What does it take to make my small winery profitable?
What does it take to make your small winery profitable?
Aside from a love of wine and passion for the craft, it takes conscious, careful planning.
Let's address the challenging reality first. Making a profit with a small winery isn’t easy. Actually, let me rephrase that: getting to the point where you can make a profit isn’t easy. Once you have everything in place–the product, the brand, the team, the marketing, the sales channels, the facilities–it can be quite easy to turn a profit year after year. But getting to that point is the hard part.
The components of operating profit
So how is operating profitability defined? What is included and what is not? Not all of the cash flowing in and out of your business is included in calculating profit. All of the inflows and outflows are considered in your statement of cash flows, but only certain items are considered in profitability and included on your profit and loss statement.
How is operating profit defined? Operating profit is the money that a business generates from current operations during a set period of time. Your profit has three major components: your revenue, your cost of goods sold, and your operating expenses.
The calculation for profit does not include your winery's investment in equipment or facilities or in building up inventory. It also does not include funds received via debt financing or owner investment, principal payments on debt, distributions to owners, or income tax payments on business profits (unless you are organized as a C-Corp).
Of course, positive cash flow is important. Ultimately, you need to get a return on your investment. Otherwise that asset you built might turn out to be nothing more than a liability. But the first step to getting a return on your investment is creating operating profit. Operating profit is what ultimately takes your investment and generates cash, so that you can pay yourself back for making that investment.
Understanding gross profit
Understanding the difference between cashflow and profit for a winery is a bit more difficult than it sounds. But for the moment, let’s just focus on operating profit. What does it take to achieve sustainable operating profitability?
The short answer is that your operating expenses need to be less than your gross profit.
Let’s back up a moment and make sure you understand gross profit.
Operating revenue is the first component of operating profit. Revenue is fairly straightforward. It’s the sales you make from selling wine, or other products and services.
Gross profit is the second component of operating profit. Gross profit is defined as your sales revenue less whatever it cost you to produce the products sold (or the services provided) in that period. The costs are your costs of goods sold for that period. This is different than your production costs. When we are talking about cost of goods sold or gross profit, we need to know the costs that were incurred to make the specific bottles of wine that are sold during the period.
For instance, if you sell a bottle of wine for $30 and it costs you $12 to make that bottle, then your gross profit on that bottle is $18 and your gross margin percentage is $18 divided by $30, or 60%. In this simplified example, if you sell 1,000 of those bottles of wine in a month, then your gross profit for the month would be $18,000. ($30,000 minus $12,000). It doesn’t matter if you also bought $100,000 worth of grapes during that month. That goes on your balance sheet, not your profit and loss.
So you can see that it is essential to know your cost of goods sold for each month if you want to measure your operating profitability. If you don’t know your cost of goods sold, the whole exercise falls apart. Determining your cost of goods sold is a topic for another post, but for now, let’s make some assumptions.
In general, winery gross profit margins fall between 60% and 80%. For wineries that are doing full-absorption costing (i.e. using UNICAP rules or following GAAP), the number will be closer to 60%. In this case, you are including overhead costs for your production facility, production labor, and associated costs, and depreciation on barrels and winery equipment in your costing, along with your raw materials costs (grapes, bottles, corks, etc).
If you are only including raw materials in your cost of goods sold, your number may be closer to 70%, and even as high as 80%.
Warning: If you are posting all of your winemaking purchases directly to the cost of goods sold section of your profit and loss and not posting a calculated cost of wine sold, then your gross margin on your financial statements will be drastically off. If this is your situation, this is probably a good time to call your accountant.
Once you have determined your gross profit, you can take a look at your operating expenses and see whether they “fit” within that gross profit. If not, you’ve got some work to do.
If your gross profit is not currently covering your operating expenses, then one thing you can do is cut expenses. Cutting operating expenses increases your bottom line, your operating profit, dollar for dollar. But simply cutting expenses, once they are incurred, is not always that easy. You should certainly keep a close eye on your expenses, but we are all doing the best we can. So once you are running your operations as leanly as you can, the other place to look is at your revenue.
Understanding your business's parameters and potential
First of all, take a moment to take a step back and assess your winery’s parameters for revenue. This is often directly related to your capacity for production. If your business plan entails making wine at your own facility, then some quick math may provide you with the maximum amount of wine you are be able to produce at your facility annually. Combine that with what you think you can sell your wine for and you will easily see the maximum top-line revenue you can expect.
For instance, if you have a small facility that can reasonably only produce 1500 cases of wine a year, and you expect to sell your wine at $300/case directly to consumers, your maximum top-line revenue would be $450,000.
Even if you are using a custom crush facility or have more flexibility with your production space, you will often know far in advance how much wine inventory you can expect to have available for sale each year, which should give you a general idea of your target revenue.
Just a caveat that you don’t want to be too optimistic when projecting revenue based on inventory. Make sure you take into consideration discounts, wine samples, and shrinkage. If possible, use a historical number for revenue per total case depletions when calculating your future revenue.
Once you have an idea of your expected revenue, you can combine this number with your gross profit margin percentage to come up with a projected gross profit. Your gross profit is what you have to spend on operating expenses, while leaving enough left over to pay down debt, invest in inventory build-up, and eventually pay back owners.
Your projected gross profit should directly inform your decisions about hiring and other major expenses associated with selling your wine. Understanding your revenue limits is essential for making informed spending decisions. Once you incur an expense by hiring for a new position, building a tasting room that needs to be staffed, hiring a marketing contractor, investing in a software platform, etc, it can be pretty difficult to downsize those expenses. So you will want to think carefully before you incur them.
Profit levers to pull
When it comes down to it, there are only a handful of ways to increase your profit:
Increase your volume of sales
Increase your pricing on the same volume of sales
Decrease your costs of production (which will eventually increase your gross margins in two or three years…)
Decrease your operating costs
Decrease your depreciation, by investing less in equipment and other fixed assets
Decrease your interest expenses, by lowering your debt
You will want to make sure that your whole plan works together, from your revenue to your margins to your production levels to your operating budget.
Fortunately, owners don't have to shoulder this responsibility alone. This is where your accountant or winery CFO plays a vital role. An experienced winery accountant can help you look at all of the factors involved, help you forecast various scenarios, and help you build a plan that leads not only to profitability but to an eventual return on your investment. Whether it's deciding when investing in new equipment or facilities makes sense, or deciding when to can a specific sales channel that isn’t pulling its weight, working with a financial partner who understands the intricacies of the wine business can help you make smarter, more profitable decisions for your winery.
P.S. Planning your revenue and profit goals for next year? We have a new profit planning calculator coming soon! Sign up for our newsletter to hear more.
