration dates.
However, it can be helpful during periods of inflation, as it reflects higher current costs — although this isn’t always good. In fact, it can distort inventory figures on your balance sheet when inflation is high.
This is one of the reasons it’s banned in some areas under the International Financial Reporting Standards (IFRS) and restricted under Generally Accepted Accounting Principles (GAAP).
#3. Weighted average costing (WAC)
WAC calculates the average cost of all units of inventory. It assigns equal weight to each unit of inventory, regardless of when it was purchased or its cost.
It’s useful if you want to simplify your inventory costing, or if you have items with similar characteristics and costs that are difficult to differentiate (such as spices or non-perishable goods).
But when it comes to restaurant ingredients that vary in price and quantity, the WAC method can make it hard to get an accurate estimate of your finances. For example, when you have large price variations, the WAC method overlooks them.
Best practices for restaurant inventory costing
Understanding the techniques for inventory costing is half the battle.
The other half?
Knowing how to implement these techniques successfully.
The good news is you’ve come to the right place to uncover what these best practices are! Here are some of our best tips and advice on how to improve inventory costing in your restaurant:
Ensure consistency
Consistency is one of the most important aspects of financial reporting. It allows you to accurately compare periods, identify trends, and pinpoint discrepancies. In other words, it gives you transparency and clarity around your financial performance.
To ensure consistency, choose the best inventory costing method for your restaurant and stick with it. This helps you maintain accuracy with your inventory management, ensuring that you have a clear picture of your finances.
Consider regulatory compliance
For inventory costing to be successful, you need an awareness of regulatory standards that apply to your restaurant. For example, accurately recording financial statements to follow UK tax rules*.
Understanding these regulations will ensure you comply with legal requirements, avoiding fines, penalties, or legal issues that will 100% not be good for business.
*The financial laws and regulations that apply to restaurants vary from business to business. If you’re unsure, talk to an accountant.
Use restaurant inventory software
A restaurant inventory management system helps you track, manage, and optimise your inventory. In fact, we’d go as far as to say that it simplifies the entire inventory costing process.
A platform like Nory, for example, gives you real-time visibility into inventory levels, costs, and usage patterns. As a result, you can make quick and informed decisions on how to minimise costs and improve your entire inventory management process.
Top tip 💡 Use a restaurant management system with a POS integration, like Toast or Vita Moja. It provides real-time data analysis into sales and performance, which gives you an even better understanding of the COGS.
Get in touch with the team at Nory to start managing your inventory costs today!
FAQs about restaurant inventory
What is the best inventory method for restaurants?
The best costing method varies from restaurant to restaurant. Inventory turnover rate, management preferences, and regulatory requirements are a few of the things that influence which technique is right for your business.
What is the best inventory management software for a restaurant?
It depends on the features you need. Ideally, you need a system that provides real-time inventory costs and usage so you can accurately track prices and make improvements. Integration with your POS system is also a major benefit, as it allows you to dive deeper into customer behaviour, inventory usage, and profitability of menu items.
Spoiler alert: Nory offers all of these features. 😎
Is Excel good for inventory tracking?
Excel is a simple and cost-effective way to track inventory, but there are a lot of challenges to be aware of. It requires manual updates, which increases the risk of human error and can be time-consuming to manage. It also doesn’t have automated intelligence features to identify trends which help you improve inventory costing.
