I am ambivalent about the positive and negative aspects of manual brewing other than it's value as a profit centre which meets a consumer demand. I am concerned that many of those who advocate manual brewing are supplying a product in the hope customers buy, instead of producing a product the customers demand. That being said, I want to examine the unique costing that applies to manual brewing so that coffee shop owners might determine whether it is right for them.
For this costing, I will use a tool that many of you are using, the excellent Intelligentsia app for iphone, and focus on the pour over method.
For this we need:
28g of whole bean coffee which I will assume $10/lb wholesale cost
V60 Dripper
V60 filter Cost $0.065
Hario Kettle or Similar
Burr Grinder
Digital Scale
Vessel to brew into
While the prescribed brew time is 2.5 minutes, I am assuming a total prep and brew time of 7.5 mins. Prep time includes water boil, coffee weighing and grinding, filter pre wash, and brew.
The costing looks something like this:
Bean Cost
454g/28g =16.21
$10 (bean cost)/ 16.21 = $0.62
Filter Cost
= $0.065
Labour Cost (Using my local minimum wage for barista's $10.25)
$10.25 x 1.15(payroll tax) = $11.78
7.5 mins/ 60mins = .125
$11.78 x .125 = $1.47
Cup and Lid (if needed)
$0.25
Cost of Goods Sold (COGS)
$0.62 + $0.065 + $0.25 = $0.935
Total Cost
0.62 + 0.065 + 1.47 + 0.25 = $2.405
I am going to try to work out a retail price using a couple of different methods.
First Method:
I have stated a couple of times in this blog that an excellent target for labour is 20-30% of revenue. I am going to ignore the fact that while one person is preparing the pour over, that revenue also needs to partially cover the cost of the labour required to take the order and only focus on the single barista. If I use the 20-30% guideline, then the retail cost should be between $1.47 X 3.33= $4.90 and $1.47 x 5 = $7.35
If we back out cost we can figure out the contribution each pour over makes to General and Administration by doing the following:
$4.90 - 2.405 = $2.495
$7.35 - 2.405 = $4.945
Second Method:
If we use a typical gross profit margin of .70 to calculate a retail price
$0.935 / 30 x 100 = $3.11
If we subtract labour cost from this number we get,
$3.11 - $1.47 = $0.707
From this calculation $0.707 represents the contribution each pour over would make to G&A costs and hopefully some profit.
Third Method:
Using a guideline for labour productivity and revenue per employee hour of $50, and the fact that a barista can do 8 pour overs per hour at 7.5mins per pour, we can calculate how much money we need to charge to hit the target.
$50 / 8 = $6.25
Contribution G&A = $6.25 - $2.405 = $3.845
While I don't profess to know all of the variables present in anyone else's coffee shop, I definitely think that these figures represent an excellent guideline for pricing your pour over. Remember that my labour calculation does not include labour required to take the order, or any management/back office labour. Given the increased labour cost associated with manual brewing, calculating based on gross margin is likely a mistake. Conversely, because labour is so high, applying high labour ratios to manual brewing likely prices it beyond any demand curve. A calculation based on overall labour productivity seems to yield more predictable pricing, and permits increased profit or more approachable pricing by increasing the efficiency of the barista.
In general, I think it's safe to conclude that if you are pricing your pour over coffee under the $4.00 mark, you should take a very hard look at your numbers.
I am including a quote from a recent article in Esquire Magazine by Todd Carmichael "375 cents (n) — An insane amount to pay for any single cup of coffee, unless of course one is at the foot of the Spanish Steps and in the company of a potential sexual partner above one's standing. If in Brooklyn, however, see also: Nigeria scam; bridge for sale."
While I acknowledge the article causes a great deal of negative reactions from those prone to comment, it is none the less valid and typical of most coffee consuming public. The problem is, price your pour over under $4 and you risk losing money, price it higher and you risk offending customers.
Try using some of the methods I've suggested and plug in your own numbers to determine whether pour overs are contributing to your profitability or even covering costs.
Wednesday, January 26, 2011
If You're in the Driver's Seat, Drive the Right Bus
Checking the responses to my quick poll about the biggest challenges you face as an owner or manager it is clear some of you are having difficulty with Controlling Costs, and others Generating Revenue. It struck me today that the two problems require the owner to be in two different places in order to best solve the problem.
First, Generating Revenue is normally associated closely to marketing, promotion and a host of other factors which are tied to your geographic location. Generating Revenue is best solved by the physical presence of the owner who can observe, tinker, chat and shake hands. These types of observations aren't produced by customer counts or staff reports but are instead experienced first hand. Customers respond to the owner in a very different way than they do employees, and are willing to share suggestions with you rather than a staffer. If generating revenue is your main problem, get out on the floor and behind the counter.
Controlling Costs, while there is an observational component, is mostly done behind a desk with meticulous review of costing, ratios and an intricate knowledge of your Financial Statements. The type of waste and loss generated by employees is best observed by management, and followed up by the senior management or owners. The real cost controls are a result of comparing supplier costs for such mundane items as mobile phones, land lines, paper products, milk suppliers and trucking. Today I discovered after speaking with my milk supplier about a cost increase, that local grocery stores are selling milk cheaper than wholesale price in a long standing price war. The savings by purchasing retail rather than wholesale represents over $750 per month. If controlling costs is your main problem, get behind your desk.
First, Generating Revenue is normally associated closely to marketing, promotion and a host of other factors which are tied to your geographic location. Generating Revenue is best solved by the physical presence of the owner who can observe, tinker, chat and shake hands. These types of observations aren't produced by customer counts or staff reports but are instead experienced first hand. Customers respond to the owner in a very different way than they do employees, and are willing to share suggestions with you rather than a staffer. If generating revenue is your main problem, get out on the floor and behind the counter.
Controlling Costs, while there is an observational component, is mostly done behind a desk with meticulous review of costing, ratios and an intricate knowledge of your Financial Statements. The type of waste and loss generated by employees is best observed by management, and followed up by the senior management or owners. The real cost controls are a result of comparing supplier costs for such mundane items as mobile phones, land lines, paper products, milk suppliers and trucking. Today I discovered after speaking with my milk supplier about a cost increase, that local grocery stores are selling milk cheaper than wholesale price in a long standing price war. The savings by purchasing retail rather than wholesale represents over $750 per month. If controlling costs is your main problem, get behind your desk.
Tuesday, January 25, 2011
Repayment of Capital Investments
Knowing and understanding our Financial Statements is vital to developing an appreciation of where your business value is currently and where it is headed.
When we look to start a business there is typically an investment made either using personal wealth, or more often borrowed money with the expectation of future profits. Sometimes this equals a substantial amount of money, mostly applied to equipment or leasehold improvements, and sometimes the purchase of another business. These assets are organized in the balance sheet under the heading Long Term or Capital Assets, and conversely, Long Term Liabilities for the outstanding loan amount. (Don't forget that the Long Term Assets value are depreciated by about 20% per year as their usefulness is consumed.)
Any coffee shop owner would hopefully understand that this capital investment needs to be repaid, and therefore any net profit is not in truth profit, but a repayment of capital until the debt is settled. In most cases this period of repayment equals 4-5 years which coincidentally is the same period of time over which the value of the investment nets to zero through depreciation. Usually we have paid monthly for 4-5 years and in the end we have zero value on the balance sheet to show for our investment except a great deal of depreciation. But all is not lost as this is the time where the assets fully return all of the profit to the company rather than servicing a loan and is the most important time in a business cycle. Given careful and attentive servicing, most well purchased equipment and leaseholds can continue to deliver utility beyond their cycle of depreciation.
Do not fall into the trap of replacing perfectly functional equipment and putting yourself back on the repayment treadmill. If your competitive advantage is tied to exhibiting the latest equipment, you have put your coffee shop in a similar situation as a pharmaceutical company that needs to spend constantly on research or risk precipitous drops in revenue. By necessity these business models require constant investments of capital that either carry interest payments, or rob owners of personal net profit.
If we fully comprehend the literal meaning of Repayment of Capital Investments, it is clear that the money spent initially was an investment and not a cost of doing business. We all know that an investment is a wise one if and only if it makes us more money than we spent. Those of us with investment accounts vested in various Stocks can quickly glance at our monthly statements and determine the present value of money invested and make a determination of whether our advisor knows what he/she is doing. As a coffee shop owner, apply the same critical values to your investment in capital expenses. If you are as rigorous with business investments as you are with personal, you will come to the conclusion that the investment only returns value once it has been paid for and that the most prudent path for future capital investments is to pay for them with past savings rather than future profits. Remember: Keep Capital Investments employed beyond the repayment period!
