Flight to Safety

We've all noticed the recent price increases from the December '13 contract low of $1.07 to recent inter-day highs of $2.07 so I thought I'd create a quick post to reassure.  We all know the well covered Roya stories, and I've written plenty about it, and to some extent this provides an excellent base for this price spike.  There is no denying that regionally there are shortages, Guatemala is especially dear right now due to Roya, but there are no pan-market shortages.  The same for the Brazil drought which was well publicized, creates worry but the long term effect is minimal.  The big mover of soft commodity (including arabica) prices right now is turmoil in the equity markets.

  For those who don't follow the market closely, last year was a massive year for investors...30% rise in markets not driven by earnings, but earnings multiples or the number of times you multiply earnings to discover a price for a stock.  There have also been dozens of Initial Public Offerings which have come to market that have priced at Tech Boom prices last seen in the late 1990's.  Many took those gains, locked them in early in January, and shied away from more speculative equities, gone to US treasuries, driving down the yield to about 2.65%.  (Coincidentally, Soft Commodities often move in the opposite direction to Treasury Yields)  

Earlier this week I posted a tweet from my twitter account @ottotrader , indicating that $2.05 was a key level of resistance for the price of arabica.  Technical analysts view this as a point where IF the price breaks through and settles above for a few days, the price will most likely go much higher.  The price breached this level twice in the past couple of weeks, most recently on Thursday but retreated to $2.01 on Friday.  Keep a close eye on this price for the most recent (kck14.nyb May) contract for an indication of where prices will go in the near term futures.  Again, if it goes higher than $2.05  and stays there for a couple of days, hold on, we're going to go much higher, not because of shortages, drought or disease, but because of a movement to safety...physical things that large funds can hold until the equity markets settle down.  While you're at it, watch the equity markets and US treasury Yields to see how they move in opposite direction to the Soft Commodities (including arabica) in times of uncertainty.

The Coffee Profit

Over the past couple of years that I've been writing this blog I've been contacted directly by dozens of you for advice on either business plans or specific questions unique to your business.  Many people are searching for advice and help from someone they trust without spending half their budget on consulting fees or worse, being made to feel insignificant because you can't afford (or are too smart to pay) exorbitant fees for services you are not certain you need or understand.

It is for this reason that I am offering a service for anyone out there who already has a business plan, but just wants someone to go over the plan, line by line, including the financials, and provide feedback designed to save you money.  Introducing...The Coffee Profit

Welcome to The Coffee Profit.  For 17 years I’ve owned and operated espresso bars and a wholesale roasting company while posting my business observations on a successful blog. Through my blog, many people hoping to open a coffee shop, espresso bar or roasting company have come to me for opinions about their business plans and most importantly their financial projections.

If you search coffee consultants on the web a long list of “We can do everything” companies pop up while the sound of your money flying out the door haunts your sleep.  You’ll never learn to fly by watching a chicken flap its wings…

I’m not those guys!

I offer one service, and one service only…I read the business plan you’ve created yourself and offer feedback and advice that is guaranteed to save you thousands of dollars.  Simply contact me and I’ll send you a link to upload your business plan to a secure Dropbox Folder, give me a week to review and produce recommendations, then we’ll schedule a one hour phone call to save you money.  Only after you are completely satisfied with our phone conversation will you receive an invoice…wait for it…for only $250.00.   If you recognize that I’ve saved you thousands of dollars and improved your chances for success, you can opt to place yourself on a $50 monthly program where, once your business is open, I will review your monthly financial statements and schedule a half hour conversation to discuss your results.

If this sounds like the kind of service that will help you make money in your coffee business, contact me at rich@thecoffeeprofit.com

Cafe Accounting Episode 1

 
     You're an expert in your field.  You have been working as a barista for several years now, you know your craft, and all of the details and procedures necessary to run a successful cafe.  Your current boss trusts you with the keys, the security codes, the cash register and their customers...for good reason.  Every day you show up early, eager to calibrate your espresso grind and pull some shots so that when the first customer arrives, you can confidently look them in the eye and boast "I made this...for you".  Every shift offers new challenges, mechanical,  procedural, staffing, quality control and customer interactions, but you are up to it and deal with everything like a pro.  There are things about the business that you don't quite understand yet, but that's what keeps you eager to show up early and master whatever presents itself.

