Why calculating cost of production is key to food production business success

2.5 min read

Many food and beverage products are a labour of love, started when a market opportunity is identified by someone who has the expertise to develop a distinct product or formulation.

Labour of love

Small businesses can be so enamoured by their product that they can fail to see some of the potential obstacles in their way.

Companies may be well-aware of their product, material and labour costs, yet the costs associated with growing the business may be a blind spot. Small businesses can be so enamoured by their product, says Quebec consultant Yanick Bouchard, that they can fail to see some of the potential obstacles — or production costs — in their way.

“So many times, companies have great ideas and products, but they don’t know how to bring them to consumers,” says Bouchard, whose company, Solution YB, works with small and medium-sized businesses to help bring their products to market. “It’s quite a bridge to cross.”

Factors such as retail price, cost per unit and distribution costs are fundamental yet frequently overlooked costs. They need to be considered up-front to ensure the business’s continued viability, he says.

Hard to go back

What sometimes happens, Bouchard explains, is detailed costs are forgotten at the time of launch. Then, several months into the venture and with some experience, the costs are identified. Processors may be tempted to increase retail prices to cover overlooked expenses. It is a tough move, Bouchard says.

“[Processors] know the cost of ingredients for that one unit, and how much labour [it requires], but they also have to include all of the other variable and fixed costs that contribute to financing the product,” Bouchard says. “This is where very often the problem starts, because they’re not clear on that level.”

Other expenses to consider when calculating the cost of production:

packaging
transportation
advertising
equipment depreciation
equipment repairs
rent
interest
taxes

Gross margin calculation

Bouchard points to the importance of knowing the business’s gross margin, which is calculated as the difference between revenue and the costs of goods sold (commonly referred to as COGS), divided by revenue and expressed as a percentage.

“If you are not over 50%, you will have difficulty considering larger distribution and keeping the same retail price,” Bouchard explains, adding that gross margins should ideally be in the 70 to 80% range if the business is to have a viable growth path.

“At 70 to 80%, we’re starting to have a serious opportunity,” Bouchard says.

For any products with gross margins of 50% or lower, Bouchard immediately inquires if either the cost of materials or labour can be reduced. If that’s not possible, the only other logical path to profitability comes from raising the price.

However, that carries considerable risk, especially if your product’s price is significantly more than that of your competitors.

“If your product is now sold at $20 and all your competitors are at $10, you might be out of the market,” Bouchard points out.

While it’s exciting to launch a new product and begin selling, it’s critical to take the time to detail projected income and expenses. Cost of production is a fundamental piece of business intelligence, often overlooked by many small businesses.

Article by: Chris Powell

Money & Finance