Boosting Your Cafe’s Profitability – Becoming Profitable: What is Cost of Goods sold (COGS) in Business and How to Calculate it?
Not many people get into business with the goal of not making any profit. Even with changes to how business is done, it’s clear that the core principles to succeed and avoid failure remain the same: be solvent and turnover profit.
But is it actually clear for cafe owners?
Over the next few weeks, we’ll be posting a few articles as part of our series, ‘Becoming Profitable,’ which is aimed at providing insight into running a profitable and successful café.
As people that have owned many cafes, both successful and unsuccessful, we know how it can feel when everything you do just doesn’t seem to get you over the line.
Want to know how much you can actually make from selling a latte? Let’s start with the basics.
What is COGS?
COGS (cost of goods sold) refers to the direct costs associated with the sale of a product or service offered by your business.
Knowing the COGS and how to minimize COGS is vital to the success of any business owner, especially in a volatile economy where you can expect a price increase at any moment.
Let’s talk about direct costs before we dig any deeper.
Direct costs are expenses that can be tied to a specific product or service, for example, making a latte. These directly impact the cost of goods sold. They often fluctuate in price based on how much you might need to order, like milk.
In the context of a café, a few direct costs would be coffee beans, milk, sugar, syrups, and other flavourings. When we’re talking about the cost of goods sold, it also includes the cost of any packaging, takeaway containers used to serve the beverages and the direct labour required to produce the final product.
Understanding and knowing how to calculate COGS can help you make informed decisions about pricing and inventory management, helping you stay on top of price increases, improve your gross margin and increase your cafe’s profitability.
The golden rule: gross profit = sales revenue - COGS
How to Calculate COGS
You’ve made it this far. Well done! You are a few steps closer to becoming profitable. If you are already profitable, you’re in the money. Keep on reading.
An important note: You’re going to need to get your hands dirty here because calculating COGS requires accurately tracking and accounting for all the costs associated with the final product. If you’re serious about becoming profitable, get out all your invoices and receipts because now is the time to shine!
A simple formula for COGS
COGS = cost of ingredients and supplies used + cost of direct labour to produce the product, for example, making a latte or sandwich. Make sure you know the unit costs of each of these products before trying to calculate the cost of goods sold –you’re more likely to get an accurate figure if you do so.
An example: the COGS for a takeaway flat white = cost of coffee + cost of milk + cost of packaging + cost of extras (sugar, syrups) + cost of direct labour to make it.
Benchmarking COGS and target numbers
Now that you know how to calculate COGS, it’s time to benchmark your COGS against industry standards. Benchmarking your COGS might seem intimidating, but it can provide you with a useful reference point to assess your cafe's performance and identify areas for improvement.
What is a good COGS percentage? In the specialty coffee industry, a common benchmark for COGS is around 30-40% of total sales. This means that for every dollar in sales, the cost of goods sold should ideally be around 30-40 cents. It’s important to note that this isn’t the same for everyone, COGS can vary depending on various factors such as location, the items on your menu and your pricing strategy.
In order to better understand and get a clearer idea of your COGS, we suggest separating direct labour from the cost of ingredients and supplies used. As a point of reference, the benchmark for cost of ingredients and supplies should be around 15 to 25% in order to be left with enough gross profit to pay for the rest of your operational expenses.
If your COGS is consistently higher than the industry benchmark, it may indicate that you need to take action to reduce costs. On the other hand, if your COGS is significantly lower than the benchmark, it could mean that you are sacrificing quality or not pricing your products optimally.
You don’t want to sway too far from the industry standard as it can hurt your business at both ends.
Word from the wise: regularly analyse your COGS and track it closely. It might seem like a lot of work, but it’s totally worth it. Having a record of your COGS will also help you if you ever want to sell your café in future, so try to keep a record where possible.
