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Metrics to Monitor for the Health of Your Business, or the Importance of Prime Cost

Metrics to Monitor for the Health of Your Business, or the Importance of Prime Cost

Nov 9th 2021 Written by Steve Morrow

Believe it or not—and if you have ever spent a few minutes hanging around an espresso machine, you probably believe it—coffee shops can be wasteful. One culprit is milk. In many cafes, the pitcher rinser doubles as an excess-milk dump and on any given week, over the course of dozens of business hours, gallons will have found their way into the drains. If you own the business, you traded real money for those gallons, so every ounce represents a concrete cost; and every ounce dumped represents a concrete, measurable loss. Cents turn into dollars and by the end of the year: hundreds, if not thousands, of dollars, not to mention the environmental impact and labor associated with getting the product from cow to carton and on to your fridge.

Any milk not accounted for by the customer’s purchase, i.e., that which slips down the drain, is a financial loss. So far this year, the average cost in the United States for a gallon of milk is as follows: $3.64 for whole milk and $4.10 for organic whole milk, for an average of $3.87. Imagine a scenario in which a shop sells 128 lattes per day; and imagine, too, that for each latte, an ounce of steamed milk remains in the pitcher after the pour. Uh oh. Down the drain goes 128 ounces, or one gallon (convenient math, no?), per day. This waste costs the company roughly $3.87 per day, $116 per month, and $1,400 per year. We know this industry. The margins are slim. A lot can be done with fourteen hundred bucks, especially if a machine goes down or other unforeseen costs mount.

The above illustrates the importance of accounting for everything. We believe in applying the same attention to detail to all aspects of a business, including cash flow, cost of goods, prime cost, and more, everything that goes into the profit and loss statement, and everything that affects the people involved. It may seem like we are splitting hairs, but as business owners know, ignoring the details is detrimental to success. The objective of all this measuring is to identify what is helping the business and what is hurting the business. Armed with this knowledge, the hurting can be eliminated, or at least addressed, and the helping can provide a blueprint for best practices.

Prime Cost

If you are only going to study one metric, or have time for only one, being overburdened by the various tasks of running a business, having a life (how is it possible for the kids to have so many soccer games?), etc., then we suggest Prime Cost (PC). This is a bit of a cheat because in order to calculate PC, one must know two other metrics: Cost of Goods Sold, or COGS, and Cost of Labor. So by paying attention to PC, you will by necessity be paying attention to two other important metrics; but Prime Cost does something more: it highlights problem areas. If we are over-staffing or spending too much on overhead, it will tell us; and if we are overbuying or wasting inventory, it will tell us. It is never wise to cut corners on ingredients or staffing. We should always strive to provide the best for our customers. But if there is something happening in the numbers, especially something detrimental to the financial health of the business, we will want to know and do something about it.

The first step in this equation is to calculate the subordinates: cost of goods sold and cost of labor. The former refers to the money you have spent for “ingredients”—think coffee, milk, syrups, etc., for a coffee shop. The easiest way to think about this is to think about the beginning and end of a time period, say a week or a month. The cost of what you had at the beginning of the period minus the cost of what you have at the end of the period is equal to that which has been sold, or cost of goods sold. Account for any new inventory bought during the week as if it had been part of the beginning inventory because, in a way, for accounting purposes, it is. If nothing is added to the inventory during the accounting period, the equation looks like this:

  • Beginning inventory – Ending inventory = COGS

On the other hand, if inventory is added, the equation looks like this:

  • Beginning inventory + New purchases – Ending inventory = COGS

“The general rule is that Prime Cost
should be somewhere around 60%.”

The next step is to calculate the cost of labor, which includes the hourly rate, payroll taxes, and benefits for each employee. This can quickly get out of hand—especially if you employ many people—so we recommend investing in a timesheet app or software that does these calculations for you. Most point of sale systems on the market will allow integrations, including for popular accounting programs. The best math is, of course, easy math.

Once you have the COGS and labor costs, you can calculate the Prime Cost, which is just the sum of the two. If the COGS is $50,000, for instance, and the labor costs are $10,000, then the PC is $60,000. But the math usually doesn’t end there. PC is not much to look at without context and context is only possible with one extra number: sales. Most restaurateurs think about PC as a percentage of overall sales, that is Prime Cost divided by Sales. The general rule is that PC should be somewhere around 60%. If sales amount to $100,000, we are on track. If, on the other hand, sales are closer to $80,000, and the PC at 75%, the business may be in trouble.

Knowing Prime Cost isn’t going to fix an ailing business. However, it will help us see what, if anything, is the problem, and provide some options for action. If the percentage is higher than 60%, in other words, a closer look at the particulars of labor and inventory costs is in order; and if the percentage is lower, a closer look at the quality of inventory and staffing is in order. Is the coffee or dairy substandard? If so, the drink quality might suffer and customers may choose to go elsewhere. Is the café understaffed? If so, morale may be low and stress high; turnover may become a problem; and customers may feel neglected. Either way, PC gives us something concrete to think about and thinking about the business, especially with data, is always a good thing for the health of the company. If you want some help looking at the numbers or would like to chat about other aspects of starting and running a coffee shop, reach out to our commercial services team.

Nov 9th 2021 Steve Morrow

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