Understanding Actual vs. Theoretical COGS: A Guide to Maximizing Bar Profitability

In the competitive world of bar management, understanding your finances is crucial for success. One of the most significant factors influencing your bottom line is your Cost of Goods Sold (COGS). Understanding your COGS and its effects on your profitability is one of the best ways to gain critical insight into your bar’s operations and identify ways in which you can maximize your profitability. 

In this guide, we’ll walk you through exactly what COGS is, the difference between your actual and theoretical COGS, how it affects your bar’s profitability, how to calculate your theoretical and actual COGS, and how to utilize this information to forecast and grow your bar’s success.

Understanding Cost of Goods Sold (COGS)

What is COGS in Bar Management?

Cost of Goods Sold refers to the costs directly incurred with the making or producing of a product to be sold. In a bar this includes the costs of all ingredients used to make every drink served, such as the costs of the liquor, mixers, garnishes, cups, napkins, and any other necessary components.

COGS represents the total cost of inventory used during a specific period. Using your COGS, you can compare your actual and theoretical costs incurred in a period with the revenue that was generated from the sales within the same period. 

This comparison, usually presented as a percentage, can be used to understand your potential profit margins and assess your bar’s overall performance.

How COGS Affects Profit Potential

The reason COGS is such a critical factor in a bar’s profitability is because, unlike fixed overhead costs—such as utilities, taxes, and rent, which account for nearly 60% of your expenses—COGS is one of the few areas where you can actively make adjustments to optimize costs

With 60% of your revenue allocated to overhead costs, it’s essential to control the remaining 40%, which is split between your COGS and profit margins. It is a simple equation, the lower your COGS, the higher your profit margin can be. This is why optimizing your COGS is where the real opportunity to maximize your bar’s profitability lies.

Most bars operate with a COGS between 20-30%, which leaves a potential profit margin of 10-20%. To run a successful and profitable bar, you must aim to operate on the higher side of this margin. With such a narrow margin that is available, even a 5% optimization in your costs can have a significant impact on your bottom line.

The first step every bar owner should take when analyzing their COGS to improve profitability, is to ensure your actual costs are truly aligning with your desired margins. This means understanding the difference between your actual and theoretical COGS.

Theoretical Cost of Goods Sold

Theoretical COGS serves as a benchmark for costs under ideal conditions, meaning no waste, spillage, or theft occurs, and the bar operates at 100% efficiency. It represents what the cost of inventory should be based on what was sold over a specific time period. Also referred to as the Ideal COGS, theoretical COGS is a crucial metric for setting expectations and identifying inefficiencies in your bar.

To calculate theoretical COGS:

1. Calculate Theoretical COGS: Multiply the total sale by the cost per unit of your ingredients
2. Determine the COGS Percentage: Divide your theoretical COGS by total sales to determine the COGS percentage.

For example, if you sold 50 shots of vodka at 1 oz each, with a cost of $0.70 per shot, your theoretical COGS would be $35.

• 50 oz x $0.70/oz = $35 COGS

If these sales generated $175 in revenue, your COGS percentage would be 20%.

• $35 (COGS) / $175 (Total sales)= 20% COGS Percentage
  

How Theoretical COGS Affects Profitability

Theoretical COGS is directly linked to your bar’s maximum profit potential. Meaning if you are not happy with your potential profit margin, you will need to find ways to lower your COGS. The lower your COGS, the higher your profit margin can be. 

For example, if your bar’s theoretical COGS is 20%, you will have 80% left to cover overhead and generate profit. If your COGS decreases to 15%, you would then have 85% left over, which increases your profit potential. 

Optimizing Your Theoretical COGS

To maximize your profitability you will need to focus on keeping your COGS as low as possible, you can do this by focusing on two key factors:

• Cost of ingredients: explore all potential suppliers and see if you are getting the best deal; always be on the lookout for sales and take advantage of case discounts whenever they make sense for your business.

• Selling price: If ingredient costs cannot be lowered, consider revising your menu pricing to ensure you are maintaining your profitability. For more strategies on pricing, check out our article on how to effectively price your drink menu.

While theoretical COGS gives you data based on ideal conditions, it's still important to remember that no bar is actually running at 100% efficiency. It just isn’t possible. Spills, waste, and theft are all bound to happen at some point. However, if you use your theoretical COGS as your goal, you will be able to track where inefficiencies are occurring and identify areas where you can minimize losses and optimize operations to ultimately boost your profitability. 

Actual Cost of Goods Sold

Actual COGS reflects the true costs incurred in your daily bar operations. Unlike theoretical COGS, which represents ideal conditions, actual COGS accounts for all real-world factors, such as waste, spillage, and theft. It represents the cost of inventory used over a specific time period, and takes into account losses from waste, spillage, or theft. This means it provides a more accurate picture of what costs were actually incurred to generate revenue.

By analyzing your actual COGS, you can understand how your actual expenses are affecting your profitability. 

To determine your actual COGS:

1. Determine Actual Usage: Opening Inventory + Purchases – Ending Inventory = Actual Usage.
2. Calculate Actual COGS: Multiply the actual usage by the cost per unit of your ingredients
3. Determine the COGS Percentage: Divide your actual COGS by total sales to determine the COGS percentage.

