What it means
In manufacturing accounting, prime costs combine direct materials and direct labour. Direct materials are the items that become part of the finished product, like flour in bread, and direct labour is the pay of workers who make it.
Both can be traced to specific units, unlike overheads that are shared across the business. Prime costs are the first layer of total product cost.
Adding manufacturing overheads gives the conversion cost, and adding all production costs gives the full cost of the item. Looking at prime costs on their own helps managers see the part of cost they can influence most directly through purchasing, recipes, scheduling and productivity.
The concept is particularly popular in restaurants and food businesses. There it usually means the cost of food and drink plus staff pay, and owners track it as a percentage of sales.
A commonly quoted target is somewhere around 60% to 65% of revenue, though the right level depends on the type of business. A rising prime cost percentage is an early warning sign.
It can mean ingredient prices are up, waste is increasing, wages are growing faster than sales, or portions are too generous. Because the figure is quick to calculate, many owners review it weekly.
A nuance is that definitions vary slightly between industries. Some businesses include direct expenses such as packaging or subcontractors, while others do not.
Whatever definition is chosen, it should be applied consistently so that trends mean something. Prime costs also help with pricing decisions.
If a dish or product has prime costs of $6 and the owner wants prime costs at about 35% of the selling price, the target price is 6 / 0.35, which is roughly $17. This keeps the focus on the part of cost the business controls.
In practice
Real-world examples
Example 1
A furniture workshop makes oak tables. The wood, fittings and the carpenters' hours spent on each table are its prime costs, while the rent of the workshop is an overhead. The owner uses prime cost per table to set minimum prices. If a table needs $180 of oak and 6 hours of labour at $25 an hour, its prime cost is 180 + 150 = $330, so no quote goes out below that figure.
Example 2
A restaurant manager totals the monthly food bill and kitchen and waiting staff wages. Prime costs come to $58,000 against sales of $90,000, or about 64%. She reviews the menu and rota to bring the figure down. A change of just two percentage points would add $1,800 of monthly profit.
Example 3
A clothing manufacturer notices that fabric prices have risen 8% while production hours are unchanged. The finance team recalculates prime cost per garment and raises wholesale prices to protect the margin.
Think of it
Think of prime costs like the ingredients and the chef's hourly pay when cooking a meal at a restaurant. You cannot serve the dish without the raw food and the cook, making these the absolute baseline expenses of the plate.
Formula
Calculation
Prime costs = direct materials + direct labour; prime cost percentage = prime costs / revenue x 100
Suppose a bakery has revenue of $200,000 in a quarter. It spent $30,000 on flour, butter and other ingredients and $45,000 on the wages of bakers. Prime costs are 30,000 + 45,000 = $75,000. The prime cost percentage is 75,000 / 200,000 = 0.375, or 37.5%, leaving $125,000 to cover overheads and profit.Case study
Seen in the real world
Saltmarsh Kitchen is an illustrative, fictional restaurant that was busy every night but barely making a profit. The owner tracked sales but never calculated prime costs, assuming that the crowded dining room meant things were going well.
When the accountant calculated the figure, food and drink cost $41,000 and kitchen and service labour cost $39,000 against monthly sales of $110,000. Prime costs were $80,000, or 72.7% of sales, far above the owner's target. By trimming over-generous portions, cutting waste and adjusting the rota to match demand, the illustrative result was a fall to 66% within three months.
The owner now reviews the prime cost percentage every Monday using the previous week's figures. The illustrative lesson was that a busy dining room is not the same as a profitable one, and a simple weekly ratio revealed the difference.
Watch out
Common mistakes
- Including rent, utilities and administration salaries in prime costs, when these are overheads.
- Ignoring labour and tracking only materials, which hides a big share of the true cost.
- Changing the definition from month to month, which makes trends impossible to compare.
Questions
People also ask
Are prime costs the same as cost of goods sold?
Not exactly, since cost of goods sold may also include manufacturing overheads, while prime costs cover only direct materials and direct labour.
What is a good prime cost percentage?
It depends on the industry, though many restaurants aim for roughly 60% to 65% of sales.
Can prime costs be used for service businesses?
Yes, if you treat the direct labour and any directly consumed materials for each job as the prime cost.