The manager of the restaurant believed "picaninny" meant "the first light of the day" and was not a derogatory term.
But Indigenous community members say it literally means small child, usually with dark skin, and in Australia is used in a derogatory context.
Djon Mundine is an arts consultant and was critical of the term's use. "It's really demeaning, and I don't know why you would use that in this day and age," he said.
"Foreign people will come here and see that and think that they can use the word 'picaninny' or 'abo' or 'coon' or whatever, and it's not ok."
When surveyed, some Aboriginal Sydney residents were shocked at the use of the term, after not hearing it for decades.
Rebecca, who was at Pancakes on the Rocks said, "I think our society has accepted the idea that that language is unacceptable. We try to teach our own children not to speak or think that way."
"To have a commercial chain have that on their menu ... not much needs to be said," Rebecca said.
"Pancakes on the Rocks" said they did not realise there would not be a problem with the name being on the menu, but after receiving many complaints from overseas visitors, they chose to remove it.
