The operating profit of a restaurant is sales minus cost of goods sold which equals the gross margin. The gross margin minus all other expenses equals the restaurant's operating profit. EBITDA is earnings before interest, taxes, depreciation and amortization. Two restaurants may generate similar operating profits but very different EBITDA, or vice versa.
Cost of Goods Sold
Restaurants calculate the cost of goods sold separately for food and beverage. Food costs run an average of 30 to 35 percent of the retail price of the dish, while beverage costs are about 20 percent but can vary. For example, a glass of wine may have a cost of 35 percent, while a glass of iced tea could cost less than 10 percent of the retail price. An experienced restaurant owner knows the cost of each dish on the menu. If costs rise too much, the ingredients in the dish are adjusted, such as by reducing the proportion of higher cost ingredients, or the price is raised.
The expenses subtracted from the gross margin include depreciation and amortization as well as labor, general and administration expenses and facility costs to arrive at operating income. Depreciation and amortization are non-cash expenses. Calculating EBITDA gives a better picture of the cash the restaurant is generating than operating profit. The purchase of new equipment increases the depreciation expense. Comparing the EBITDA of two restaurants, one with older equipment and one with new equipment, gives a better picture of the operations than operating profit, which includes the effect of depreciation.
How the restaurant is funded -- the capitalization of the restaurant -- shouldn't be included in a comparison of two restaurants. Suppose one restaurant was started with a bank loan to convert the space to a restaurant, buy furniture and fixtures and provide working capital while the other restaurant was funded from the owner's savings. The interest expense is deducted to arrive at operating profit. There is no interest expense for the self-funded restaurant. Comparing the two operating profits isn't a true comparison of how successful the companies are from an operational standpoint.
The legal structure of the restaurant affects how taxes are paid. A restaurant that is a C Corporation pays taxes on net income. Restaurants that are S Corporations, Limited Liability Corporations, partnerships or owned by sole proprietors do not pay income taxes on net income. The owners of the restaurant reflect the restaurant's income in their personal tax returns. Comparing the net income of a C Corporation to an S corporation requires that the taxes be netted out of the analysis.
Brian Hill is the author of four popular business and finance books: "The Making of a Bestseller," "Inside Secrets to Venture Capital," "Attracting Capital from Angels" and his latest book, published in 2013, "The Pocket Small Business Owner's Guide to Business Plans."