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.
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