Everything about you says "I'm ready to run my own espresso bar" except one thing...money, how to track it and how to make it, after all, you can't make espresso unless you make money.

You know what your boss charges for coffee, heck, you even know what Starbucks charges for coffee, and they both seem to be making lots of cash.  How hard can it be?  You know that customers LOVE the drinks you prepare and how you serve them and you are confident they'll come if you had a store of your own.

If this sounds a little like you, then I hope to provide you with the financial knowledge and confidence to leverage your skills into running your own shop.  In the next few posts I'm going to produce a narrative that I hope will be easily understood for even the most timid budding masters of coffee business.

I'm going to make this series as easy to read as possible (even a bit corny), with very few Financial Terminologies, and a lot of common words and phrases so that you completely grasp the concepts used in EVERY business financial statements.  This is not going to be a post, but instead, a series of long posts walking you through the steps a new cafe owner would take in Mastering the Finances of their business.  I expect to edit this many times once it is posted, to make it flow better, include some details that readers notice are missing, or add things that I should have noticed on my own.  This series is intended to give you power over your own business finances, and if I am happy with the result, I hope to work this into a presentation which I hope to debut at a coffee industry event in 2014.  I hope this in helpful.

Here we go:

You've got a great idea to open your own espresso bar, fortified with several years of experience as a barista and a few more as a store manager.  There is a great spot that opened up in a promising neighbourhood (not too close to the shop you manage), and you think this is the time to finally act on your dream of owning your own shop.  You've been saving up your tips and even have some money that your grandparents gave you for a graduation present.  All together you've $20,000 of hard earned cash as seed money for the rest of your life.  This money represents countless hours of dedicated work, great customer service, not to mention the hopes and wishes entrusted to you by close family...it is a significant amount of money and not something to be committed without planning and diligence.  If you are going to dedicate this money as your seed money for your dream business you had better find a way of keeping track of it.  It represents your business hopes and you want to know it is safe. To keep track of it you write your investment down on paper.  On the left side of the paper you write:

That feels great.  Twenty grand is a lot of cash and it looks even better on paper, but hey, did you notice that the 2 sides equal each other?  Why?  

On the left side of the paper we record the valuable things the business has, and on the right...who owns those things.  Just because the business "has" things, doesn't mean it owns those things.  In this case, the Owner's Investment is something to be used by the business...but make no mistake, you own it.  At the bottom of this page you add up all of the items in each side and create a Total, with equal numbers on each side...What The Business Has, and Who Owns It.  Balanced, just like a BALANCE SHEET.  This is the first financial term you will become familiar with.  Get comfortable with it,  Balance Sheet...What the Business Has (Left Side), Who Owns It (Right Side).

Now just because you are new to business doesn't mean you are foolish or unrealistic...in fact the opposite.  You are careful, thoughtful, and diligent because this is your dream we're talking about.  You've penciled out an equipment list along with some quotes from local tradesmen, and you know for a fact that you will need at least another $80,000 to start your business.  While you've been saving and planning for years, you are still very short of the money needed to start your shop, but good news arrives just in time.  All that planning has paid off when your application for a bank loan attached to a government sponsored program to encourage new business is approved!   The faith the bank and the government has placed in you and your business is well founded.  The experience you bring to the table, and your own investment seals the deal for you, but we now need to record these new funds in your new BALANCE SHEET.

Now THAT is impressive, $100,000.  On the left side of the sheet the business has $100,000 to use to get the business off the ground.  On the right side of the sheet you record the $20,000 that belongs to you, and $80,000 which belongs to the Bank.

The Left Side = The Right Side...Balance Sheet.

Now is the time to introduce two new Financial Terms, Assets and Liabilities.

We are going to replace "What the business has" with Assets.

Assets are things that the business can use that have value ie Cash

We are going to replace "Who Owns it" with Liabilities.

Liabilities are things that the business Must pay back ie Loans

When an owner makes an investment in their own business it is also something which the business Owes, but most owners don't draw on this money until the business is making enough money to pay it back.  So instead of simply recording it as "Owner's Investment" like a Loan we are going to place it under the Heading "Owners Equity".  Equity means:  Owner's Share.  In this case, the owner's share of the $100,000 = $20,000.  Got it?  So let's re-do the Balance Sheet to reflect these changes.

