The Food Business Profit & Loss Account
We deal with a considerable number of food businesses. One of the things that we always stress (and with all business owners for that matter) is to understand the profitability of your business. To know whether or not your business model is profitable is essential and not something that you can wait until the year end to discover. In a consumer product business this is even more important as you generally will only get one opportunity to set price with your customers. If you get this wrong it could be fatal to your business.
So what are the components of the Profit & Loss Account:
Minus Cost of sales
Equals Gross profit or Gross Margin
Equals Net Profit
So what are sales? This would seem pretty straight forward. It is generally the value of the sales invoices raised for product sold. That is only partially correct in a food business. The invoice value is what is known as “Gross Sales”. There may be some other factors that impact your sales and move the number from Gross Sales to Net Sales.
If you are selling to multiples there will generally be an expectation that you will partake in various promotion cycles throughout the year. This plan is often agreed at the start of the year. You know the ones that you see advertised – buy one get one half price or €1 off etc. The cost of these promotions will in most instances be passed back to the supplier. This charge from multiple or retailer to the supplier is often referred to as an LTA or rebate. It results in a reduction in your effective selling price. While it is very difficult to know what the LTA cost may be in advance it is very important that an estimate is made to account for it in your weekly or monthly sales figures so that you can determine what your true Net Sales price is.
Every product type you sell is a SKU. A Key Performance Indicator (KPI) that you should monitor on a monthly and cumulative basis is the average net selling price of each individual SKU. This is determined using the following calculation:
SKU “A” – Gross Sales less (expected LTA) divided number of units sold
By tracking this Average Selling Price (ASP) for each SKU you can monitor trends and where profit is being eroded. You will also be able to compare the ASP by customer and this will allow you to make strategic business decisions (Do I continue to service a particular customer?)
Cost of Sales
Cost of sales is the cost of producing all units sold. This does not therefore include the cost of your stock on hand. Again in a food business, with potentially a number of different products and several ingredients going into each this can be difficult to determine.
All costs of creating the product need to be included – raw materials, transport in, packaging, labour.
Ideally for each SKU you should have a Bill of Materials (BOM). This is effectively the recipe or inputs required and the cost of each element.
For labour, at a minimum you should be using a best estimate per unit. Let’s say that you have 2 staff members who work full time in production for you. They each earn €400 gross per week. This would be €443 including employers PRSI. Assume that for the last 3 weeks, on average, they have produced 2000 units of products in total. A fair estimate of labour cost per unit would therefore be €0.443 (€443 x 2 divided by 2000 units)
The Bill of Materials for each SKU should become your best friend and should be a template that you use when pricing, amending pricing or before making any major business decision. Knowing this is what will result in a successful business model.
Gross profit (used interchangeable with gross margin) is Net sales minus Cost of Sales. In an ideal world you want to develop a system to calculate this number by each product. The gross profit divided by sales gives the gross profit %. This is another key indicator that you should be tracking.
In a food business the Gross Profit number is key. You need to ensure you get very comfortable with the components of this number, understand what impacts it positively or negatively and design KPI’s to monitor. You want to get to this number by SKU and track week on week, month on month.
What can impact Gross Profit?
Some of the key factors that can effective gross margin are:
- Net sales price
- Increase in raw material costs
- Foreign exchange – this is particularly relevant post Brexit. If you sell in Sterling, a weakening Pound negatively effects your net sales while if you buy your raw materials in Sterling a weakening Pound reduces the cost of your raw material input
- Labour efficiency – In the example above we used 2000 units as the average production run in a week. Let’s say that the boss is on holidays for 2 weeks and everyone takes their eye off the ball and only 1500 units are produced for each of those weeks. The labour cost per unit now jumps to €0.59 or 15cent higher per unit. If you normally produce the product for €1 it now costs €1.15. If you were selling for €2 this is the equivalent of a 7.5% reduction in gross margin per unit!
- Production Efficiency – as with labour efficiency for every unit of raw material that goes into production, a target number of finished products get produced. If this efficiency is not maximised margin can be eroded.
The majority of costs below gross profit are fixed (salaries, rent & rates, utilities). Sure, there will be increases in those costs when the business scales (i.e. you take on another sales team member, or rent additional space) but when monitoring if your current business model is profitable or not you are most interested in the gross profit number by SKU. If that profit is sufficient the rest is a volume game. Your aim is to increase volumes to a sufficient level of cover and exceed the fixed overhead costs. If there is no gross profit the business model is not profitable and the longer you stay in business, the more money you are going to lose.
As you try to grow your food business ask yourself the following questions:
- Do I know what my average selling price is by product and by customer?
- Do I track this information in a spreadsheet or graph?
- Do I understand the LTA or rebate expectations or contracts I have signed up to? Do I know what this will mean for the net sales value?
- Do I have a Bill of Materials spreadsheet for each of my products which allows me to determine the cost of production?
- Do I know my margins and target margins? By SKU?
- Are gross margins reviewed and monitored with reasons for variances investigated?
- How do I arrive at my pricing when pitching for new business?
As always, if you would like to discuss any aspects of the above or to have a chat about how Comerford Foley could help your Food Business feel free to contact us.