13.3 Profit, contribution margin and EBITDA

In restaurant performance management, profit, contribution margin, and EBITDA help us understand whether the business is operating effectively. Imagine that we are running a small lemonade stand. We want to examine how much revenue we need to cover all costs and still have some money left over for ourselves.

1. What is contribution margin?

The idea:
Contribution margin is what remains from revenue after subtracting the direct cost of producing something, such as ingredients.

Analogy:
If you sell one glass of lemonade for ISK 100, and the lemons, sugar, and water cost a total of ISK 40 per glass, then your contribution margin is ISK 60 per glass. That ISK 60 is the amount available to cover rent for the stand, wages for helpful friends, and eventually generate some profit for yourself (Silverman, 2011).

Formula:
Contribution margin = Revenue − Direct cost

Here, revenue refers to total sales income, while direct cost refers to ingredients and packaging (Silverman, 2011).

2. What is profit?

The idea:
Profit tells us how much money remains after all costs have been paid, both direct costs, such as ingredients, and indirect costs, such as electricity, rent, and wages.

Analogy:
Once you have paid for lemons, sugar, water, rent for the stand, and even the coffee you drank while selling, whatever remains is yours. That amount is your profit (Baker & Baker, 2017).

Formula:
Profit = Sales revenue − (Direct cost + Indirect cost)

This is what we often refer to as net profit (Baker & Baker, 2017).

3. What is EBITDA?

The idea:
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. In other words, it is operating profit before deducting interest on loans, taxes, depreciation, and amortization.

Analogy:
Imagine that you did not have to pay rent on borrowed money, taxes, or account for the declining value of equipment. Then you would see how much the lemonade stand itself generated purely from operations (Bragi, 2018).

Why does this matter?

• It provides a clearer view of operating performance without various accounting items distorting the picture.
• It allows us to compare different businesses, even when their financing structures and tax conditions differ significantly (Bragi, 2018).

Formula:
EBITDA = Profit + Interest + Taxes + Depreciation + Amortization

This figure shows what the business generates from operations alone, regardless of how the company is financed or taxed (Bragi, 2018).

4. Benefits in restaurant operations

Looking at contribution margin per dish or beverage
To determine whether a menu item is profitable, we subtract the direct cost of ingredients from the selling price (Silverman, 2011).

This helps us decide whether prices should be adjusted or ingredients changed.

Monitoring profit to control expenses
When we know the net profit, we can see whether we are exceeding the budget or whether cost reductions are needed (Baker & Baker, 2017).

Using EBITDA for comparison
EBITDA allows us to compare restaurant operations even when some businesses pay higher interest or taxes than others (Bragi, 2018).

Profit per guest
To see which customers generate the most value, EBITDA may be divided by the number of guests (Baker & Baker, 2017).

If EBITDA is ISK 100,000 per month and 2,000 guests visited, then the profit per guest is ISK 50.

Example

You sell 500 lemonades per month at ISK 100 each.
Revenue = ISK 50,000

Ingredients cost ISK 40 per unit.
Direct cost = ISK 20,000

Rent and electricity cost a total of ISK 15,000.
Indirect cost = ISK 15,000

Profit = 50,000 − (20,000 + 15,000) = ISK 15,000

If interest, taxes, and depreciation total ISK 5,000, then:
EBITDA = 15,000 + 5,000 = ISK 20,000

Profit per guest (500 guests) = 20,000 / 500 = ISK 40 per guest