Keeping your customers happy? That’s the easy part of running a coffee shop. Up to 60% of cafés and small restaurants close in their first year of opening, for reasons such as market saturation, inadequate capital, industry inexperience, and a lack of business planning.
So, how can you plan for financial success as a coffee shop owner? What are the most common financial mistakes and how can you avoid them?
I spoke to Jim Starcev and Mark Calhoun of PerfectCube and Chris Deferio of the Keys to the Shop podcast to get their advice. Jim and Mark are presenting on Real Numbers in Your Café: The Financial Side of Running a Successful Business at Coffee Fest New York 2019 this March 3rd to 5th, while Chris is presenting on The Top 10 Ways to Lose Employees. (You can book your ticket here.)
These talks are part of a range of free and paid workshops in Coffee Fest’s Business Operations Track. Topics include Business Owner Bootcamp, Pricing Strategies, and Cut The Waste & Save Money. The International Restaurant and Foodservice Show of New York is also taking place alongside Coffee Fest.
Here’s what Jim, Mark, and Chris had to say about running a financially healthy coffee shop.
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Don’t judge your profitability by your popularity.
Understand Your Costs & Profits
It’s one thing to know your cortados from your piccolos, but do you know the difference between your fixed and variable costs? As a café owner, understanding the ins-and-outs of costs and profit models will help you shape your business plan.
This knowledge is also useful in discussion of litigation and legislation, when consulting with an accountant, and when deciding if you should invest in new equipment or open a new site. Most importantly, it will help you isolate which factors you need to focus on or streamline to increase your profitability.
“Thankfully, coffee does not have any special terminology to speak of when it comes to business metrics,” Chris says. “This means you can talk to someone about setting up a good system of metrics to track in your shop and it requires no translation whatsoever.”
So, here are some common financial terms that you should be familiar with:
Profit margin: The amount by which revenue from sales exceeds costs. When considering adding a product, you should factor in the costs of materials, waste, and labor. This will allow you to price the product so that all these costs are adequately covered.
Your profit and loss statement (PNL) versus your balance sheet: Both of these are financial statements that companies issue on a regular basis to demonstrate the financial health of their business. A profit and loss statement breaks down the revenues, costs, and expenses incurred during a specific period of time. A balance sheet is a record of a company’s assets, liabilities, and shareholders’ equity at a specific point in time.
Cost of goods sold (COGS): The direct costs of production of goods sold in a company. This includes the cost of the materials used as well as the direct labor costs involved.
Prime costs: The direct cost of a product, accounting for the materials and labor involved in its production, excluding fixed costs. Jim says, “I like prime costs as a number because those are your two variables that you control – COGS and labor.”
Variable versus fixed costs: Fixed costs often include rent, buildings, machinery, etc. Variable costs are those that vary with output. “Your variable costs [are] what your COGS and your labor ratios are [combined],” says Jim. “Your fixed cost is your rent and your overall occupancy costs. [These are often] the three drivers to determine if your coffee shop’s making [profit] or not, in most cases.”
Food costs: How much it costs you in raw materials to make a dish as a percentage of how much revenue you generate from that item. This helps you price your menu appropriately. “It’s also a way that you could venture into tracking waste,” says Jim. “I know exactly what an item should cost me to do; I [also] know this is how much of [the item] we sold. [If] my ideal food costs were 22%, and my actual COGS were 24%, I know I have exactly 2% of waste.”
Return on Investment (ROI): A measure of the gain/loss generated on an investment relative to the amount of money invested. “You want to make sure that every business decision you make – buying a piece of equipment, discounting, etc. – is going to be worth it and whether you’re going to get your investment back on every dollar you spend,” says Mark.
Cost of growth: The cost of financing your own growth and expansion, usually sustained over a period of time.
A busy café can still fail if it mismanages its profit margins and costs.
Wage War on Waste
Tracking, managing, and minimizing waste is a key part of financial success. But what should you focus on to reduce waste, especially of bulk perishables like coffee, milk, and in some cases, food?