When we look to start a business there is typically an investment made either using personal wealth, or more often borrowed money with the expectation of future profits. Sometimes this equals a substantial amount of money, mostly applied to equipment or leasehold improvements, and sometimes the purchase of another business. These assets are organized in the balance sheet under the heading Long Term or Capital Assets, and conversely, Long Term Liabilities for the outstanding loan amount. (Don't forget that the Long Term Assets value are depreciated by about 20% per year as their usefulness is consumed.)
Any coffee shop owner would hopefully understand that this capital investment needs to be repaid, and therefore any net profit is not in truth profit, but a repayment of capital until the debt is settled. In most cases this period of repayment equals 4-5 years which coincidentally is the same period of time over which the value of the investment nets to zero through depreciation. Usually we have paid monthly for 4-5 years and in the end we have zero value on the balance sheet to show for our investment except a great deal of depreciation. But all is not lost as this is the time where the assets fully return all of the profit to the company rather than servicing a loan and is the most important time in a business cycle. Given careful and attentive servicing, most well purchased equipment and leaseholds can continue to deliver utility beyond their cycle of depreciation.
Do not fall into the trap of replacing perfectly functional equipment and putting yourself back on the repayment treadmill. If your competitive advantage is tied to exhibiting the latest equipment, you have put your coffee shop in a similar situation as a pharmaceutical company that needs to spend constantly on research or risk precipitous drops in revenue. By necessity these business models require constant investments of capital that either carry interest payments, or rob owners of personal net profit.
If we fully comprehend the literal meaning of Repayment of Capital Investments, it is clear that the money spent initially was an investment and not a cost of doing business. We all know that an investment is a wise one if and only if it makes us more money than we spent. Those of us with investment accounts vested in various Stocks can quickly glance at our monthly statements and determine the present value of money invested and make a determination of whether our advisor knows what he/she is doing. As a coffee shop owner, apply the same critical values to your investment in capital expenses. If you are as rigorous with business investments as you are with personal, you will come to the conclusion that the investment only returns value once it has been paid for and that the most prudent path for future capital investments is to pay for them with past savings rather than future profits. Remember: Keep Capital Investments employed beyond the repayment period!
Saturday, January 22, 2011
Tenant Allowance (Landlord Contribution)
I've alluded to this in a couple of posts relating to negotiating a lease, and controlling costs but I felt it required a post of it's own given the considerable funds that can be saved.
When negotiating a lease it is customary to ask the landlord for a tenant allowance in order to make changes and alterations to the space and make it more suitable for cafe use. A tenant allowance is normally valued at certain value per square foot/metre and is negotiable. Using a figure of 10-20% of the total value of the lease over 5 years is a good rule of thumb. I have been fortunate enough to benefit from $30 per square foot allowance adding up to over $32,000 on one build.
For example:
Let's say I'm looking at a 1000 square foot space that costs $20 per square foot plus $5 in CAM costs. The space costs me $25,000 per year in rent multiplied by 5 years = $125,000. Using this as a guideline, it is not unreasonable to ask for $12,500-25,000, or $12.50-$25 per square foot in tenant allowance.
Some landlords are extremely frugal in offering an allowance and in these cases it is best to walk away from the space. Recently I was informed that Starbucks received a $75 per square foot tenant allowance on a new build in Canada. (I don't want to be more specific because the info is confidential and could get my buddy in trouble) For a typical 1000 square foot build, that equals a contribution of $75,000 to improving the space for use. Anyone who has undertaken a new build understands how far 75k goes, and is a significant advantage weighing in Starbucks favour when trying to compete with them.
Chain wide the allowance granted to Starbucks is huge and could represent a $1,500,000,000 off balance sheet gift to the company. Given these depreciating assets are not paid for by Starbucks they are not on their balance sheet, certainly something to be concerned about if you're an investor in SBUX.
Remember the importance of reducing the depreciable assets appearing on your balance sheet (SBUX has), since it usually represents a 20% loss per year on your income statement, and having a healthy income statement is how your make money.
When negotiating a lease it is customary to ask the landlord for a tenant allowance in order to make changes and alterations to the space and make it more suitable for cafe use. A tenant allowance is normally valued at certain value per square foot/metre and is negotiable. Using a figure of 10-20% of the total value of the lease over 5 years is a good rule of thumb. I have been fortunate enough to benefit from $30 per square foot allowance adding up to over $32,000 on one build.
For example:
Let's say I'm looking at a 1000 square foot space that costs $20 per square foot plus $5 in CAM costs. The space costs me $25,000 per year in rent multiplied by 5 years = $125,000. Using this as a guideline, it is not unreasonable to ask for $12,500-25,000, or $12.50-$25 per square foot in tenant allowance.
Some landlords are extremely frugal in offering an allowance and in these cases it is best to walk away from the space. Recently I was informed that Starbucks received a $75 per square foot tenant allowance on a new build in Canada. (I don't want to be more specific because the info is confidential and could get my buddy in trouble) For a typical 1000 square foot build, that equals a contribution of $75,000 to improving the space for use. Anyone who has undertaken a new build understands how far 75k goes, and is a significant advantage weighing in Starbucks favour when trying to compete with them.
Chain wide the allowance granted to Starbucks is huge and could represent a $1,500,000,000 off balance sheet gift to the company. Given these depreciating assets are not paid for by Starbucks they are not on their balance sheet, certainly something to be concerned about if you're an investor in SBUX.
Remember the importance of reducing the depreciable assets appearing on your balance sheet (SBUX has), since it usually represents a 20% loss per year on your income statement, and having a healthy income statement is how your make money.
Wednesday, January 19, 2011
Determining Labour Productivity
Labour is a huge component of our costs associated with running our coffee shop and a major headache for most operators. As I noted in my Page Post on Income Statements , an excellent target for labour cost is 20-25% of gross revenue to be spent on labour. A useful way of calculating labour cost over short periods of time is to calculate the Per Person Hour Revenue for each period by dividing the daily/weekly sales by the number of staff hours recorded for the same time period. A great time to do this is when you are preparing payroll, which for us is every 2 weeks. For example:
Let's say our coffee shop is open from 7am-7pm and revenue for the day is $1000. We have 2 staff working at all times and so our total number of hours booked is 12 hours x 2 staff = 24 hours.
Next we divide $1000/24 = $41.66
This number represents the dollar value each employee sells in a given hour and a number of $40-$50 per hour per staff is excellent.
We can also use the per hour wage to determine whether we are close to our goal of 20-25% for labour. In Ontario our minimum wage is $10.25/hour plus approximately $.50/hr payroll tax and therefore dividing $10.75/$41.66= .258% which is just outside our target. This is not difficult math but provides us with very quick numbers which will assist you in controlling your labour cost. Keep your labour cost below 25% and you have an excellent chance of success.
Knowing your Labour Productivity cold is critical if you are considering adding labour intensive manual brewing (Read Jason Dominy's post about manual brewing) into your coffee bar. Measure and memorize your productivity before and after introducing manual brewing so you can make a business decision about it's value to your business, and not an emotional one based on the latest trends.
Let's say our coffee shop is open from 7am-7pm and revenue for the day is $1000. We have 2 staff working at all times and so our total number of hours booked is 12 hours x 2 staff = 24 hours.
Next we divide $1000/24 = $41.66
This number represents the dollar value each employee sells in a given hour and a number of $40-$50 per hour per staff is excellent.
We can also use the per hour wage to determine whether we are close to our goal of 20-25% for labour. In Ontario our minimum wage is $10.25/hour plus approximately $.50/hr payroll tax and therefore dividing $10.75/$41.66= .258% which is just outside our target. This is not difficult math but provides us with very quick numbers which will assist you in controlling your labour cost. Keep your labour cost below 25% and you have an excellent chance of success.
Knowing your Labour Productivity cold is critical if you are considering adding labour intensive manual brewing (Read Jason Dominy's post about manual brewing) into your coffee bar. Measure and memorize your productivity before and after introducing manual brewing so you can make a business decision about it's value to your business, and not an emotional one based on the latest trends.
Monday, January 17, 2011
Negotiating a Lease Part 2
I wanted to provide an important update to my Negotiating a Lease post. The inspiration for this was provided by an old friend who suggested I structure a new lease offer differently in order to reduce depreciable long term assets in the form of leasehold improvements on the balance sheet in favour of rent which is expensed. The math goes like this:
Lets say we're looking at leasing a 2000' space for $20 per square foot and the space requires $100,000 in leasehold improvements. The rent on this space would equal $40,000 per year. If we're working from a 5+5 year lease, the improvements represent $5 per square foot over the course of 10 years. As mentioned in my first post on Negotiating a Lease, landlords sometimes offer tenant allowances for leasehold improvements and in this case asking for a $50 per square foot allowance covers the improvements. This is relevant because having the landlord pay for the improvements allows us to keep it off our balance sheet as a long term asset which we must depreciate over 5 years. By paying a little bit more per month over 10 years, you have effectively financed your build, avoided having long term debt and long term assets on the balance sheet, and instead structured it as an expense that reduces our tax at the end of the year.
