Production Cost and Gross Margin of the Business

Production Cost, how to calculate and analyze

Let's do the calculation and analysis of the cost of production of the business, after drawing up the sales plan that we have already discussed. Explain how to calculate the cost of production and, subsequently, be able to calculate the gross profit margin of our project, to assess its economic viability.

Estimated reading time: 7 minutes

With the example of the catering business, we will now discuss the impact of our ideas and strategy, to calculate the cost of production, as well as the profit margin.

The products we sell daily

As we saw in the example of a restaurant presented, the sales plan of daily meals is as follows:

Daily Sales Plan, prices with VAT
Daily Sales Plan, prices with VAT

In summary, our idea is to sell 25 meals a day at an average price of € 9,28, with VAT included.

What we now want to know is the production cost of these meals to calculate and analyze the profit margin that this sale will generate.

For this we have to calculate the costs of the raw materials necessary for the production of the menus.

Let's admit that one of the dishes we are going to make is “Alentejo-style pork".

Of course, the Chef knows how to prepare this dish, what are the ingredients and the best way to present it to be a success.

As we are not chefs, when consulting a recipe we concluded that the ingredients are as follows:

Recipe for 4 servings:

  • 600 g of pork
  • 2 onions
  • 2 garlic cloves
  • 1 tablespoon of pepper paste
  • 4 tomates
  • 2 tablespoons of olive oil
  • 800 g of clam
  • as coriander
  • qb salt
  • qb pepper
  • qb butter
  • qb lemon and pickles
  • 2 dl of white wine
  • 2 bay leaves
  • 2 cloves (cloves)
Atlantic clams Calculate Production Cost and Gross Margin
Atlantic clams; Calculate Production Cost and Gross Margin

The Chef's touch has no economic and financial expression here, but it will truly be what will make the difference, without losing sight of the fact that the dish has to be profitable, under penalty of having the best product in the world but which, in the short term, does not generate a sufficient profit margin.

Alentejo Pork Meat Calculate Production Cost and Gross Margin
Pork; Alentejo Calculate Production Cost and Gross Margin

What is the production cost of each menu

With the quantification of the ingredients, we built a plan with the production cost of this particular dish:

Production Cost of Pork Meat in Alentejo
Production Cost of Pork Meat in Alentejo

If we don't know the cost of the ingredients, we go to the supermarket next door, or look up prices using the existing online markets.

We can thus analyze the production cost of each dish and compare it with the price at which we propose to sell it.

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Prices with or without VAT

We know that Raw Material prices are with VAT - Value Added Tax.

Therefore, the average price paid by our client, as already mentioned in Sales Plan, is €9,28 but for the business we can only count on €8,07, assuming an average VAT of 15%.

On the other hand, VAT for food is 6%, but we can make the plan with VAT included in the costs, which gives us some additional leeway, or we do a more rigorous process where we calculate the VAT value of each ingredient and we deduct this value from the cost.

Calculate the profit margin or gross margin of this menu

To calculate the gross profit of a product or service, it is enough to make the difference between the sale price and the production cost. Profit is therefore a monetary value.

Gross Profit = Sales - Production Cost

To calculate the gross margin or contribution margin of a product or service, simply make the difference between the sale price and the production cost (gross profit) and divide by the sales value. Multiplying by 100 the result is a percentage value.

Gross Margin = Gross Profit / Sales (value in %)

In this case, the sale of the “Carne de Porco à Alentejana” dish is €8,07 excluding VAT and the variable cost or production cost is €11,24/4 = €2,81 (VAT included).

So, on average, if the dishes are sold at €8,07 and their cost is €2,81, our gross profit is €5,26, or 65%. Put another way, the production cost is 35% (100%-65%) of the selling price.

It looks like we are going to have a good profit margin, but we must not forget that we have not yet calculated the margins of the other products we want to sell, namely drinks, coffees, desserts (see daily sales plan below) nor the fixed costs or costs of our restaurant.

Sales of the various products, prices without VAT
Sales of the various products, prices without VAT

If we include VAT at 6% in the costs (€2,81) we have a slack.

If we remove VAT from the cost, the value becomes €2,64, the profit margin becomes €8,07-€2,64 (price and cost without VAT)=€5,42, ie, 67 %.

Gross Margin, Profit Margin or Contribution Margin = 67%

Calculate the annual profit margin.

Assuming 300 days of work, that is: 365 days a year - 52 Sundays - 13 days of holidays, annual sales will be as we saw:

Annual Meal Sales
Annual Meal Sales

Let us now admit that we have calculated the cost of production for several menus and that on average these menus have a production cost of 25% compared to the sale price, ie € 8,07 x 25% = € 2,02 . Like this:

Annual Meal Costs for Meals
Annual Meal Costs for Meals

With this meal service, the contribution margin for the business is €45.392 (€60.522-€15.130) / €60.552 = 75%. In short:

Gross Profit or Gross Contribution = €15.130

Profit Margin, Gross Margin or Contribution Margin = 75%€

Analysis of the production cost of other menus

We still need to add the other products and services that we intend to provide annually, to complement the business plan.

See too

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