When it comes to running a coffee shop, financial jargon like “breaking even” often gets thrown around. But do we truly understand what it means to break even? In this blog post, we’ll explore the concept of breaking even, the financial challenges specific to the coffee industry, and essential metrics every coffee shop owner should know.
What Does Breaking Even Mean?
Breaking even is often misunderstood. It doesn’t just mean that a business is covering its costs; it implies that the business has generated enough revenue to cover all its initial setup costs and ongoing expenses.
Often, breaking even is conflated with profitability. A business can certainly be profitable without breaking even. Take, for example, a business that borrows $500,000 for initial startup and buildout costs. If that business makes $1,000,000 in the first year, with the bottom line net profit being 10%, or $100,000, and ZERO of those dollars are taken by the owner as distributions and put completely towards the loan, the business still hasn't hit "break-even". However, this business is clearly profitable.
Initial Costs and Challenges
For coffee shops, initial costs can be substantial. Here’s a breakdown of common expenses:
- Espresso Machines and Equipment: High-quality machines can cost tens of thousands of dollars, along with other equipment like grinders, refrigeration and furnishings.
- Build-Out Costs: Renovating and setting up the café space can be a significant investment. Commercial construction, in 2024, is near an all-time high.
- Initial Inventory: Purchasing the first round of coffee beans, milk, and other supplies. If you're looking to purchase custom branded products, the number gets even more substantial.
- Staffing: Hiring and training baristas and other staff members can take your time or a managers, plus the cost of staffing the employee being trained during training hours.
These costs can quickly add up, making it challenging to break even, especially in the first year.
Realistic Financial Expectations
In the coffee industry, achieving profitability, let alone breakeven, can take time. Here’s a realistic outlook based on our experience:
- Year One: It can be extremely hard to hit profitability in your first year in business. Your focus should be on building a customer base and refining operations.
- Year Two: You might start to see positive cash flow, but significant profits are still unlikely. Expect a higher top line (total revenue) along with better management of cost of goods sold (COGS), leading to a better net profit percentage.
- Year Three: With steady growth and optimized operations, reaching profitability becomes more attainable.
Key Financial Metrics
Understanding and tracking key financial metrics is crucial for managing a coffee shop’s financial health:
- Profit and Loss Statement (P&L): This report shows your revenue, costs, and expenses during a specific period. The bottom line indicates whether you’re operating at a profit or a loss.
- Cash Flow Statement: Unlike the P&L, this statement tracks the actual cash coming in and going out, providing a clearer picture of financial health.
- Cost of Goods Sold (COGS): This includes the direct costs of producing goods sold by the business. For a coffee shop, it involves coffee beans, milk, syrups, and other consumables.
Looking Behind the Profit and Loss (P&L) Statement
If you take away one thing from this podcast or article, let it be this: the Profit and Loss Statement does not give a full picture of your company's financial health.
The following are not shown in your Profit and Loss Statement:
- Inventory Assets: Some businesses simply record inventory as cost of goods sold if they're selling through items in a reasonable time. But when you're dealing with inventory that lasts months, such as a roastery who purchases a container of green coffee or tens of thousands of custom coffee bags, it becomes necessary to book inventory as an asset that is then transfered to COGS monthy. Therefore, if you purchase $10,000 worth of green coffee, but only use $1,000 worth of that inventory in January, only $1,000 will be reflected on your January P&L.
- Fixed Assets: When you purchase a substantially priced piece of equipment, such as an espresso machine, that purchase is depreciated either at the end of the year (as a Section 179 deduction according to US Tax Law), or over the course of several years. Therefore, in many cases, you do not reflect this in the month/year you purchased the item, as you would
- Loan Payments: If you take a loan for startup, working capital, or anything else, only the interest you pay on the loan will be registered on your P&L. Loan payments can be a substantial percentage of your monthly revenue, so just looking at a P&L bottom line can be extremely misleading.
Want a spreadsheet that can help you get a better picture? Download our Cafe Viability Spreadsheet and get a picture of what your financials and cash actually look like, including loan payments: Cafe Viability Spreadsheet
Strategies for Financial Success
- Control Initial Costs: Opt for a lean startup model where possible. Prioritize essential equipment and consider used options for non-critical items. You can always add things as you go, if you build out your space to accommodate additions. For example, we started with a simple, white, plastic impervious service as our backsplash, then tiled later (ourselves) a couple years later when we had more cash reserves.
- Monitor Cash Flow: Regularly review your cash flow statements to avoid surprises and plan for future expenses. Don't keep your head buried in only your P&L.
- Optimize Pricing: Ensure your pricing covers both direct and indirect costs, while remaining competitive in the market. Don't be afraid to raise your prices yearly.
- Build a Loyal Customer Base: Invest in marketing and customer service to retain customers and encourage repeat business. Your regulars are the key to keeping your business going year over year.
Case Study: Valor Coffee’s Experience
At Valor Coffee, we’ve navigated these financial waters firsthand. Here are some insights from our journey:
- Lean Build-Out: For our Alpharetta location, we opted for a more cost-effective build-out strategy, which helped us manage initial costs better.
- Strategic Budgeting: We set a budget and prioritized essential expenses, allowing us to allocate funds effectively without overspending.
- Continuous Improvement: Regular feedback from staff and customers helped us refine our operations and improve efficiency, contributing to financial stability.
Conclusion
By understanding key financial metrics and implementing strategic budgeting and operational improvements, coffee shop owners can navigate the path to profitability, while setting a longer-term goal of breaking even. At Valor Coffee, we’ve learned that a combination of financial acumen and a commitment to quality service can lead to sustained success.
