Congratulations, you have decided to start your dream food business. The time is right. You have done your market research and have an idea of what customers want. What about deciding how much money you want to make? As a food entrepreneur, you have to understand your costs before you can know just how profitable your food business will be.
If you are creating a business plan, you need to be completely certain of your gross profit % (GP%). Every investor and bank manager will want to know your gross profit percentage. It is the standard measurement of profitability in the food business. Before you can calculate your GP however, you need to work out your costs. There are typically two types of costs to understand: direct and indirect.
What are my direct costs (ingredients)?
Direct costs are the costs of every single ingredient used to make your cookie. That does really mean everything! You have to know the cost of a single chocolate chip and the cost of every tablespoon of sugar. If you are using 15 chips in each cookie, you need to know how adding 15 chips affects your profit margin. Adding 18 chips rather than 15 chips means that you will have less chips to make the next cookie. It’s as simple as that!
It may sound fussy when you are just starting out, but you can be certain that the company, which sold you the chocolate chips knows exactly how many chips were in that bag as well as all the costs that were incurred in making them. The price of those chocolate chips takes all of these food costs into account. That’s why they are still in business!
What are my indirect costs (non-food) ?
Indirect costs are all the costs (apart from ingredients), which you will incur in running your food business. These are sometimes referred to as operational costs. You definitely have to make allowance for these when pricing your product. Here is a sample list of indirect costs:
• Rent (when producing food from a commercial kitchen)
• Mortgage payments (when producing food from an approved home kitchen).
• Commercial rates (refuse collection, water etc.)
• Labor (how long did you or employees take to make the cookies?)
• Lighting and heating
• Equipment (even if you already own it)
• Logo design
• Business planning software
• Website hosting and maintenance
Many businesses fail in their first year of operation because their owners overlook indirect costs (non-food) and fail to include them when deciding their selling price. It would be a mistake to assume that the costs of your cookies should not include the costs of labor and operational costs (i.e. the costs of running the business).
Just because you ‘already own’ the food mixer, it does not mean you should exclude it and the electricity to power it as costs of production. If you did not buy a mixer or pay for the electricity which powers the mixer, you could not produce your cookies. Therefore you should allow for all these costs as indirect costs in your calculations.
Calculate your gross profit
Okay! Now that you understand the difference between direct costs and indirect costs, you will use this information to calculate your gross profit and gross profit percentage. As a guide, your new cookie business should aim for a Gross Profit (GP) of between 65-70%. This is a standard GP in the food industry. You can always modify it. Let’s go with this figure for now.
You decide to sell your cookies for $USD 8 per pack. Your have worked out that your ingredients (direct costs) amount to $USD 5.00.
1. To calculate GP (Gross Profit), subtract the cost ($USD 5.00 ) of your cookie ingredients from your selling price ($USD 8.00)
($8 – $5 = $3)
2. Got that? Let’s now convert this number into a percentage.
( $3 / $8 x 100 = 37.5%)
You should be aiming for a gross profit of 65-70%. However, it seems that you are only making a gross profit of 37.5%! Ouch! It looks like you are way off target! You may need to choose cheaper ingredients or increase your sales price significantly in order to cover costs.
Keep things simple
It can be very ‘messy’ to work out all your indirect costs and indirect costs, so here’s a very ‘rough’ way of approaching things. Take your direct costs (in this case $USD 5.00) and multiply the number by 4 ($USD 5.00 x 4 = $20).
This gives you a selling price of $USD 20.00 per pack. Alternatively, you can divide your direct costs by 0.25 ($USD 5.00 / 0.25 = 20). Both methods give you the same result.
If you sell your pack of cookies at $USD 20.00, you are now making $USD 13.00 gross profit:
$USD 20.00 selling price – 5.00 food costs = USD $13.00 gross profit
Let’s see what this price increase means in terms of a percentage:
$USD 13.00 / 20 x 100 = 65 %
You are now making 65 % gross profit. That’s more like it!
Another ‘rough’ guide is: 33% direct costs | 33% indirect costs | 33% profit
Some food businesses prefer: 30% food costs | 30% Labor | 30% Overheads |10% profit
Keep things real
There are many types of food businesses making different types of food products under a range of different economic and competitive conditions. These calculations are only guides. You may need to ‘play’ with the price of your cookies if not enough people are buying them at your new price of $USD 20.00.
Your price should BOTH cover your costs AND be attractive to customers. You can make the best cookies in the world, but if they cost more than your competitor’s cookies, not enough people will buy them. Similarly, you can make affordable cookies but if your gross profit is too low, your business will struggle and may have to close.
You can always start with a rough price and change it in response to demand. Keep in mind that the recipes or brand of cookie you make today may not be the brand of cookie you are selling in 6 months time. Consumer tastes change rapidly. Your pricing model must be flexible to allow for such changes.
You are in this to make money
As a food entrepreneur, it is enough to have a pricing formula which you understand and which enables you to make money. When all is said and done, you must cover costs in order to survive. Not only that, you must also make what you deem to be an adequate reward for the time and effort you put into your business.
If you are not making a profit and enjoying yourself, you need to reconsider your options quickly. On a positive note, there is always demand for an excellent food product at an attractive price. With a lot of passion, a little research and a good degree of skill, you can satisfy customer demand profitably.
The number of new food entrepreneurs launching amazing highly profitable bakeries, cereals, health food, craft beers and cookie brands every day around the world is proof of this. Have belief in yourself! You can’t put a price on that!