Win, win, win.
Lets say we're looking at leasing a 2000' space for $20 per square foot and the space requires $100,000 in leasehold improvements. The rent on this space would equal $40,000 per year. If we're working from a 5+5 year lease, the improvements represent $5 per square foot over the course of 10 years. As mentioned in my first post on Negotiating a Lease, landlords sometimes offer tenant allowances for leasehold improvements and in this case asking for a $50 per square foot allowance covers the improvements. This is relevant because having the landlord pay for the improvements allows us to keep it off our balance sheet as a long term asset which we must depreciate over 5 years. By paying a little bit more per month over 10 years, you have effectively financed your build, avoided having long term debt and long term assets on the balance sheet, and instead structured it as an expense that reduces our tax at the end of the year.
Win, win, win.
Sunday, January 16, 2011
Raising Capital
There are many reasons a coffee company may wish to raise money including purchasing new equipment, opening a new location, purchasing another company or expanding the business in another way. If you are looking to raise capital to support a failing business, stop right now and remember the old adage, "when you find yourself in a hole...stop digging". If this is the case, please read my post on Controlling Costs. It is my opinion that using your accumulated profits to fund growth is the best way forward but here are some other options if this is not possible.
When raising funds the first place a business owner would think to look is the bank where your daily deposits go. This is a great place to start given your account manager can quickly access your account to determine consistency of deposits and net change in cash position on a monthly basis. Getting a loan from your financial institution comes with standard repayment terms and rest assured that they don't want to run or seize your coffee business, they just want to be paid on time. Interest paid on financed debt is deductible before taxes, and is on the whole a less expensive option than issuing Equity. The problem with banks and other financial institutions is they are fickle and prone to turning off the tap if they themselves are facing difficulty. The credit crisis of 2008 to present is a great example where money went from being abundant to scarce overnight. During this period, most businesses were forced to cut expansion plans and conserve cash as a self preservation mechanism knowing the banks wouldn't be there for them. A last note about banks, don't ever sign pledge your personal assets in order to obtain a loan. This is one of the reason's why you should incorporate your coffee company and sequester your personal assets from the reach of creditors should your business fail...which unfortunately does happen.
Family and friends are useful sources of cash, but beware of the impact it can have on your personal life. People who are not entrepreneurial view cash differently than business owners and expect to see the money on demand. Use this source of cash only as a last resort, and always provide a written term sheet detailing repayment details. I want to emphasize that this can be the most costly type of cash you'll ever access, and in many, many instances is not worth the cost.
Issuing Preferred Shares is a more complicated method of raising money but in a lot of cases is a great way of establishing a relationship with savvy investors without giving up any control of your coffee company. Preferred Shares are a special class of Shares in a corporation that do not have voting rights to make decisions for the company. Instead these Shares have a higher claim to the company assets should liquidation be necessary, and either a yearly dividend or other monthly income provision. Preferred Shareholders are always paid before Common Shareholders, and therefore will receive their money before the owners can receive any. Any investor in Preferred Shares will normally demand that management/owners wage and salary be capped to protect the value of their investment. This is a more expensive method of obtaining cash since payments dispersed to Preferred Shareholders are made after tax as opposed to pre tax for interest on loans.
I am constantly amazed at the clever ways a determined entrepreneur employs to raise funds. I have heard of pre-selling customer cards at a discount which gives the business immediate access to cash on goods to be delivered in the future. Selling under applied assets and equipment is another valid way of creating cash quickly. Some companies have used their connections to wealthy patrons to create "founders clubs" that act as informal Preferred Shares by offering the founders extra bonuses and services plus repayment terms. No matter how you raise cash, it all has a cost that should be studied and examined to determine how it will impact your Income Statement and Balance Sheet.
When raising funds the first place a business owner would think to look is the bank where your daily deposits go. This is a great place to start given your account manager can quickly access your account to determine consistency of deposits and net change in cash position on a monthly basis. Getting a loan from your financial institution comes with standard repayment terms and rest assured that they don't want to run or seize your coffee business, they just want to be paid on time. Interest paid on financed debt is deductible before taxes, and is on the whole a less expensive option than issuing Equity. The problem with banks and other financial institutions is they are fickle and prone to turning off the tap if they themselves are facing difficulty. The credit crisis of 2008 to present is a great example where money went from being abundant to scarce overnight. During this period, most businesses were forced to cut expansion plans and conserve cash as a self preservation mechanism knowing the banks wouldn't be there for them. A last note about banks, don't ever sign pledge your personal assets in order to obtain a loan. This is one of the reason's why you should incorporate your coffee company and sequester your personal assets from the reach of creditors should your business fail...which unfortunately does happen.
Family and friends are useful sources of cash, but beware of the impact it can have on your personal life. People who are not entrepreneurial view cash differently than business owners and expect to see the money on demand. Use this source of cash only as a last resort, and always provide a written term sheet detailing repayment details. I want to emphasize that this can be the most costly type of cash you'll ever access, and in many, many instances is not worth the cost.
Issuing Preferred Shares is a more complicated method of raising money but in a lot of cases is a great way of establishing a relationship with savvy investors without giving up any control of your coffee company. Preferred Shares are a special class of Shares in a corporation that do not have voting rights to make decisions for the company. Instead these Shares have a higher claim to the company assets should liquidation be necessary, and either a yearly dividend or other monthly income provision. Preferred Shareholders are always paid before Common Shareholders, and therefore will receive their money before the owners can receive any. Any investor in Preferred Shares will normally demand that management/owners wage and salary be capped to protect the value of their investment. This is a more expensive method of obtaining cash since payments dispersed to Preferred Shareholders are made after tax as opposed to pre tax for interest on loans.
I am constantly amazed at the clever ways a determined entrepreneur employs to raise funds. I have heard of pre-selling customer cards at a discount which gives the business immediate access to cash on goods to be delivered in the future. Selling under applied assets and equipment is another valid way of creating cash quickly. Some companies have used their connections to wealthy patrons to create "founders clubs" that act as informal Preferred Shares by offering the founders extra bonuses and services plus repayment terms. No matter how you raise cash, it all has a cost that should be studied and examined to determine how it will impact your Income Statement and Balance Sheet.
Friday, January 14, 2011
Goodwill and How to Value a Company
Goodwill appears as an item on our Balance Sheet usually as a Non Current Asset and is essentially the value a company attaches to intangibles that it purchases. Having Goodwill on your Balance Sheet may be an indication that you have overpaid when acquiring another company or it's assets.
Under current accounting rules companies are not expected to amortize the Goodwill, but are expected to provide fair market value based on future profits generated by the acquired company. If for example the Goodwill was valued at 300k based on Net Profits of 60k per year over 5 years and the net profit drops, the value of the Goodwill needs to be reduced accordingly. If the Net Profit increases, it needs to be adjusted upwards.
For example:
Let's say a company decides to purchase another. Usually the purchaser will require that it be permitted to perform "due diligence" and inspect the sellers financial statements, and more importantly it's tax returns. (Companies sometimes lie to themselves, but lying to the Government is fraud) In return the seller will likely ask for a non disclosure/confidentiality agreement. If satisfied that the company's financials are in order and verified, the purchaser will usually obtain an equipment and asset list in order to fix a value on those items.
So imagine that the selling company has net assets of $200,000 and is asking $500,000 from the purchaser for it's business. Everything over the $200k is considered Goodwill, which in this case equals $300k. There are many ways of determining whether the amount of Goodwill is appropriate for the purchaser to spend but it is normally a calculation based on Net Profit multiplied by a number of years, usually 4-5. In this case, as the purchaser we would expect that Net Profit is somewhere around $60-75k per year in order to value the company's Goodwill at $300k.
Existing coffee companies purchase others for many reasons and we don't have to look to long to see some recent examples. Intelligentsia's purchase of Ecco Caffe is a private business matter where only the principals and their lawyers really know the details, but certainly a great deal of the purchase price would have been valued as Goodwill due to the excellent distribution, customer list, reputation and name brand associated with Ecco Caffe. In this case acquiring the facilities and hard assets of the Ecco Caffe may have been less enticing than the Goodwill itself, but for individuals starting out in the coffee business, beware.