Now is the time to introduce you to the most important rule of Accounting.

ASSETS = LIABILITIES+OWNERS EQUITY

Memorize this, it is the equivalent of "the sun rises in the east" for accounting.

Now that you've accounted for the new Bank Loan and introduced some fancy new accounting terms you're feeling pretty good about yourself.  You've begun to feel some power and ownership over this enterprise and you are developing a sense of control.  All of the preparation time and effort is paying off when your contacts within the coffee industry come through by telling you about a relatively new cafe that has closed its doors, having run out of money and stopped paying its rent.  The landlord, after seized the equipment, is offering the equipment and fixtures for sale and is willing to take an amount roughly equal to 50% of the original purchase price.  For the grand total of $30,000, you take possession of a lightly used espresso machine and grinder, a bean grinder and scale, 10 tables, 20 chairs, blender, signage, some small wares, two refrigerators plus an awesome display refrigerator.  You know that there are many things you will still need to buy before you open your shop, but this is a great find and you close the deal with a handshake.  A handshake is all it takes because you are good to your word.  You arrange with the landlord to pick up the items (after preparing a certified cheque for 

$30,000 payable to the landlord) and talk your parents into storing the items in their garage until your beautiful new space is ready.  Lets now make an entry to reflect the changes.

Notice how our Balance Sheet has changed.  On the Assets side, we have exchanged $30,000 in cash for $30,000 in equipment.  The total value of everything has not changed at all...you still have $100,000 in Assets.

Notice that nothing has changed on the Liability Side of the Balance Sheet.  Everything remains the same.  The total must equal $100,000 because remember, we are working on a BALANCE SHEET.  The left side always equals the right side, and when that happens:

ASSETS = LIABILITIES+OWNERS EQUITY

While negotiating your bank loan, sweet talking your parents, high fiveing your buddies and scoring big on the equipment purchase, you also found time to get a great deal on a 5 year lease for that awesome corner spot you've had your eyes on.  After reading a blog on the subject, (see my post on Negotiating a Lease) you decided to ask the landlord for a contribution to renovating the space.  You're not sure whether it was your steely gaze, you playing hard to get, or the landlord's faith in you and your concept, but whatever it was, the landlord decided to contribute the equivalent of 3 months rent ($7,500) to the renovation plus grant you 2 months free rent to get the space ready to open.  All together, the landlord is contributing $12,500 to getting your business open.  This is a HUGE deal for you since the plumber has informed you that the City Building Department has notified him that you need to install handicapped accessible washrooms which will increase his estimate by approximately $2,500.  The cabinets are also going to cost you more than expected mostly because you have decided to install marble countertops to match the table tops which came with the tables you bought from the failed business liquidation.  All together you will be spending $60,000 to renovate your awesome space, including electrical, plumbing, refinished hardwood floors, new cabinets and counters, framed in handicapped washrooms, storage room, drywall, paint, a prominent outdoor lighted sign, plumbing and electrical fixtures.  One of the biggest hassles proves to be the permits required, but the process of producing architectural drawings by a professional firm proves to be a great investment, easing the permit process by providing all of the documents and drawings required by the City Building Department. 

Lets now make an entry to reflect the new expenditures.

The Balance Sheet has changed resulting from the money spent on renovations and the landlord's contribution to the expenses.  In order to reflect these changes on the ASSETS side we have reduced the Cash by $52,500 and created a new line called "Fixed Assets" which contains all items which are considered "fixed or attached" to the building, like cabinets, toilets and sinks.  The other $7,500 needed to make up the $60,000 comes from the "Landlord's offer to pay for some expenses" as an inducement for you to sign a lease.

On the LIABILITIES side we have created a new line called "Landlord Contribution" totalling $7,500.  Both sides total $107,500 and of course are BALANCED.

The building process is now almost complete and you are creating a lot of buzz in the neighbourhood after placing a sign in the papered up windows proudly declaring "Coming Soon...My Awesome Espresso Bar".  It is time to start assembling the goods you need in order to open.  These include, milk supplies, coffee and tea supplies, cups and lids, take away bags and trays, and find a dessert supplier.

