Managing a restaurant involves many challenges, and one of the most important tasks is keeping track of your inventory costs. Without proper inventory costing, you might struggle to determine how much you're spending on ingredients and supplies. This can lead to pricing mistakes, lower profits, and even financial losses.

What is Inventory Costing?

Inventory costing is the process of calculating how much your ingredients and supplies cost over a specific period. It helps you track expenses, set menu prices, and determine your overall profit. If you don’t have a clear idea of your inventory costs, you could be losing money without realizing it.

For example, if you purchase 100 kilograms of chicken at different prices throughout the month, how do you decide the cost of chicken used in a particular dish? That’s where inventory costing methods come in.

Why is Inventory Costing Important?

Proper inventory costing ensures that you know exactly how much it costs to prepare each dish. This helps in setting the right prices while maintaining profitability. Without the right costing methods, you may overprice your dishes, pushing customers away, or underprice them, reducing your profits.

It also plays a big role in financial reporting and tax calculations. The cost of the inventory you have on hand and the cost of goods sold (COGS) directly affect your financial statements. According to the National Restaurant Association, food costs make up about 28%–35% of a restaurant’s expenses. Using the right costing methods can help control these expenses and improve profitability.

What Are Inventory Costing Methods?

There are different ways to calculate the cost of your inventory, and each method affects your financial reports differently. The method you choose will depend on how your restaurant purchases and uses ingredients. Let’s take a closer look at the main inventory costing methods.

First-In, First-Out (FIFO) Accounting

FIFO stands for First-In, First-Out. This method assumes that the oldest stock is used first. In simple terms, the ingredients you buy first are the ones you use first.

For example, if you buy 10 kilograms of salmon on Monday at RM50 per kg and another 10 kilograms on Wednesday at RM55 per kg, FIFO assumes you use the RM50 per kg salmon first.

FIFO is useful for restaurants because it ensures ingredients are used before they expire. This method is great for keeping your food fresh and reducing waste. It also reflects the actual cost of inventory more accurately when prices are rising. However, when ingredient costs increase, FIFO can make your profits look higher, which may lead to higher tax payments.

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Last-In, First-Out (LIFO) Accounting

LIFO stands for Last-In, First-Out. This method assumes that the most recently purchased inventory is used first.

Using the same salmon example, LIFO assumes you use the RM55 per kg salmon before the RM50 per kg batch. This means the cost of goods sold will be higher when ingredient prices rise.

LIFO can be beneficial for tax purposes because it reduces reported profits when prices are increasing, leading to lower tax payments. However, it’s not commonly used in the food industry because it can lead to older ingredients being left unused, increasing the risk of food spoilage.

Weighted Average Cost (WAC) Method

The weighted average cost method calculates the average cost of all inventory items and uses that average cost to determine the cost of goods sold.

For example, if you buy 10 kilograms of salmon at RM50 per kg and another 10 kilograms at RM55 per kg, the average cost would be:

(10 x RM50 + 10 x RM55) / 20 = RM52.50 per kg

This means every kilogram of salmon used in your restaurant would be recorded at RM52.50, regardless of which batch it came from. WAC smooths out price fluctuations and simplifies accounting, making it a good option for restaurants with fluctuating ingredient costs. However, it may not be as accurate in reflecting real-time costs compared to FIFO or LIFO.

Specific Identification Method

This method tracks the exact cost of each inventory item. It is mostly used for high-value ingredients or special items.

For example, if you purchase a premium cut of Wagyu beef for RM500, this method assigns the exact RM500 cost to that item. This method ensures precise costing, but it requires detailed tracking and is not practical for everyday restaurant ingredients.

Choosing the Right Costing Method

The best inventory costing method depends on your restaurant’s needs. FIFO is the most common and practical choice for restaurants because it keeps ingredients fresh and reduces waste. However, if ingredient prices fluctuate often, the weighted average cost method may work better.

Using a restaurant inventory management system can simplify this process. These systems automatically track purchases, usage, and costs, reducing errors and saving time. According to a study by Leanpath, many restaurants that use inventory management systems report a reduction in food waste by up to 20%.

FAQs

1.What are the 4 inventory costing methods?

The four main inventory costing methods are FIFO (First-In, First-Out), LIFO (Last-In, First-Out), Weighted Average Cost (WAC), and Specific Identification. Each method has its advantages and is used based on different business needs.

2.What is the best inventory costing method?

The best inventory costing method for restaurants is usually FIFO, which ensures fresh ingredients are used first, reducing food waste and maintaining food quality. However, the weighted average cost method can help stabilize cost calculations if ingredient costs fluctuate significantly.

Managing your restaurant’s inventory effectively can greatly impact your profits. Choosing the right inventory costing method and using a restaurant inventory management system can help you reduce waste, set better prices, and improve your profits.

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