How to work out profit?

[bobfather]

coyft said:

bobfather said:

The Austrian School of Economics teach a very good principle. Do all those things mentioned above to determine the fixed and variable cost of running the business.

Then as a totally separate activity, determine the maximum value that your chosen customer base would give to the items you intend to sell. Once you understand your customers maximum value position you simply need to price a little below this and ensure that this results in a positive financial delta, if the delta is negative then do not proceed with the venture as it is guaranteed to fail.

The principle is that both supplier and customer should sense that they have profited from the transaction. You receive more money than it cost to produce, your customer buys something for less than they were willing to pay, both perceive that they have profited.

Any debate about cost-plus product pricing totally misses the point and fails to maximise your profit. BTW The Austrian School of Economics is world renowned for creating the worlds most wealthy entrepreneurs.

Great theory, but unpractical in this scenario. How can he possibly know his potential customers maximum value proposition for a cup of tea! There are way too many variables including how the customer is feeling that day. In any event, all customers aren't the same, you may determine that a customer a) would pay £3.00, customer b) £1.00 and all prices in between for customers c-z. It totally over complicates what is a very simple business. Give the place a nice ambiance, serve good quality consistent food and drink, together with friendly service, price you products competitively in the marketplace, locate the cafe in a good location with plenty of passersby and be better than your competitors. That's all you can do. Once the place is busy, you can experiment with your pricing. Get the basics right first, before worrying about maximum value your potential customers are likely to give.

I understand that this is theory or rather it's an academic model but it points out that cost-plus business plans miss out on potentially larger profits. There are many business models for which it is difficult to apply the principle because there is insufficient market information. In this case it is easy to work out his customer profile and the value those customers have for his products. Is it intended to be the equivalent of a Greasy Spoon or a Costa Coffee? Sure there will be variation among potential customers but there is also a norm (target customer). From there he can judge the pricing from the type of outlets he intends to emulate. Smart businesses have been doing this for years. It's not an exact science but it's better than sticking a finger in the air and it opens the opportunity to improve profit margins.

[V8mate]

BoRED S2upid said:

What an interesting thread to read everyones different views on the subject.

That's because so many people offered the answer based on their own experience rather than for the OP's situation. Calculating profit margins for a factory producing widgets is much different to the approach taken by a cafe, for example. And the scenarios above reflect that.

I would suggest that the OP follows Landlord's approach (though I'd run it ex-VAT), listens carefully to customer feedback and then takes another look at his prices in 2-3 months, tweaking as necessary. Invariably, you will find some items which can make a greater (and others a lesser) gross margin than those set by the rule of thumb.

Good luck!

Edited by V8mate on Tuesday 20th October 13:50

[HiRich]

I think Road2Ruin has a point, but perhaps slightly different from what the OP wants and Landlord is commenting on.

It would be very wise to do weekly (and monthly) financial analysis. Two sets of numbers for:

• Revenue (money through the till)
• Variable costs (food bought)
• Gross profit

Set 1 is your absolute minimum GP - basically the red alert figures you must achieve to pay the bills for the week.
Set 2 is your low target - your amber alert figures where you are just covering your costs (so rent, rates, bit aside for maintenance and emergencies).
Weekly, you can see wherther you are doing OK, struggling, or heading to oblivion. You can then assess costs and revenue (both rate of sale and value of each sale) with appropriate urgency.

You can also model your typical week (how many of what item you expect to sell at what price). You can now analyse where your profit is coming from, and how it is generated (size of margin, rate of sale). This would help you focus on problems:- your breakfast menu is popular, but lunch is weak, so try a different menu or lower prices for lunch.

Getting back to the original question, which as someone spotted would appear to be what prices to put on the menu. Landlord has given a guide formula - it's worth dumping this into a spreadsheet, but it is just a guide. You also need to use your skill & judgement to decide what the market will accept for a cup of tea or whatever, and make sure it's higher than your costs.

You've now got the tools for estimating pricing, estimating weekly financials, and making a weekly assessment of how well the business is doing.

[TooLateForAName]

Enough of this waffle!


Will there be pasties?

[DamianBlades]

TooLateForAName said:

Enough of this waffle!


Will there be pasties?

Cheers guys for the advise, currently trying to digest through it all.

Yes my good sir!!! and there will be discounts for you fine gentlemen of PH on pies

[thisislife]

I would folow HiRich comments, it all made good sense to me and is how i would work out pricing.

[Eric Mc]

Current VAT registration threshold is £68,000 per annum by the way (not £50,000).

[Muzzlehatch]

Don't forget to factor in for things such as bad debts, wasted stock, and depreciation.

[LivinLaVidaLotus]

HiRich said:

Gross profit is therefore 77p. Of that (depending on the VAT rules relevant) 15% effectively goes on VAT, leaving a nominal gross profit for your calculations of about 65p

It's been a while since I looked at VAT in relation to food stuffs, but the VAT will be a variable proportion - because some of the input materials may well be VAT exempt, but the output most likely won't be - so you can't rely on claiming the VAT back on the whole of the expenses and if you're operating on slim margins then forgetting about this fact could cost you all your margin and then some.

Muzzlehatch said:

Don't forget to factor in for things such as bad debts, wasted stock, and depreciation.

If you do the weekly figures and keep track of what has been sold then the wasted stock should be able to be kept to a minimum - as you should be able to spot trends, as a really obvious example: A decline in icecream sales as you approach winter (although worth keeping an eye on the weather as the big boys do).

Edited by LivinLaVidaLotus on Thursday 22 October 16:49