You've been in the coffee business for several years and have selected a local roaster who happens to employ one of your best buddies.  They have a great reputation and have even offered to work with you to create an espresso blend just for you!  Since you are new to business, and the roaster has been around a while and seen companies come and go, they ask you to pay for your first order BEFORE they ship.  These terms are similar to every other supplier except the cool local baking company who offers you terms of Net 7 Days. (The bill must be paid within 7 days of invoice).

You've thought of everything needed and place orders with all of your suppliers totalling $5,000 PLUS a baked goods order of $100 for the first day.

Let's make an entry to reflect these changes.

Notice what we've done.  We reduced the Cash balance by 5,000 but create a new line called "Inventory", and simply converted Cash into Inventory.  Inventory are things the business sells to make money.  In inventory we also add $100 which represents the baked goods that we have but don't need to pay for until 7 days have passed.  On the Liability side, everything remains the same EXCEPT we have created a new line called "Accounts Payable" where we record the $100 that you need to pay to the local baker in a week.  This is a subtle but important point:  Notice how the totals have increased by $100.  This represents the value of the baked goods and it increases the Balance Sheet Total but doesn't really make the business wealthier.  Don't confuse a big number in the Balance Sheet Total with a Valuable Company.  The increase simply means that the baker contributed to the value of the baked goods (Assets) that company can use to make money, but the other side of the Balance Sheet (Liabilities) clearly shows that the company owes that money to the baker as an Account Payable. 

You have done your planning, saved your pennies, borrowed a great deal of money, and with it, made your dream a reality.  The contractors finished on time (due mostly to a great deal of pushing and prodding from you), and tomorrow you are ready to open the doors!  You haven't hired any staff yet because you want to save as much money as possible and think the demand may take a few weeks, even months to grow.  While your cafe can comfortably seat 20, you expect to slowly fill those seats.  Offering very simple baked goods will help you to keep service requirements minimal, so you can focus on preparing the best coffee in town.  Early on you expect to do about 100 transactions per day, which is no problems since that is about half of what your previous employer's shop did in a morning.  Working alone doesn't worry you either, sure the restroom breaks might be a little challenging, but your buddies said they would stop by and give you a break, free of charge, just to get you on your feet.

Your cash register is nothing more than your 2 year old ipad with Square Register loaded on it, a simple cash box made from an old fishing tackle box, and a data plan for your ipad so you can process transactions.  You are ready!  Tomorrow you open for business, so the priority is to get a good nights sleep and arrive like you always do...early for your shift.

Cosmetics and Good Taste

Yesterday I read an article announcing some incredible findings from a Harvard study relating reductions in suicide rates and coffee consumption.  Other than my shock at the positive mental health benefits of coffee which are new to me, something else struck me as very interesting.

When I read news about the positive benefits of coffee consumption I normally picture a typical Specialty Coffee customer, automatically placing the news within a personal context.  However, whether a person drinks the finest coffee available, or the saddest gas station swill, the physical and mental health benefits are enjoyed equally.(Reduced type 2 diabetes, positive for parkensons prevention, same alzheimers, fends off oral cancers and some skin cancers, reduced depression, reduced suicide etc). Additionally, the caffeine related increase in alertness, stamina etc also accrue equally whether a person drinks the finest cappuccino or a vending machine mess.
Interestingly the poor quality consumer brands offer a further benefit by being considerably cheaper than Specialty Coffee, making the significant health and stimulant benefits accessible to those with less discretionary income.

The only benefits Specialty Coffee wield over the discount brands are taste (a huge factor) and "perceived or cosmetic" attraction to brand, theatre, process or origin.  I think it is helpful to understand that when researchers announce new and amazing previously unknown benefits of coffee consumption, that it is good news for ALL coffee drinkers...even those who consume the lowest strata of beverage quality. 

Truth and Obfuscation

Coffee is perhaps the least understood of all commodities, even by those whose livelihoods depend upon it.  It is so misunderstood that any mention in media is immediately given unassailable credence and is repeated, retweeted and reposted endlessly to the point where consumers believe Kopi Luwak is the finest coffee available, coffee is the 3rd most traded commodity in the world and the only way to benefit growers is to buy something with a third party certification.  We accept these mistruths as part of the landscape with the understanding that we must correct the misconceptions by personally engaging consumers every time they are referenced.

