Lesson 3: Calculating a “Cost of Goods”
To make money in the coffee business, you must control “cost of goods,” along with all your other expenses, and you must also increase sales. For this and the next month’s article we’ll concentrate on cost of goods, also referred to as your “cost of sales.”
To put it simply, cost of goods (COG) is the money you spend on beverage and food ingredients, paper & chemical products, and retail merchandise. COG is usually analyzed monthly as a percentage of the sales those items create. For example, if you generate $30,000 in sales for a month, and use $10,000 of those items to create your sales, then your COG represents 33.33% of sales ($10K ÷ $30K = .3333 or 33.33%). Most profitable coffee businesses maintain a COG between 30% & 35%. This means that 30¢ to 35¢ out of every dollar earned in sales, will go back to pay for consumable products, a significant portion of your revenue!
Items included in your cost of goods calculations are: beverage and food ingredients, ready-to-serve beverages and food items (bottled beverages, pastries from the bakery, etc.), paper and plastic goods (cups, lids, Java Jackets, napkins, trash bags, cellophane wrap, etc.), cleaning chemicals, and retail merchandise (including whole bean coffees to be sold by the bag or pound).
To calculate your COG, you’ll need to count all the consumable ingredients left on your shelves after you close for business on the last day of the month. You will then need to multiply the total number of each item by its corresponding cost (what you paid for it), and then add together all the item totals. This will provide you with the dollar value of your month-end inventory. Your ending inventory dollar value will also be the value of your inventory the next morning, (your beginning inventory for the following month). Next, you’ll need to record the dollar value of all the consumable products you purchase over the following month. And finally, at the end of that month you’ll need to take another store inventory. With this information in hand, simply run the numbers through the cost of goods formula, which is:
Cost of Goods Formula
When you have generated your COG as a percentage of sales, the next question you need to ask yourself is: is this a good number, or a bad number? To answer this question, you’ll need to determine your “ideal cost,” which is what your COG should have been if it were a perfect world. In other words, if you experienced absolutely no waste, over-portioning, unauthorized employee consumption, or theft, what would your cost of goods be as a percentage of sales?
To determine your ideal cost, you’ll need to calculate the exact cost for every item you serve from your menu, in all sizes. As you determine the ingredient cost for each item, be sure to use the most current prices you paid for those ingredients. Then at the end of the month, record how many of each item was sold, multiply the total of each item by its perfect cost, and then add together all the extended totals. This will represent the dollar value of product that should have been used… if it were a perfect world. Divide that number by your actual sales to see your cost as an ideal percentage. (If your ideal cost ends up being over 35%, then it’s a good indicator that your prices probably need to be increased.)
Now, simply compare the two numbers: your actual COG% vs. your ideal COG%. Understand that you should never actually achieve or come under your ideal percentage. This would require never making any mistakes in preparation or portioning, never losing any product to waste, spoilage or employee consumption, which of course is impossible! What becomes important is the variance between your actual and ideal percentages.
Years ago, when I worked in the corporate restaurant industry, a variance of 1% to 1½% was considered normal, and acceptable. So, if you generated sales of $45K in a month ($1,500 per day), a loss of product valued at $450 to $675 would be expected ($15 to $22.50 per day). This may seem like a lot of money slipping away, and it is, but when you consider the scalded pitcher of milk, the two drinks left over at the end of the rush, the five day-old pastries you had to dispose of, and the two pots of drip coffee your employees dumped because the holding time had expired, it becomes more understandable.
What you need to be on the look out for is a huge deviance from you ideal cost. What if you are 6% over your ideal? In the above example this would represent a monthly loss of product of $2,700 or $90 a day! At this point you would know you have problems far beyond a few erroneously prepared drinks, and a scalded pitcher of milk!
Sadly, some coffee businesses are running a COG 5%, 7% or even 10% over what would be ideal, but the owners don’t even know that they have a problem. They might not be able to pay themselves, yet $2K, $3K, or more is hemorrhaging from their business every month. You have to calculate the numbers to know where you are at, and to determine if you have a problem!
Next month we will examine why your COG might be inflated, and how to fix those problems.
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