If you are looking at purchasing an existing coffee company, remember that everything above the value of the Net Assets is Goodwill and that you should be very very careful purchasing anything you can't see.
Under current accounting rules companies are not expected to amortize the Goodwill, but are expected to provide fair market value based on future profits generated by the acquired company. If for example the Goodwill was valued at 300k based on Net Profits of 60k per year over 5 years and the net profit drops, the value of the Goodwill needs to be reduced accordingly. If the Net Profit increases, it needs to be adjusted upwards.
For example:
Let's say a company decides to purchase another. Usually the purchaser will require that it be permitted to perform "due diligence" and inspect the sellers financial statements, and more importantly it's tax returns. (Companies sometimes lie to themselves, but lying to the Government is fraud) In return the seller will likely ask for a non disclosure/confidentiality agreement. If satisfied that the company's financials are in order and verified, the purchaser will usually obtain an equipment and asset list in order to fix a value on those items.
So imagine that the selling company has net assets of $200,000 and is asking $500,000 from the purchaser for it's business. Everything over the $200k is considered Goodwill, which in this case equals $300k. There are many ways of determining whether the amount of Goodwill is appropriate for the purchaser to spend but it is normally a calculation based on Net Profit multiplied by a number of years, usually 4-5. In this case, as the purchaser we would expect that Net Profit is somewhere around $60-75k per year in order to value the company's Goodwill at $300k.
Existing coffee companies purchase others for many reasons and we don't have to look to long to see some recent examples. Intelligentsia's purchase of Ecco Caffe is a private business matter where only the principals and their lawyers really know the details, but certainly a great deal of the purchase price would have been valued as Goodwill due to the excellent distribution, customer list, reputation and name brand associated with Ecco Caffe. In this case acquiring the facilities and hard assets of the Ecco Caffe may have been less enticing than the Goodwill itself, but for individuals starting out in the coffee business, beware.
If you are looking at purchasing an existing coffee company, remember that everything above the value of the Net Assets is Goodwill and that you should be very very careful purchasing anything you can't see.
Wednesday, January 12, 2011
What Went Wrong (with my lease negotiations)
Last week things went sour in my effort to obtain a lease for a third location in the downtown area of my hometown. I want to share with you my experience to show you that even when you make every effort to do things right, they can go wrong.
I have been looking for a third retail location for quite some time, with my primary focus on the downtown area of my city. This past summer I was approached by a landlord who had a corner space available, which I rejected it because the space required extensive renovation. I did however notice that there was a space in the same building that was of interest to me and asked the landlord if that spot was available. I suggested that he speak with the occupant to determine if they would be interested in selling the location (equipment and leaseholds) to me. I didn't hear back from the landlord so I moved on.
In late November I noticed a For Rent sign appeared in the window of the business I had asked about and immediately contacted the landlord to view the space. That very day I had a handshake agreement to purchase the equipment and leaseholds for $35,000. I viewed this as an excellent price for:
Given the refusal of the landlord to provide a lease, I chose to pass on this location and keep looking. I remain disappointed because the space was ready to go with very little additional money required, and it afforded us an opportunity to bake and prepare our own food to be supplied to our other locations.
The main thing I hope to share is that no matter how many benefits a location offers, if there is a significant problem, walk away. In my case, the possibility that I could be evicted on 60 days notice wasn't worth the benefit of purchasing the leaseholds and equipment so cheaply.
I have been looking for a third retail location for quite some time, with my primary focus on the downtown area of my city. This past summer I was approached by a landlord who had a corner space available, which I rejected it because the space required extensive renovation. I did however notice that there was a space in the same building that was of interest to me and asked the landlord if that spot was available. I suggested that he speak with the occupant to determine if they would be interested in selling the location (equipment and leaseholds) to me. I didn't hear back from the landlord so I moved on.
In late November I noticed a For Rent sign appeared in the window of the business I had asked about and immediately contacted the landlord to view the space. That very day I had a handshake agreement to purchase the equipment and leaseholds for $35,000. I viewed this as an excellent price for:
- walk in refrigerator
- double glass door cooler
- double glass door freezer
- single glass door cooler
- large gas convection oven
- gas grill
- gas cooktop
- gas stove
- gas soup stock pot units
- commercial dishwasher
- cabinetry
- flooring
- 2 handicap washrooms
- tables
- health unit approval to use the space.
Given the refusal of the landlord to provide a lease, I chose to pass on this location and keep looking. I remain disappointed because the space was ready to go with very little additional money required, and it afforded us an opportunity to bake and prepare our own food to be supplied to our other locations.
The main thing I hope to share is that no matter how many benefits a location offers, if there is a significant problem, walk away. In my case, the possibility that I could be evicted on 60 days notice wasn't worth the benefit of purchasing the leaseholds and equipment so cheaply.
Monday, January 10, 2011
Controlling Costs Part 1 General and Administration Expenses
Already it is clear to me through the results of my simple online poll that controlling costs is a problem for many of us. Each coffee business is different and has different COGS and payroll challenges which are both difficult to alter significantly without affecting quality. But our General and Administration Expenses contain many areas where a sharp pencil can save a business plenty of money without any change in the quality of your products. For this post, refer to the Sample Income Statement Page.
*I want to make the importance of this clear by providing you with an example.
Let's say our company achieves a Net Profit before taxes of 10% of gross sales.
Let's also say that through this exercise of identifying savings in the G&A expenses we can save $20,000 per year. That means that our company would need to sell an extra $200,000 in order to achieve the same profit level had we not reduced G&A costs. Think about how hard it is to increase sales at a cafe by $200k. Now think about how easy it is to reduce how much you are paying for advertising, legals and phone bills.
"It is easier to save a dollar than it is to make one."
Accounting and Legal are areas which should be relatively stable unless the company is either engaged in a lawsuit, seeking a trademark, purchasing/opening a new location, or otherwise making many visits to their lawyer. If you must engage a lawyer, it has been my experience that conducting as much negotiation as possible without a lawyer, nailing all details with a caveat that they be reviewed by a lawyer saves significant costs. Also, when negotiating a lease or any other contract, insist that the landlord provide the lease document rather than paying for your lawyer to provide one. That way you can simply pay your lawyer to pick apart the document and remove what you object to.
Don't touch the money you spend on Accounting. These numbers are the tools you need to improve your business. Make sure your accountant is providing you with monthly, quarterly and yearly financials, and meet regularly with them to discuss goals and measure results.
Advertising and Promotions is an area where it is easy to overspend and under deliver on results. Making use of free online marketing is an excellent way of eliminating these expenses almost entirely. Twitter, Facebook, Foursquare, and an excellent blog or website are effective ways of advertising your company, and given effective data management, emails targeted to existing customers also work. If you are having a difficult time managing cash flow, consider eliminating advertising completely at least until you get things under control.
Reducing Amortization Expense and Equipment Lease charges require more long term planning, but reading my previous post about Investing in Equipment will help keep you out of trouble. This is where a lot of gold is kept, and spent needlessly chasing status from machinery. Overspending on equipment is a dangerous path which imperils profitability in the long term.
Targeting insurance, internet, telephone, paper and mobile providers in a systematic way can yield immediate results and save a company plenty per month. This is where most of the accessible savings are to be found. I used to play a game with our office staff, whereby I would identify costs which didn't affect quality and post them on a white board for all to see. The game was whether we could reduce the cost of every listed item over the course of the year. This all happened in our spare time and people become rightly proud of deals they secured on the company's behalf.
Rent is impossible to address unless you have a very understanding landlord. When you negotiate a lease, it is like taking on a car loan, with specific terms attached. It is unlikely your landlord will open up a lease and renegotiate it unless you are near bankruptcy. The time to think about the lease is when you sign it. Going into negotiations with realistic expectations of revenue, and a target of spending 10-12% of gross revenue on rent should set your target price and eliminate the need to renegotiate.
Repair and Maintenance is a difficult one to cut over the long term since not maintaining equipment will eventually lead to higher Capital Asset costs. I would not recommend cutting maintenance budgets. A better strategy is to maintain a proper training program for staff that helps keep machinery in tip top condition and gives them a sense of ownership of the equipment. Training staff is also a method of increasing professionalism which translates into happy customers. If a business can rely on quality staff to attract customers rather than gimmicks, give aways, and flashy equipment, they have put themselves in a competitive position which will be difficult to displace.
Travel and Entertainment is a luxury item, and can be easily cut or eliminated all together. Just because you own a business does not mean you own a successful business. Travel is completely discretionary, and should only be expensed if entirely necessary to a critical part of your business.