All my interviewees agree that it’s important to manage your inventory well. “You should be keeping track of inventory turnover and basing how much you have on the shelf on how quickly you can move it,” says Chris. “Overstocking the storage closet will tie up all your cash that could be used to serve other needs in the café as they come up.”
“[With] inventory management, there are just a lot of nuances you really have to understand, particularly, ‘what is the shelf life of all my products?’” adds Jim. “If my pastries last two days, having a week’s supply of pastries is a very big mistake; coffee lasts two weeks, but carrying two months’ worth is a problem.”
Chris says, “Keep track of how quickly you go through a five lb bag on bar, and the retail bags too.” When it comes to restocking the bar, look at your retail shelves for bags that are aging out for customer sales (two weeks is a good general rule). Then, brew that coffee on your bar instead of ordering a new five lb bag of the same beans.
“The worst that could happen is you end up with a ton of coffee that is too old to brew on bar because you can’t move it and then end up donating it or giving it away,” Chris stresses.
Additionally, it’s important to balance what storage will cost you versus what it will cost you to always maintain a fresh and lean inventory. “You don’t want to have too much inventory unless it saves you more money in the long run,” Jim tells me.
For example, there may be a delivery charge for your milk. “If I’m paying a delivery fee and suddenly find milk is going to cost $5 a gallon versus $3 a gallon every time I do this, I’ll suddenly start thinking, I could do one delivery a week [instead of two],” he says.
Know how much milk you need to have in stock – and how much is being poured down the sink.
Recognize Your Hidden Staffing Costs
Tracking most product wastage is relatively easy. But what happens when you are wasting things that are either less tangible or harder to isolate? Can you track how much these factors are indirectly eating into your profit margin? What are some of these hidden costs and how do you mitigate them to the best of your ability?
Some hidden costs are caused by a lack of staff training. Costs can rise as a result of bad portion control – small amounts of milk, food, and coffee add up over time. “[Often] you’ll have someone make a latte and [they use] as much milk as they need and steam it, fill the cup and… there are two or three ounces left that are just dumped down the sink,” says Jim.
“Things that result from a lack of training and therefore accuracy are [coffee wastage when] dialing in, brewing too much, back-up brewed coffee, breaking service vessels, not keeping up with the preventative maintenance of equipment, etc,” adds Chris. The answer, he tells me, is to train yourself and your staff to be knowledgeable, detailed, and intentional.
“Staff costs are one of the biggest factors to consider when looking at the profitability of a shop,” he stresses. “Training staff needs to follow a robust onboarding system that invests significantly up-front in order to properly equip baristas for success long-term. Cutting costs by cutting training never works in the long run.”
Good staff training can result in the efficient use of time and resources behind the bar.
Another common culprit is overstaffing, which Chris jokes is a hidden cost that isn’t quite so hidden. “Owners sometimes never think to look at the number of people on a shift because their workflow is built around a particular number,” he says. “But if the numbers don’t justify three people, you need to adapt and adjust.”
“When people are busy, they tend to overschedule the beginning and ending of [busy periods],” Jim adds. “But… if it’s 15 minutes in front, and 15 minutes behind, that’s 30 minutes. 30 extra minutes for three people working [adds up to] 1.5 hours. If that happens five times during the week… it makes up a massive difference to you.”
Mark also cautions against letting your feelings dictate your staffing levels at any particular moment. “We’ve seen this a lot: before they get busy and right after they’re busy, [café managers] keep the staff levels high because they feel busy, but they’re really not,” he says. “They need to start letting people go home.”
This can be difficult for a number of reasons, especially for small coffee shop owners. Often owners and baristas have a relationship bordering on friendship, and owners know that their staff needs the hours. Additionally, there may be laws in place restricting employers from cutting hours that have previously been contracted.
What’s more, cutting hours has the added negative impact of increasing staff dissatisfaction. This could exacerbate turnover in an industry already notorious for its high staff turnaround levels.