Improving gross margin
Gross margin is the difference between your sales and COGS and here are a few quick tips to help you improve your gross margin:
Optimize your menu
Analyse your menu offerings and identify how you can improve profitability on items with lower profit margins. Consider adjusting prices or removing low-performing products to focus on higher-margin products.
A simple way to do this is to promote items that have higher profit margins, such as batch brew or cold brew. These items have fewer direct costs and consumers expect to pay a little more for them.
Build strong relationships with suppliers
Building long lasting relationships with your suppliers will allow you to negotiate for better pricing on supplies. Enquire with your suppliers to see if you qualify for bulk or loyalty discounts. You can also look to source products from local suppliers to cut out freight expenses and potentially reduce your COGS.
Remember, it’s in your supplier’s best interest to take care of you, especially if you purchase from them regularly. If you do well, they do well. This is why our philosophy at Zest is focused on helping cafes get the most out of our coffee. “Your success is our success” – click here to request samples of our coffee for your café.
Ensure that your staff follows consistent portion sizes to avoid wastage. It’s important to note though, don’t become greedy. Customers can tell. Instead, implement strict inventory management practices, workflows and systems to avoid wastage and prevent overstocking or spoilage of perishable items.
Train your staff
Provide proper training on brewing techniques, milk steaming, and other coffee preparation methods to minimise waste and ensure consistency. This can help you reduce the amount of coffee or milk used per cup, which will ultimately help you reduce costs and result in a more favourable COGS.
We provide free barista training to our wholesale partners, so feel free to reach out if you’re not exactly sure where to start.
Monitor and analyse data
If you are in the position to, implement a café management software or POS systems to track and analyse sales, inventory, and other relevant data. Regularly review reports and data to identify trends, patterns, and opportunities to improve. This can help you make more accurate decisions, that are backed by data, to optimize your pricing, inventory, and operations.
Our team was recently introduced to Viability IO, an AI-led software that helps hospitality operators get a better idea of their business by predicting future sales using historical data.
One of the cool features is its ability to make staffing and general operational recommendations that help improve net profit. We are amazed by how accurate Viability IO is and how it has improved profitability for businesses using it.
Regularly review your pricing strategy to ensure that your prices align with your COGS and required profit margins. Avoid under-pricing your products and consider periodic price adjustments to keep up with market trends, inflation, and changes in COGS.
Focus on customer experience
There’s nothing that can beat good old fashioned customer service.
Creating a memorable experience for your customers can help you build customer loyalty and increase repeat business. Happy customers are more likely to return and send more business your way, which can boost sales and profitability in the long run by increasing your volumes (and thus decreasing the impact of direct labour onto your COGS).
Common mistakes and pitfalls that affect gross margin negatively.
There are some common mistakes that negatively impact gross margin in cafes. Try to avoid the following things to ensure your gross margin isn’t in the red zone:
- Not sufficiently increasing the price for a large or extra-large coffees. This means you wear the cost for the additional coffee and milk, resulting in inconsistency in your gross margin percentage.
- Not charging an appropriate surcharge for more expensive ingredients such as plant-based milks or special coffee blends or singles.
- Buying cheaper quality ingredients or packaging. Doing this reduces the value and experience of your product. This can affect the reputation of your business and negatively impact your profitability through lower patronage. Keep in mind, if you’re using a $30/kg coffee instead of a $25/kg (only $0.05 more per cup), it allows you to sell your cups for an additional $0.20, and you can easily justify the increase due to the improvement in quality.
- Not increasing prices when ingredients, packaging or labour costs increase. This is a current problem in many cafes where margins are hurt due to café owners trying to maintain current prices. It might be okay at the start, but it’s not sustainable and will negatively impact profit margins over time.
Let’s be profitable together
Understanding and effectively managing your COGS is essential for improving your cafe's profitability. By accurately calculating COGS, setting target numbers, and benchmarking against industry standards, you can identify areas for improvement and make informed decisions that will help you improve your gross margin. Continue reading along as we explore ways to make cafes more profitable.