The last thing to remember is we are all in this business for the long haul. Thinking you have to make loads of money immediately is unrealistic, instead constantly tweak your business and find your financial groove. The changes I am suggesting will not result in an immediate $20,000 in your bank account, but over the course of a year you can easily save $20,000 by making wise decisions and paying attention to G&A. I know what I'll be doing in 20 years, working my business and figuring out ways to improve it. If you have a firm grasp of your costs, produce a great product, and have developed a community around your coffee shop, you will provide an excellent income for yourself and family for a great long time.
*I want to make the importance of this clear by providing you with an example.
Let's say our company achieves a Net Profit before taxes of 10% of gross sales.
Let's also say that through this exercise of identifying savings in the G&A expenses we can save $20,000 per year. That means that our company would need to sell an extra $200,000 in order to achieve the same profit level had we not reduced G&A costs. Think about how hard it is to increase sales at a cafe by $200k. Now think about how easy it is to reduce how much you are paying for advertising, legals and phone bills.
"It is easier to save a dollar than it is to make one."
Accounting and Legal are areas which should be relatively stable unless the company is either engaged in a lawsuit, seeking a trademark, purchasing/opening a new location, or otherwise making many visits to their lawyer. If you must engage a lawyer, it has been my experience that conducting as much negotiation as possible without a lawyer, nailing all details with a caveat that they be reviewed by a lawyer saves significant costs. Also, when negotiating a lease or any other contract, insist that the landlord provide the lease document rather than paying for your lawyer to provide one. That way you can simply pay your lawyer to pick apart the document and remove what you object to.
Don't touch the money you spend on Accounting. These numbers are the tools you need to improve your business. Make sure your accountant is providing you with monthly, quarterly and yearly financials, and meet regularly with them to discuss goals and measure results.
Advertising and Promotions is an area where it is easy to overspend and under deliver on results. Making use of free online marketing is an excellent way of eliminating these expenses almost entirely. Twitter, Facebook, Foursquare, and an excellent blog or website are effective ways of advertising your company, and given effective data management, emails targeted to existing customers also work. If you are having a difficult time managing cash flow, consider eliminating advertising completely at least until you get things under control.
Reducing Amortization Expense and Equipment Lease charges require more long term planning, but reading my previous post about Investing in Equipment will help keep you out of trouble. This is where a lot of gold is kept, and spent needlessly chasing status from machinery. Overspending on equipment is a dangerous path which imperils profitability in the long term.
Targeting insurance, internet, telephone, paper and mobile providers in a systematic way can yield immediate results and save a company plenty per month. This is where most of the accessible savings are to be found. I used to play a game with our office staff, whereby I would identify costs which didn't affect quality and post them on a white board for all to see. The game was whether we could reduce the cost of every listed item over the course of the year. This all happened in our spare time and people become rightly proud of deals they secured on the company's behalf.
Rent is impossible to address unless you have a very understanding landlord. When you negotiate a lease, it is like taking on a car loan, with specific terms attached. It is unlikely your landlord will open up a lease and renegotiate it unless you are near bankruptcy. The time to think about the lease is when you sign it. Going into negotiations with realistic expectations of revenue, and a target of spending 10-12% of gross revenue on rent should set your target price and eliminate the need to renegotiate.
Repair and Maintenance is a difficult one to cut over the long term since not maintaining equipment will eventually lead to higher Capital Asset costs. I would not recommend cutting maintenance budgets. A better strategy is to maintain a proper training program for staff that helps keep machinery in tip top condition and gives them a sense of ownership of the equipment. Training staff is also a method of increasing professionalism which translates into happy customers. If a business can rely on quality staff to attract customers rather than gimmicks, give aways, and flashy equipment, they have put themselves in a competitive position which will be difficult to displace.
Travel and Entertainment is a luxury item, and can be easily cut or eliminated all together. Just because you own a business does not mean you own a successful business. Travel is completely discretionary, and should only be expensed if entirely necessary to a critical part of your business.
The last thing to remember is we are all in this business for the long haul. Thinking you have to make loads of money immediately is unrealistic, instead constantly tweak your business and find your financial groove. The changes I am suggesting will not result in an immediate $20,000 in your bank account, but over the course of a year you can easily save $20,000 by making wise decisions and paying attention to G&A. I know what I'll be doing in 20 years, working my business and figuring out ways to improve it. If you have a firm grasp of your costs, produce a great product, and have developed a community around your coffee shop, you will provide an excellent income for yourself and family for a great long time.
Recommended Article
Just a quick post to provide a link to an excellent article (click here) I found online today. Very timely given the content of my blog, and something I will definitely investigate and review in the coming weeks. Article was written by Kirk Simpson, CEO of Wave Accounting
Sunday, January 9, 2011
Investing in Equipment
For most coffee businesses equipment should be an investment, not a marketing tool, and that is why it is critical for coffee businesses to understand the financial impact of significant purchases on our profit and cash flow.
A typical espresso machine can be fairly assessed at a 4-5 year lifespan given regular maintenance. That lifespan can be increased indefinitely with complete rebuilds. If we purchase an espresso machine, we are expected to depreciate it over 5 years until it ceases to be a capital asset on our balance sheet. The fact that it's balance sheet value is depleted is offset by the fact that it is no longer a long term liability in the form of a bank loan. If we regularly maintain our machine, we have the potential to benefit from the utility of a machine which has already been paid for and depreciated. Think about driving around your 5 year old car...no payments...same utility.
Lets compare two new espresso machines, one costing $5,000 and the other $20,000.
We will assume that the $5k machine is capable of producing the same quantity of espresso beverages per hour. We will also assume that the $20k machine does produce a better, more consistent espresso. I don't want to explore the technical merits of one machine over another, just how the cost impacts our profitability.
In both cases, the machinery will be financed at 10% (high rate for some, low rate for others), although it is always better to purchase outright with cash accumulated from profits. Obviously paying $5k cash is significantly more accessible for most coffee businesses than $20k, but we will assume both are financed.
Loan amount: $20,000
Interest Rate: 10%
Loan Term Months: 48
Monthly Payment: $507.25
Total Paid: $24348.08
Interest Paid: $4348.08
Loan amount: $5,000
Interest rate: 10%
Loan Term Months: 48
Monthly Payment: $126.81
Total Paid: $6087.02
Interest Paid: $1087.02
Look at the total burden to the company for each machine represented by the Total Paid number. The difference in purchase price is $15k but the total financed burden is $18,260.98 or an extra $380.44 per month over 48 months. The same utility is withdrawn from the machine in the form of beverages per day, but one machine cost significantly more to produce those beverages. I have already discussed the impact on the balance sheet, but the income statement is also adversely affected by the burden of lease/loan payments and amortization expense, reducing profit at the end of the year.
Choosing a $20,000 espresso machine over a $5,000 or even $10,000 is likely tied to an expectation that the equipment will elevate status, quality perceptions, and increase revenue. These are marketing decisions since identical utility from a less expensive option was foregone in favour of an effort to increase awareness/buzz. Coffee Companies with competitive advantages based upon location, skilled baristas, exceptional service etc, don't need to constantly upgrade equipment in order to maintain buzz. Theoretically I would argue that any expense over and above significantly cheaper options should be identified as Goodwill rather than Capital Assets.
Choosing the more expensive option is also a strategy which is a long term expense, since every year a newer, more sophisticated model with more buzz will hit the market. Heaven forbid that your closest competitor engage in similar strategies, resulting in an espresso gear arms race ;) Review your purchases, remember that every dollar added to General and Admin Expenses is a dollar of reduced profit. Every coffee business needs to purchase equipment, just make sure that your purchases impact on financials are known before the decision is made. Last, if you are expecting a jump in revenue when you make a luxury purchase, measure it, confirm or debunk it and learn from it. If it doesn't increase your revenue, you have just made yourself significantly poorer.
A typical espresso machine can be fairly assessed at a 4-5 year lifespan given regular maintenance. That lifespan can be increased indefinitely with complete rebuilds. If we purchase an espresso machine, we are expected to depreciate it over 5 years until it ceases to be a capital asset on our balance sheet. The fact that it's balance sheet value is depleted is offset by the fact that it is no longer a long term liability in the form of a bank loan. If we regularly maintain our machine, we have the potential to benefit from the utility of a machine which has already been paid for and depreciated. Think about driving around your 5 year old car...no payments...same utility.
Lets compare two new espresso machines, one costing $5,000 and the other $20,000.
We will assume that the $5k machine is capable of producing the same quantity of espresso beverages per hour. We will also assume that the $20k machine does produce a better, more consistent espresso. I don't want to explore the technical merits of one machine over another, just how the cost impacts our profitability.