The solution, Mark and Jim think, is smart and predictive scheduling. This allows staff to predict busy and quiet periods, and allows owners to be transparent about when baristas might be expected to stay longer or leave earlier. It permits a greater level of flexibility with which to mitigate hidden labor costs.
In addition, fair compensation, clear communication channels, and a culture that both cares for and challenges employees to grow can reduce turnover.
Read more in How to Keep Your Best Baristas From Quitting
Empty tables and no line mean fewer staff members are needed behind the bar.
Manage Your Menus & Pricing
No matter how efficiently your coffee shop runs, you will still fail if you don’t have a sufficient profit margin per item or a menu that draws in customers.
According to Chris, it’s essential that your shop offers variety – but not so much that you end up sacrificing quality. “There are staples that people will come in for daily, like coffee drinks, beans, and tea,” says Chris. These are your main business drivers and need to be both high quality and highly profitable.
“Don’t offer too much to try to please everyone. You won’t,” advises Chris. “Keep it simple and excellent.”
Yet don’t pare your menu down too much: it’s still a good idea to offer added-value items, like food, that also attract people. You can also choose to sell retail items.
As a general rule, Chris believes that the acceptable profit margin for beverages should be around 70% after factoring in all the material costs. For retail items, he recommends doubling what you paid to start with and then adding a bit more in order to profit from the sale.
When considering your pricing strategy, Jim and Mark emphasize that it’s also important to implement small incremental price increases at least annually. “It’s just a healthy way to run your business,” says Jim.
“It has almost no effect on you losing customers. Most coffee shops are scared of price increases because there’s one irate customer and they worry that everybody’s thinking that way. But the truth is that 95% of your customers probably didn’t even notice.”
Jim and Mark tell me about one of their clients who used PerfectCube’s technology: the client raised their prices 5% and, as a result, lost 1% of their customers. However, this still resulted in an additional US $1,300 of profit.
“What we’re trying to demonstrate is that even if you do upset 1% of your customers and they never come back – which won’t happen – you know you’re still going to make more money because that’s how profit margins work,” Mark says. “We want people to understand that it’s safe to raise prices in small increments, to do it annually.”
Chris warns against the temptation to price low to attract more business. “This will kill you in the end,” he says. “You need profit to sustain business and grow. Price what you need to make enough profit so you can serve your customers well into the future.”
Consider pricing up best-selling items or seasonal items. Mark recommends perhaps tying price increases with a promotion or changes in the season. And he stresses, “Most customers either never notice, or they don’t care, because they understand costs go up.”
Select your menu and prices carefully to ensure healthy profit margins.
Calculate Your Ideal Shop Size & Layout
Finally, your shop layout and size have a direct impact on your financial success. Avoiding bottlenecks and frustrating design elements is key since these factors can make people seek coffee elsewhere. Your customer flow should be intuitive and painless from start to finish.
Product placement is also essential. Retail needs to be in eye-catching areas where people naturally gather and look, such as when they first walk in, while they’re waiting in line, and at the register.
If you have a bigger shop, you will most likely be paying more in overheads. Designing your café to give you (at least) the average number of customers daily that you need to profit is critical. Consider not just the optimal number of covers, or customers ordering and consuming food and beverages, but also your rate of customer turnover.
You don’t want your coffee shop to feel so full that it turns customers away. You also don’t want to have too many covers relative to your staffing levels, which could be detrimental to customer service.
“For this, you need to know or project what each customer spends or needs to spend,” says Chris. “You can find reports on the average number of sales, average ticket amount, and average number of items purchased on the back-end of most POS systems.”
The rate at which you turn your tables over can affect the shop size you need in order to profit.
Running a financially viable café is not just about good branding, good coffee, and a good customer experience. It’s also about careful planning, understanding your profit margins, and reducing your costs. So make sure that you really know your business. Work out how much you need to make, how much you need to serve, and how much stock and staff you really need.
Because knowledge and planning truly are key to success in the café industry.
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