Lesson 1: Understanding Profitability
Over the next several months we will examine the conditions, variables, and actions that are necessary for generating a profit from your retail Specialty Coffee Business.
While only three factors are important to your customers:
1. product quality, 2. customer service, and 3. store ambiance, you’ll need to control numerous other variables to yield a profit. Before we discuss these variables in future articles, I thought it might prove useful to talk about profitability in general, what it is, and how it is generated.
To put it simply, profit is the money that is left over from your sales after you have subtracted all the costs and expenses related to those sales. When I speak of costs, I’m referring to your “cost of goods” (COG), the dollar value of ingredients and packaging that were used to produce your sales. Most profitable coffee businesses will run a combined cost of goods somewhere between 32% and 38% of total sales. In other words, 32¢ to 38¢ out of every dollar of sales you earn will go back to pay for ingredients & packaging.
After this cost has been subtracted from sales, the income that remains is referred to as you “gross profit on sales.” All other expense must then be subtracted from your gross profit to determine your actual bottom-line profit or loss. Other expenses includes such things as employee and management labor, payroll taxes, rent, insurance, repairs and maintenance, utilities, small wares, bank charges and credit card fees, etc. If there is money left over after subtracting all these expenses, you were profitable! However, if there isn’t enough money to pay all your expenses, and yourself, then you lost money.
So, if you aren’t making any money, then why is profit eluding you? Lack of profitability can be attributed to a couple of reasons: 1. excessive costs and expenses, and/or 2. lack of sales. While there is always room to tighten-up on spending, lack of sales is the culprit responsible for most business failures.
It’s important to understand that a certain level of sales will be necessary to make money. What that level is, will be determined by the unique conditions associated with your business; i.e. average purchase per customer, the number of customers that visit your business each month, and your cost of goods and expenses. In reality, even an inexperienced owner who is making some mistakes may find that it is impossible to not make a profit if their sales are great enough. And, conversely, a very experienced, seasoned owner may find that it’s impossible to make a profit if sales are anemic. If you own a typical sit-down coffee café, the following chart shows the profitability you might expect at various levels of sales.
Understand that your cost of goods should not change much as a percentage of sales as your sales grow. For example, if you generated $10,000 in sales last month, and used $3,500 in product to produce those sales, then your cost of goods was 35% ($3,500 ÷ $10,000 = .35 or 35%). Therefore, if you generate $100,000 in sales next month, you should expect that your cost of good will remain around 35%, or you should use about $35,000 in ingredients. Obviously, what also increases as sales increase is the gross profit that’s leftover after you subtract your cost of goods from sales. In the above example, your gross profit would increase from $6,500 on $10,000 of sales ($10K – $3,500 COG = $6,500), to $65,000 from $100,000 in sales. This would provide you with a lot more money with which to pay expenses, yourself, and a lot more would be left over as profit. I’m not suggesting that if your current monthly sales are only $10,000 that you should expect to be able to increase them to $100,000, but it does illustrate the effect higher sales has on profitability.
What’s exciting is that as sales grow, profit grows exponentially! In other words, your profit will grow at a faster rate than sales. For example, if your sales double, your bottom-line profit might increase by 2 ½ to 3 times. This happens because most expenses won’t increase by the same percentage as your sales growth, and some expenses won’t increase at all. Expenses like labor, payroll taxes, laundry and uniform, employee meals, and credit card fees might increase slightly. However, fixed expenses such as rent, insurance, loan payments, licenses and permits, etc. won’t increase at all. So to put it simply, build sales and profit will blossom!
Ed Arvidson is a 25-year veteran consultant to the Specialty Coffee industry, and President of E&C Consulting. Elements of this article are from his new book, “How to Get Profitable in the Coffee Business.” www.coffeebizhelp.com
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