In both cases, the machinery will be financed at 10% (high rate for some, low rate for others), although it is always better to purchase outright with cash accumulated from profits. Obviously paying $5k cash is significantly more accessible for most coffee businesses than $20k, but we will assume both are financed.
Loan amount: $20,000
Interest Rate: 10%
Loan Term Months: 48
Monthly Payment: $507.25
Total Paid: $24348.08
Interest Paid: $4348.08
Loan amount: $5,000
Interest rate: 10%
Loan Term Months: 48
Monthly Payment: $126.81
Total Paid: $6087.02
Interest Paid: $1087.02
Look at the total burden to the company for each machine represented by the Total Paid number. The difference in purchase price is $15k but the total financed burden is $18,260.98 or an extra $380.44 per month over 48 months. The same utility is withdrawn from the machine in the form of beverages per day, but one machine cost significantly more to produce those beverages. I have already discussed the impact on the balance sheet, but the income statement is also adversely affected by the burden of lease/loan payments and amortization expense, reducing profit at the end of the year.
Choosing a $20,000 espresso machine over a $5,000 or even $10,000 is likely tied to an expectation that the equipment will elevate status, quality perceptions, and increase revenue. These are marketing decisions since identical utility from a less expensive option was foregone in favour of an effort to increase awareness/buzz. Coffee Companies with competitive advantages based upon location, skilled baristas, exceptional service etc, don't need to constantly upgrade equipment in order to maintain buzz. Theoretically I would argue that any expense over and above significantly cheaper options should be identified as Goodwill rather than Capital Assets.
Choosing the more expensive option is also a strategy which is a long term expense, since every year a newer, more sophisticated model with more buzz will hit the market. Heaven forbid that your closest competitor engage in similar strategies, resulting in an espresso gear arms race ;) Review your purchases, remember that every dollar added to General and Admin Expenses is a dollar of reduced profit. Every coffee business needs to purchase equipment, just make sure that your purchases impact on financials are known before the decision is made. Last, if you are expecting a jump in revenue when you make a luxury purchase, measure it, confirm or debunk it and learn from it. If it doesn't increase your revenue, you have just made yourself significantly poorer.
Saturday, January 8, 2011
Your Banker Doesn't Care
Well not really. What your banker doesn't care about is how many grams you are using for a double shot of espresso... they don't care whether the water temperature is 198 or 203, and they don't care about Cup of Excellence, Fair Trade or Organic. They don't care how many twitter followers you have, how you placed at the Regional Barista Championships or your industry status. They care whether you are making money, and whether you are a good credit risk. No matter how involved we become in discussions about coffee quality, best practices or sustainability, the 800 pound gorilla in the room is your income statement. If you are a business owner producing the finest coffee in the world but you are not making money, you are doing something terribly wrong.
Every coffee business owner should spend at least as much time considering the quality of their financial statements as they do their products. None of us stepped into the coffee industry armed with vast amounts of knowledge, and in fact for most of us, accumulating coffee knowledge and experience is an ongoing process. The same can be said for Financial Literacy, it is the process of accumulating knowledge which benefits our business.
If you are a coffee business owner or manager at the helm of a struggling company, the tools to change the outcome are contained within your financial statements. Goal setting, target ratios and identifying problem areas all become easier when you become familiar with the look of your financials. Please review the posted pages with relevant definitions as well as the sample Income Statement, and Sample Balance Sheet.
Every coffee business owner should spend at least as much time considering the quality of their financial statements as they do their products. None of us stepped into the coffee industry armed with vast amounts of knowledge, and in fact for most of us, accumulating coffee knowledge and experience is an ongoing process. The same can be said for Financial Literacy, it is the process of accumulating knowledge which benefits our business.
If you are a coffee business owner or manager at the helm of a struggling company, the tools to change the outcome are contained within your financial statements. Goal setting, target ratios and identifying problem areas all become easier when you become familiar with the look of your financials. Please review the posted pages with relevant definitions as well as the sample Income Statement, and Sample Balance Sheet.
Friday, January 7, 2011
Negotiating a Lease
Every coffee business at one point or another, unless you are fortunate enough to own your own building, will need to negotiate a lease with a landlord. While I tend to handle all of the negotiations myself, I always have any lease reviewed by my lawyer. The most important thing to remember about a lease is that it represents a debt that you must pay to your landlord for as long as your lease is valid. When you review your financial statements at the end of the year, rent is usually one of the most significant costs in our Income Statement under General and Administration. Rent is a fixed cost which doesn't increase or decrease depending on how busy your shop is, it is the same each month and only escalates under terms permitted in the signed lease document.
A typical lease cost is broken into three parts,
Net cost + Common Area Maintenance/Operating Costs (CAM), and realty taxes. These costs are given Per Square Foot or Per Metre and monthly rent is determined by:
Net Cost psf + CAM psf + Realty Taxes psf x square footage / 12
If our rent is $15, CAM $4, and Realty taxes $3 pst on a 1500 square foot space, our rent would be:
$15+$4+$3= $22 x 1500 sqft = $33,000/12= $2750 per month
While most landlords won't negotiate reductions in CAM or taxes, the Net Rent is usually negotiable. This is an area where business owners must squeeze every dollar out of the landlord to reduce the break even point. In our example, each $1 reduction in the psf rent represents $1500 savings per year, and $7500 over the course of a 5 year lease. An excellent goal for rent cost is 10-12% of gross revenue. When negotiating your lease, keep this goal in mind, and use it to quickly determine whether you can achieve the target. *You can also use the 10-12% guideline to determine whether you are generating enough income from your existing lease. It is easier to save a dollar than to make one.
Once the per square foot costs are agreed upon, fixturing or rent free periods are typically granted as a landlord inducement for a business to sign a lease. It is critical to take advantage of this since paying rent while you are under construction and not earning any income is an odious burden for a new enterprise. Make sure you have enough time between the date you sign your lease, and when the fixturing period starts in order to adequately plan your build and obtain proper permits.
Another inducement typically offered by landlords is a cash allowance for leasehold improvements. The allowance can represent as much as 10-20% of the lease value over 5 years. Your lawyer will make suggestions which are specific to your location, such as parking space allowance, garbage disposal, signage, plate glass window repair, business interruption, but please remember that it is better to pass up on a location than overpay and jeopardize your profitability. Don't forget that when looking for a location for your new coffee shop don't be afraid to take over a space from a failed coffee shop. The plumbing, electrical, and many other leasehold improvements are in place, and if you can secure some inducements from the landlord your path to profitability is made significantly clearer.
A typical lease cost is broken into three parts,
Net cost + Common Area Maintenance/Operating Costs (CAM), and realty taxes. These costs are given Per Square Foot or Per Metre and monthly rent is determined by:
Net Cost psf + CAM psf + Realty Taxes psf x square footage / 12
If our rent is $15, CAM $4, and Realty taxes $3 pst on a 1500 square foot space, our rent would be:
$15+$4+$3= $22 x 1500 sqft = $33,000/12= $2750 per month
While most landlords won't negotiate reductions in CAM or taxes, the Net Rent is usually negotiable. This is an area where business owners must squeeze every dollar out of the landlord to reduce the break even point. In our example, each $1 reduction in the psf rent represents $1500 savings per year, and $7500 over the course of a 5 year lease. An excellent goal for rent cost is 10-12% of gross revenue. When negotiating your lease, keep this goal in mind, and use it to quickly determine whether you can achieve the target. *You can also use the 10-12% guideline to determine whether you are generating enough income from your existing lease. It is easier to save a dollar than to make one.
Once the per square foot costs are agreed upon, fixturing or rent free periods are typically granted as a landlord inducement for a business to sign a lease. It is critical to take advantage of this since paying rent while you are under construction and not earning any income is an odious burden for a new enterprise. Make sure you have enough time between the date you sign your lease, and when the fixturing period starts in order to adequately plan your build and obtain proper permits.
Another inducement typically offered by landlords is a cash allowance for leasehold improvements. The allowance can represent as much as 10-20% of the lease value over 5 years. Your lawyer will make suggestions which are specific to your location, such as parking space allowance, garbage disposal, signage, plate glass window repair, business interruption, but please remember that it is better to pass up on a location than overpay and jeopardize your profitability. Don't forget that when looking for a location for your new coffee shop don't be afraid to take over a space from a failed coffee shop. The plumbing, electrical, and many other leasehold improvements are in place, and if you can secure some inducements from the landlord your path to profitability is made significantly clearer.