Over the past couple of years, the exceptional rise and fall of arabica prices have generated their share of inaccuracies and deliberate obfuscation of the facts by individuals and organizations with an agenda other than the efficient operation of the Market.  

The unusual ascent of prices 2010-2011 was blamed on increased consumption by BRIC nations whose huge population moved the market by depleting stocks.  Every news organization repeated this story, The Specialty Coffee Association of America repeated this story, and it was widely accepted as fact.  So what happened in 2012-13 to consumption in the BRIC's if it was true?  Did the massive increase disappear?  Has consumption in the rest of the world drop significantly to cause the price to drop?  No, the BRIC story was just that, a convenient story served to an industry looking for a simple explanation to a complex problem.  I've posted a couple of times about the BRIC situation, and so won't rehash old posts, but it is useful in demonstrating our willingness to buy into a story with almost no vetting.

More recently the Leaf Rust Disaster has become the most written about story of coffee in the press.  I am not doubtful of the devastating effect Leaf Rust has had, or will have, on individual growers, but on a macro level its impact is highly questioned by coffee traders.  Individuals and organizations predicting wildly exaggerated drops in harvest numbers and apocalyptic estimates of job losses and social upheaval are common.  As I mentioned in my previous post, the Market doesn't believe the story, and has recently settled the price of arabica below $1.30 for the first time in 4 years.  Even more striking is the price for coffee to be delivered one year from now, which sits below $1.42, not reflective of market conditions which expect supply to drop by 20-30%.  I can understand how activists and large exporters might feel they would benefit from promoting stories of harvest failures and Supply Shocks, but the mistrust and uncertainty these stories create actually hurt growers rather than benefitting them by reducing market liquidity and increasing uncertainty.  Non trade investors who simply purchase contracts as an investment are not likely to participate IF they feel that uncertainty (delta) is too high a factor.  Remember, it is those speculators who deserve most of the credit for the price increase of 2010-11.

The reality is that small growers are not generating the misinformation, and must simply react to the information they consume.  They have no choice but to be Market participants, their family income depends on it.  When they read stories of huge drops in harvest numbers, they are inclined to plant more to benefit from an increased price they naturally expect, which will negatively impact pricing going forward.  These small farmers might also be tempted to hold coffee off the Markets in the near term, with the expectation of higher prices in the future...which never arrive.  The incremental gaps in Supply which may develop when small farmers withhold coffee, is quickly filled by large green coffee holders looking to dump past crop on the market, hurting small growers.

  

Today I read a tweet composed by a well known writer within the coffee community which boldly stated "the world is running out of coffee".  Why someone hoping to attain or retain any credibility would tweet such a thing is debatable, but I prefer to think it is misguided good intentions hoping to push prices higher for the farmers they are obviously emotionally attached to.  Statements like these, if left unchallenged are not likely to result in higher prices, but markedly lower prices when plantings increase in an already oversupplied market causing larger surpluses.  The fact the market is oversupplied is unquestionable...prices don't EVER drop in a market with supply shortages...EVER.  As I stated previously, these statements also discourage all but the most risk seeking speculators from participating, reducing the bid numbers on all offers.  

The solution to chronic low prices is not fantasy stories of pan-global crop devastation and destruction, but honest, transparent, trust building relationships between Supply and Demand participants.  As an industry, let's recognize that the Supply side benefits from the halo's we've placed above their heads, and disabuse the notion the Demand side all have tridents and horns ready.  Maybe once we've accepted that premise, we can begin to talk about balancing Supply and Demand to achieve a fair price growers deserve and consumers want.  

Helileia Vastatrix and Coffee Futures

Over the past several months there have been a flurry of panicked press releases and hastily arranged meetings to deal with an outbreak of Helileia Vastatrix or more commonly
Coffee Leaf Rust or Roya. The International Coffee Organization calls it an epidemic, The Specialty Coffee Association of America calls it a devastating outbreak while the participants who trade Arabica Futures appear dismissive.  The purpose of this post is not to examine the degree or veracity of the claims, but to review how the Futures Market is treating the claims.