For example, if you start with 45 oz of vodka, purchase an additional 26 oz, and end with 15 oz, your actual usage is 56 oz.

• 45 oz(opening inventory) + 26 oz(purchase) - 15 oz(ending inventory)= 56 oz Actual Usage

At a cost of $0.70 per oz, your actual COGS is $39.20 

• 56 oz (actual usage) x $0.70 (cost per unit) = $39.20 Actual COGS

If your total sales during this period amount to $175, your actual COGS percentage is 22.5% 

• $39.20 (COGS) / $175 (Total Sales) = 22.5% COGS Percentage
  

Actual COGS directly impacts your profitability. From the example above we can see that although your theoretical COGS is 20%, your actual COGS is 22.5%, meaning that you are overspending on ingredients by 2.5%, which led to a profit loss of $4.80. 

• $39.20 (actual COGS) - $35 (theoretical COGS) = $4.80 additional cost

This shows how waste, spillage, or other inefficiencies are reducing your potential profit.

Reducing Actual COGS

Monitoring and managing actual COGS is critical for improving financial performance. The goal should always be to minimize the gap between your theoretical and actual COGS to maximize your profitability. 

Here are a few ways to reduce actual COGS:

• Track and Reduce Waste:  Implement better waste tracking practices, such as writing it in a notebook, tracking it on your POS, or using inventory software. Encourage staff to use precise pour measures, if overpours become a large problem consider using a liquor control system. Always monitor any discrepancies closely to find the cause of the issue, so that you can find a solution.

• Investigate Theft: Theft can occur in various ways, such as staff giving away unauthorized free drinks or substituting expensive and cheaper liquors. Even intentionally overpouring can be considered theft. Ensuring that inventory is properly monitored and regularly audited to detect any theft, either by staff or customers is key to reducing COGS.

• Optimize ordering:  Avoid over-purchasing by ordering based on sales trends, and implement a FIFO (First In, First Out) inventory system to minimize stock loss.

Actual COGS provides a real-time view of your bar’s inventory costs, factoring in inefficiencies like waste and theft. By calculating your Actual COGS regularly, you can identify problem areas, make improvements, and lower costs to improve your bottom line. 

Key Differences Between Actual and Theoretical COGS

When to Use Each Method

Utilizing both theoretical and actual COGS is essential for effective business planning and reporting. Each serves a distinct purpose that can enhance your operations and profitability.

Theoretical COGS should primarily be used for planning and forecasting. Because it is based on ideal conditions, it provides a valuable baseline for understanding potential costs and revenues. By analyzing theoretical COGS, you can identify trends that highlight what works and what doesn’t within your operations. This insight allows you to set realistic goals, make informed predictions about future performance, and devise strategies to optimize your business processes.

On the other hand, actual COGS is crucial for reporting, budgeting, and making operational decisions. Since actual COGS reflects real data, it accurately demonstrates your business's performance over a specific period. This information is essential for inventory reporting and financial assessments, as it reveals how effectively you are managing your resources. Additionally, using actual COGS in budgeting helps you create a more accurate financial plan for the next period, allowing you to identify areas for improvement or adjustment to drive profitability.

In summary, while theoretical COGS offers insights for strategic planning, actual COGS provides the concrete data necessary for operational decisions and performance evaluations.

Actual Vs. Theoretical COGS = Variance: Your key to profitability

While theoretical and actual COGS are both important factors to consider on their own, comparing them to each other is where the real opportunities to increase your bar's profitability lie. By observing the difference between your actual COGS and your theoretical COGS you will be able to identify exactly how much potential profit is being missed out on, and where these inefficiencies are coming from. 

This difference between the theoretical and actual COGS is called variance. Eliminating or at the very least minimizing this variance is one of the most effective ways that you can maximize your profitability. By setting realistic goals using your theoretical COGS, reducing inefficiencies with your actual COGS, and utilizing the insights received from your variances you can significantly increase your bottom line. 

For a deeper dive into variances and how they affect your bar’s profitability, look into our article about understanding variances.

Unlocking Profitability through COGS Optimization

In conclusion, the real opportunity to maximize your bar’s profitability lies in understanding the difference between your theoretical and actual Cost of Goods Sold (COGS). The key is not just in tracking these figures, but in using them to actively identify inefficiencies and areas for improvement.

Optimizing your COGS isn’t just about cutting costs—it’s about finding the right balance between managing expenses and maintaining quality. By focusing on areas like ingredient sourcing, portion control, and staff training, you can improve your efficiency and reduce unnecessary losses. Even small adjustments, such as negotiating better supplier prices or reducing over-pouring, can have a significant impact on your bottom line.

Remember, this process is ongoing. By continually monitoring both your theoretical and actual COGS, you can make data-driven decisions that drive profitability and help ensure your bar runs efficiently. Minimizing the gap between ideal and real costs is a step toward building a more sustainable and profitable business.

Start tracking your COGS today, and take action to optimize costs while maximizing revenue. With consistent monitoring and careful management, you can turn your COGS data into one of the most powerful tools for your bar’s long-term success.