Thursday, January 6, 2011
Pricing Baked Goods (Perishables)
When pricing baked goods or any perishable at your coffee shop you need to consider them very differently than any other product you sell. If, for example you have 10 coffee makers on the shelf, it is likely you will continue to sell them until all of them are sold. You may wish to discount them as stock gets old, but you will eventually sell through all of the coffee makers.
With baked goods, sandwiches, anything with a very short shelf life, you may not have the opportunity to sell all of your daily stock because you ordered too many, it was a bad weather day and traffic was reduced, or any one of a thousand reasons cafes have slow days. For this reason you need to think of them very differently, and price them differently.
Use this equation to determine target price from a known target margin.
Target Price = unit cost/((100-target margin)/100)
Example 1:
one dozen muffins:
purchase $12
re-sell $1.50 each
Break Even 8 x $1.5 = $12
Target Price = $1/(100-33)/100 = $1.50
Therefore our coffee shop does not make a single penny on any one of the first 8 muffin sales, it only pays back what we paid for them. All of the profit lay in the final four muffins. If we have a quiet day and we fail to sell at least 8 of our 12 muffins, we lost money on our muffin sales that day. As the day gets on towards 4pm and our baked goods sales slow, we may choose to discount, which further reduces profit especially if we are reducing more than the last 4 muffins.
Example 2:
one dozen muffins:
purchase $12
re-sell $2 each
Break Even 6 x $2 = $12
Target Price = $1/(100-50)/100 = $2
In this example we only need to sell 6 of our muffins to break even, pricing being the key factor. By moving the price up from 33% margin to 50%, we have set up conditions to make it unlikely that we will fail to profit from our perishables.
If our margin is: 25% we only break even when we sell 9 of 12 muffins
33% we only break even when we sell 8 of 12 muffins
50% we only break even when we sell 6 of 12 muffins
Remember, when dealing with perishables we calculate profit not on a per unit basis, but as a group because at the end of the business day, they are worthless if unsold.
Let me know if this is helpful, and if you have any pointers that you'd like to pass along.
With baked goods, sandwiches, anything with a very short shelf life, you may not have the opportunity to sell all of your daily stock because you ordered too many, it was a bad weather day and traffic was reduced, or any one of a thousand reasons cafes have slow days. For this reason you need to think of them very differently, and price them differently.
Use this equation to determine target price from a known target margin.
Target Price = unit cost/((100-target margin)/100)
Example 1:
one dozen muffins:
purchase $12
re-sell $1.50 each
Break Even 8 x $1.5 = $12
Target Price = $1/(100-33)/100 = $1.50
Therefore our coffee shop does not make a single penny on any one of the first 8 muffin sales, it only pays back what we paid for them. All of the profit lay in the final four muffins. If we have a quiet day and we fail to sell at least 8 of our 12 muffins, we lost money on our muffin sales that day. As the day gets on towards 4pm and our baked goods sales slow, we may choose to discount, which further reduces profit especially if we are reducing more than the last 4 muffins.
Example 2:
one dozen muffins:
purchase $12
re-sell $2 each
Break Even 6 x $2 = $12
Target Price = $1/(100-50)/100 = $2
In this example we only need to sell 6 of our muffins to break even, pricing being the key factor. By moving the price up from 33% margin to 50%, we have set up conditions to make it unlikely that we will fail to profit from our perishables.
If our margin is: 25% we only break even when we sell 9 of 12 muffins
33% we only break even when we sell 8 of 12 muffins
50% we only break even when we sell 6 of 12 muffins
Remember, when dealing with perishables we calculate profit not on a per unit basis, but as a group because at the end of the business day, they are worthless if unsold.
Let me know if this is helpful, and if you have any pointers that you'd like to pass along.
Wednesday, January 5, 2011
Leasehold Improvements
Leasehold Improvements appear as a line on our Balance Sheet under Capital Assets, and typically have a note attached identifying accumulated depreciation. They include all improvements a coffee business makes to a rented building that typically remain with the landlord or next renter after your lease expires. Things like cabinetry, countertops, washroom fixtures, lighting, flooring, anything that is attached to the building and not easily removed. Sometimes a coffee business may choose to identify items they consider proprietary and therefore specifically identified with the business, (ie logo signs )and may wish to have them excluded in the signed lease document. If not identified within the lease as exempt, all of the money a business spends to get a building to operational condition is considered a leasehold improvement.
It is very important to consider how much leasehold improvements cost a new business when preparing a business plan. These expenses are likely the most significant any business faces when opening a new location, and servicing any debt needed to pay for them cause a huge obstacle to profitability and positive cash flow. Like all capital costs, we are expected to depreciate the value over a period of time, most likely matching the period over which any associated loan is to be repaid. For example, if a company borrows 200k to build out a new cafe, and has arranged to repay the bank over 5 years, we would choose to depreciate the value 40k per year over 5 years. In some cases, you and your accountant may choose to depreciate the leaseholds over the period defined in the lease, 10 years for example.
The important thing to remember is leasehold improvements only are useful to a company if they still occupy the building. Therefore, when negotiating a lease it is useful to obtain a 5 years initial lease period, with an optional 5 year period to follow. That way the company can continue to use the assets past the point that they are paid for.
The last point I want to bring up when considering leaseholds is how to take advantage of someone else's mistakes. When a poorly run or struggling coffee shop closes, the money spent on fixtures and improvements remain within the building. This is an opportunity for the right operator to benefit from the huge savings to be had. Even the cost of installing mechanical, plumbing, and electrical in a cafe can be significant, and if all a building needs is some new paint, counter tops and lighting, you have given yourself a minimum 100k head start towards profitability.
It is very important to consider how much leasehold improvements cost a new business when preparing a business plan. These expenses are likely the most significant any business faces when opening a new location, and servicing any debt needed to pay for them cause a huge obstacle to profitability and positive cash flow. Like all capital costs, we are expected to depreciate the value over a period of time, most likely matching the period over which any associated loan is to be repaid. For example, if a company borrows 200k to build out a new cafe, and has arranged to repay the bank over 5 years, we would choose to depreciate the value 40k per year over 5 years. In some cases, you and your accountant may choose to depreciate the leaseholds over the period defined in the lease, 10 years for example.
The important thing to remember is leasehold improvements only are useful to a company if they still occupy the building. Therefore, when negotiating a lease it is useful to obtain a 5 years initial lease period, with an optional 5 year period to follow. That way the company can continue to use the assets past the point that they are paid for.
The last point I want to bring up when considering leaseholds is how to take advantage of someone else's mistakes. When a poorly run or struggling coffee shop closes, the money spent on fixtures and improvements remain within the building. This is an opportunity for the right operator to benefit from the huge savings to be had. Even the cost of installing mechanical, plumbing, and electrical in a cafe can be significant, and if all a building needs is some new paint, counter tops and lighting, you have given yourself a minimum 100k head start towards profitability.
Tuesday, January 4, 2011
Balance Sheet Simplified
The Balance Sheet is always in balance.(Refer to Balance Sheet Page and Sample Balance Sheet to familiarize yourself with terms and look of Balance Sheet)
The Balance Sheet is comprised of:
1. Assets (things we own); Current and Long-term
2. Liabilities (things we owe); Current and Long-term plus Equity (shares owned by shareholders/owners)
The reason Equity is a Liability is that the company owes money to the shareholders if and when they decided to sell their shares in the company. For most coffee businesses, there are likely between 1-5 shareholders who have each contributed funds in exchange for a percentage ownership. The percentage ownership is reflected in number of shares owned by each individual. For example, in our Sample Balance Sheet Page, there exists 100 common (voting) shares. If a partner owns 20% of the company, they own 20 common shares. (I will post more on Common and Preferred Shares soon)
The most important thing to know is the following equation:
ASSETS = LIABILITIES + EQUITY
ASSETS are for our purposes:
Short Term; cash on hand, bank accounts, investments and receivables
Long-term; equipment (tables, chairs, coffee makers and espresso machines) and leasehold improvements (things you've done to the space you rent, but cannot remove when you leave, ie cabinetry, flooring, washrooms)
When we add these things together we know, because we are working on a Balance Sheet, that the Liabilities plus Equity will equal this figure.
LIABILITIES are:
Short Term; accounts payable under 1 year(suppliers, rent, utilities, taxes payable)
Long-term; bank loans (note: there is usually a note listed in the Financial Statements outlining the terms of any outstanding loans, and lease agreements)
Example: In this simple example, our Balance Sheet is truncated, but clean and clear. We have $2,000 in cash, 20k in the bank, 50k in equipment and 72k in total assets. On the other side of the Balance Sheet, we owe 5k to suppliers, are making payments on a 20k bank loan, and as an owner we have 47k in value built up in the company.
