Without Knowing Your COGS, How Can You Become a Master of Margins?
One rather sad truth that I know to be true for all of my distillery clients… When a shopper looks at a bottle of their spirits on the shelf, they have no idea how much it costs to produce that bottle. Another sad truth? That is also the case for many distillers themselves. The simple truth is, figuring out the actual cost of one bottle of distilled spirits is much more complicated than it sounds. Yet, there is nothing more essential to the overall success of a distillery business than truly understanding the actual cost of production.
And you know what? We are in an inflationary time, that makes understanding the costs of the various elements of your product even more essential. Taking ownership of understanding the cost of production can make you a master of margins! So, let’s get into this.
Components of Cost Production
Raw Materials – As a shopper gazes at the bottle on the shelf, prepared to satisfy his/her taste buds, the last thing they may be thinking about are the raw materials that go into making this coveted creation. The yeast, the hops, the grains. Furthermore, what they DON’T know is that the price on these raw materials can fluctuate.
Labor Costs – We know that the most essential (and expensive) piece of the puzzle is actually the cost of labor. Whether it is the expert that makes sure that the mashing operation is done correctly, the young lady that greets visitors in the tasting room, or the cleanup operation that makes sure everything is clean for the next day, labor is at the heart of what we produce.
Overhead Expenses – There is nothing cheap about producing distilled spirits at scale. In addition to all sorts of “normal business expenses”, it requires investment in a warehouse, stills, and production facilities. While this doesn’t fit neatly here, I will also mention the maturation process. The fact that some spirits need to sit for longer periods of time before they are ready to sell can add to the costs and complicate the calculation.
Packaging and Labeling – Recently I read a book that talked about distilled spirits (or in this case moonshine) being distributed in old bottles that were reused from around the community. The cost of that glass containing the liquid gold has risen so much over the last few years, including the freight associated with shipping the glass, labels, corks, & label designs. How times have changed. Now we hire branding consultants, and create unique and individualized bottles and labels. Each of these items add to the overall cost of the product.
Marketing and Distribution – Next we get to Marketing and Distribution costs. The sad truth is that no matter what the movie The Field of Dreams tells us, they won’t just come just because we build it (or in this case make it). Selling our products means incurring marketing and distribution costs.
Doing the math
Ok, now that you have gathered all of the information above, I can see you thinking to yourself, “Ok Robin, that is great. I have a bunch of numbers, but I am no closer to knowing the cost of an individual bottle of spirits.” I get it. When you are dealing with both fixed and variable costs, getting to the cost of actual bottle by bottle Cost of Goods Sold (COGS) is complicated.
I will be honest, this part is more of an art than a science. Here is how I get my distillery clients to their individual bottle COGS calculation:
- Step 1: Figure out fixed costs for a given time period (a year is ideal if you have the data)
- Step 2: Determine your production of sellable products over that time period.
- Step 3: Calculate the full variable cost of your product.
- Step 4: Divide the result of step 1 by step 2 and add the results from step 3.
Is that a precise calculation? Nope. Does it give you a good idea from which to start? Yep.
What to do with that information
If you are with me still, you might be wondering why you care? Does it really matter what the individual price of a bottle of spirits is? Isn’t it just important if your company is profitable or not? This is where I like to use a line from Dr. Sharon Fieldstone, one of my favorite (and sadly underrated) characters from Ted Lasso, “The truth will set you free… but first, it will piss you off.”
While overall profitability numbers can give you the big picture, knowing the individual elements of your COGS calculation gives you a superpower, you will become what I like to call a “margin master”. As a master of margins, you can make better decisions about individual elements of your business knowing how they will impact your COGS and thus your profitability.
Well? Can you tell me the cost of your most popular selling product? If not, why not work with an expert that can help you figure this out (and so much more). At KBS CFO, we specialize in working with Distillery customers in making sure that they understand their numbers, so they can understand and grow their business. Get in touch.