I have covered the incredible rise and fall of the C over the past few years, and have been critical of both the forces driving the price to unsupportable levels in 2010-11, and the efforts by large players to support the price in the face of price deflation. Last year in Portland at the Specialty Coffee Symposium a Costa Rican Official claimed a 30% reduction in harvest numbers for 2013 due to lack of pruning, planting and heavy rains. This year, the 30% number was again trotted out in reference to the Roya outbreak, and many reports of vast devastation were circulated. In both cases, the claims failed to move the price of the C in any significant way. Today the Futures Market Price for Coffee to be delivered in March of 2014 is $1.50.  There is no doubt that a 30% reduction in harvest numbers from affected producing countries would create a massive shortage of coffee worldwide, throwing Supply and Demand out of balance. The Shortage would drive prices up well beyond the $3 level we witnessed back in 2010-11 where there we no Supply or Demand shocks effecting change. So why has the price not moved up if the market believed and expected that the harvest would fall significantly. In order for there to be no impact resulting from a supply shock there would need to be an equal demand shock compensating for the reduced supply. In other words, demand for coffee would need to plummet (without a price increase causing it) at the same rate that supply decreases. That scenario is highly unlikely.

A quick glance at the Options chain going forward or the Futures pricing beyond Q1 2014 reveals a normal time premium (contingency for unexpected shocks) but nothing even remotely approaching numbers necessary to compensate for a huge supply shock. Again, the Market is expecting a price of approximately $1.50 for Arabica delivered in March 2014.  These are the numbers produced by the most sophisticated coffee traders and financial analysts in the world leveraging ALL of the known information regarding the arabica harvest. They read the reports on Leaf Rust, rain, pruning and planting...so what gives?

 I'm speculating (guessing) that the world of arabica traders doesn't believe the claims or severity of the outbreak or some combination of other factors. I'm concerned. As recently as last night I posted to my twitter feed a prediction that the price would break out of the narrow trading range it's been bound by when it breaches $1.44 spot. I have formed this opinion based on a conventional strategy used by chartists who view a 3% increase over the recent high within a narrow horizontal trading range as being a strong indicator of sustained upward price movement.  When this move happens it will be blamed on Leaf Rust, but don't believe it because leaf rust has failed to move the market to date.  The move will be driven by the price breaking through a key chart indicator, the search for alternative investment vehicles while the Equity Markets are falling, and relative weakness of the USD.

My advice is for all those involved to be careful when reading reports assigning specific numbers to harvest losses which are wildly speculative and often formulated with the intention of influencing market price.  Remember that the C is a zero sum game.  When the market functions rationally, a shortage (or perceived shortage) of supply always results in an increase in price thereby benefitting producers who are unaffected by any production problems.  Conversely, when there is an abundance of coffee in the supply chain, the prices drop and all parties are harmed.  Without diminishing any difficulties facing growers who are battling leaf rust, if there are significant supply shortages, the price will rise and growers unaffected by leaf rust will benefit from the price increase.

*NOTE:  The C, in the three trading days since I wrote this piece, pushed over $1.43, bristled at the breakout price and retreated strongly to (at present) $1.378.  I believe this validates my assertion that the  Market does not believe in the Leaf Rust narrative, and that the $1.44 price level is significant.  If over the course of the next few weeks the price retests the recent high of $1.43, the breakout price will reestablish at approximately $1.47.  Time will tell, but there is little doubting that currently Arabica Traders do not believe Leaf Rust will adversely impact Arabica Supply next year.

A "C" Change

Today The Dow Jones Newswire carried a story which is the most significant development in Specialty Coffee in a decade.  The article indicated that a new Futures Contract specifically for Specialty Grade Coffee will begin trading next year.  As I have suggested in several previous posts including one 2 years ago (Delinking from the C Part I and Part II) and 1 year ago (The Shared Hedge), Specialty Coffee deserves and needs a special contract to more accurately set pricing and to insulate from the vagaries of the C which is fed and starved by speculation.
The establishment of the Specialty Coffee Futures Contract will necessarily (due to low liquidity/volume) trade with a much higher risk (Delta) premium than the C, as I suggested in the exchanged counterparty option contract of The Shared Hedge.  This new Specialty contract should act as a true hedge rather than a speculative vehicle and therefore appeal mostly to coffee growers, green merchants, importers and roasters leaving speculators huddled around the C where volume and liquidity provides safety should they need to wind up a contract to free up cash.  Mark my words...THIS IS HUGE!