ASSETS
cash 2,000
bank account 20,000
equipment 50,000
total 72,000
LIABILITIES
accts payable 5,000
bank loan 20,000
equity 47,000
total 72,000
If we decide to upgrade some equipment and take a bank loan for $20,000 out to do this, our new Balance Sheet will look like this.
ASSETS
cash 2,000
bank account 20,000
equipment 70,000
total 92,000
LIABILITIES
accts payable 5,000
bank loan 40,000
equity 47,000
total 92,000
Our Balance Sheet has grown, but the shareholders didn't profit, in fact cash flow will now need to be diverted to service the new debt, thereby reducing the profit at the end of the year. There are many different ways we could have acquired the equipment without taking on a new loan, lease, lease to own, pay cash, or issue preferred shares. Each has a cost associated with them, some more costly than others.
A very important factor I have omitted is the fact that new equipment depreciates the moment we take possession. (think new cars) This depreciation always happens at a constant rate determined by Generally Accepted Accounting Principles, normally 10-20% per year. This means that we need to reduce our ASSET equipment account by 20% of 70k each year, and if we do that, we need to reduce our LIABILITIES account by the same amount because we are working on a Balance Sheet. If we are reducing the value of equipment by 20% per year, and we are not paying off the equipment by more than 20% per year, we need to reduce the equity account by the difference to keep the sheet balanced. This means less value for the owners.
Play around with these concepts, apply them to your own situation and let me know if you find this helpful.
The Balance Sheet is comprised of:
1. Assets (things we own); Current and Long-term
2. Liabilities (things we owe); Current and Long-term plus Equity (shares owned by shareholders/owners)
The reason Equity is a Liability is that the company owes money to the shareholders if and when they decided to sell their shares in the company. For most coffee businesses, there are likely between 1-5 shareholders who have each contributed funds in exchange for a percentage ownership. The percentage ownership is reflected in number of shares owned by each individual. For example, in our Sample Balance Sheet Page, there exists 100 common (voting) shares. If a partner owns 20% of the company, they own 20 common shares. (I will post more on Common and Preferred Shares soon)
The most important thing to know is the following equation:
ASSETS = LIABILITIES + EQUITY
ASSETS are for our purposes:
Short Term; cash on hand, bank accounts, investments and receivables
Long-term; equipment (tables, chairs, coffee makers and espresso machines) and leasehold improvements (things you've done to the space you rent, but cannot remove when you leave, ie cabinetry, flooring, washrooms)
When we add these things together we know, because we are working on a Balance Sheet, that the Liabilities plus Equity will equal this figure.
LIABILITIES are:
Short Term; accounts payable under 1 year(suppliers, rent, utilities, taxes payable)
Long-term; bank loans (note: there is usually a note listed in the Financial Statements outlining the terms of any outstanding loans, and lease agreements)
Example: In this simple example, our Balance Sheet is truncated, but clean and clear. We have $2,000 in cash, 20k in the bank, 50k in equipment and 72k in total assets. On the other side of the Balance Sheet, we owe 5k to suppliers, are making payments on a 20k bank loan, and as an owner we have 47k in value built up in the company.
ASSETS
cash 2,000
bank account 20,000
equipment 50,000
total 72,000
LIABILITIES
accts payable 5,000
bank loan 20,000
equity 47,000
total 72,000
If we decide to upgrade some equipment and take a bank loan for $20,000 out to do this, our new Balance Sheet will look like this.
ASSETS
cash 2,000
bank account 20,000
equipment 70,000
total 92,000
LIABILITIES
accts payable 5,000
bank loan 40,000
equity 47,000
total 92,000
Our Balance Sheet has grown, but the shareholders didn't profit, in fact cash flow will now need to be diverted to service the new debt, thereby reducing the profit at the end of the year. There are many different ways we could have acquired the equipment without taking on a new loan, lease, lease to own, pay cash, or issue preferred shares. Each has a cost associated with them, some more costly than others.
A very important factor I have omitted is the fact that new equipment depreciates the moment we take possession. (think new cars) This depreciation always happens at a constant rate determined by Generally Accepted Accounting Principles, normally 10-20% per year. This means that we need to reduce our ASSET equipment account by 20% of 70k each year, and if we do that, we need to reduce our LIABILITIES account by the same amount because we are working on a Balance Sheet. If we are reducing the value of equipment by 20% per year, and we are not paying off the equipment by more than 20% per year, we need to reduce the equity account by the difference to keep the sheet balanced. This means less value for the owners.
Play around with these concepts, apply them to your own situation and let me know if you find this helpful.
Monday, January 3, 2011
Break Even Analysis
Break Even Analysis is in my opinion the most important number in running any coffee business...how much do I have to sell to pay all of the bills? Normally we would determine break even for a specific period of time, usually per month. A simple definition applied to a coffee shop is how many customers, when multiplied times the average gross margin sale amount is equal to the cost of doing business. (Refer to Income Statement Page for review of Gross Margin)
From our Income Statement Sample Page our gross margin is $0.637 per dollar, and it cost us $334,180 in Labour, and GSA to run our business, we need to sell 334,180/0.637 worth of sales, or $524,615.38 to hit our break even point.
Let's say we know that on average, each transaction at our cafe is for $5.85, we can now determine that we need $524,615.38/5.85= 89677.84 customers per year, or approximately 250 customers per day.
These are all very simple calculations, using numbers generated by either our cash register, or our income statements, that can quickly identify whether our coffee shop is able to pay it's bills. If there exists a situation whereby we can't get enough people through the door, we need to address either gross margin, pricing, or average per sale figure. But first we need our break even. Spend some time familiarizing yourself with this concept, and let me know if this info is useful to you.
From our Income Statement Sample Page our gross margin is $0.637 per dollar, and it cost us $334,180 in Labour, and GSA to run our business, we need to sell 334,180/0.637 worth of sales, or $524,615.38 to hit our break even point.
Let's say we know that on average, each transaction at our cafe is for $5.85, we can now determine that we need $524,615.38/5.85= 89677.84 customers per year, or approximately 250 customers per day.
These are all very simple calculations, using numbers generated by either our cash register, or our income statements, that can quickly identify whether our coffee shop is able to pay it's bills. If there exists a situation whereby we can't get enough people through the door, we need to address either gross margin, pricing, or average per sale figure. But first we need our break even. Spend some time familiarizing yourself with this concept, and let me know if this info is useful to you.
Sunday, January 2, 2011
Welcome to Coffee Kings
Coffee Kings is my new blog dedicated to helping coffee business owners develop financial literacy through sharing and exploring strategies to profitability. Internet sites, trade associations such as the Specialty Coffee Association of America and trade magazines dedicated to coffee focus primarily on strategies to improve quality, freshness, product range, as well as roasting and barista skills. While these things are very important, none is possible without a profitable business to serve as host. Ultimately each of us founded our companies in order to create an income level sufficient to support our needs, our family's needs and by extension, our employees and community's needs. In the next few weeks, most of us will receive preliminary Financial Statements for 2010 from our accountants. Ideally content published here will advance your understanding of your own company, and furnish you with some tools to positively impact financial results.
One of my goals for Coffee Kings is to focus solely on financials, and how business decisions affect them regardless of the relative positioning of the company's products. Cutting edge espresso bars, and local family owned coffee shops each make decisions which impact profit. Some rely on innovation, some on consistency, some on exclusivity, others on accessibility, all use financial statements.
I have spent some time creating pages on my blog which explain in simple terms, important definitions necessary to the development of financial statement literacy. These pages are Income Statement, Balance Sheet, and Cash Flow Statement. I have also attempted to make these definitions relevant to coffee business owners and I will expand the number of pages as our conversation grows. Hopefully I can generate dialogue and suggestions from some of the industry experts I admire, and some I haven't even met. Welcome to Coffee Kings.
One of my goals for Coffee Kings is to focus solely on financials, and how business decisions affect them regardless of the relative positioning of the company's products. Cutting edge espresso bars, and local family owned coffee shops each make decisions which impact profit. Some rely on innovation, some on consistency, some on exclusivity, others on accessibility, all use financial statements.
I have spent some time creating pages on my blog which explain in simple terms, important definitions necessary to the development of financial statement literacy. These pages are Income Statement, Balance Sheet, and Cash Flow Statement. I have also attempted to make these definitions relevant to coffee business owners and I will expand the number of pages as our conversation grows. Hopefully I can generate dialogue and suggestions from some of the industry experts I admire, and some I haven't even met. Welcome to Coffee Kings.
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