Rethinking Cash Flow: Understanding Food Industry Profit Margins
(Video + closed caption available on YouTube. Full transcript below.)Have you ever thought “How can I grow my
business without taking on more debt?”
You’re not alone! In fact I was asked this very question by a good food business founder who was struggling to understand why she needed to invest more money into her growing business despite the fact that she was selling a profitable product. The answer was in her food business profit margins.
Most founders don’t understand that in the food INDUSTRY
profit margins have a direct impact on cash and
the ability to grow their businesS.
It is a myth that 50% margin is “good”. But that myth has been perpetuated in the food industry by consultants, former execs, traditional business media and even higher education.
In this episode Sarah is sharing what a good food industry profit margin actually is, why modeling a small food business after large corporations won’t work (hint they can take on HUGE amounts of debt), and helps us understand profit margins and how they impact cash flow once and for all.
This episode will have you completely rethinking
cash flow and food business finance.
Tune in to learn:
Key terms for understanding your cash flow
Exactly how food business profit margins relate to your cash flow
How to understand the impact of your profit margins across sales channels
How to rethink your sales channel strategy to meet your cash flow goals
4 Steps for gaining knowledge and confidence around your cash flow today
You’ll leave this episode with a better understanding of the relationship between your margins and cash flow so you can make informed decisions about funding the growth of your business.
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Episode Timeline
Introduction to Cash Flow Discussion (00:00:04)
Sarah introduces the podcast's focus on cash flow strategies for food businesses and scaling production.
Challenges of Scaling Production (00:01:26)
Discussion on the emotional challenges founders face when considering loans for scaling production.
Lack of Transparency in the Industry (00:02:58)
Sarah highlights the industry's transparency issues regarding costs and margins affecting cash flow.
Understanding Food Business Margins vs. Cash Flow (00:04:16)
Emphasis on the need to understand how margins impact cash flow and business decisions.
Food Business Profit Margin Terminology Overview (00:05:53)
Sarah explains key financial terms that will be used throughout the episode.
Industry Benchmarks for Sales Channels (00:08:25)
Sarah shares the food business profit margin benchmarks for direct-to-consumer, wholesale, and distribution channels.
Gross Profit Margin and Cash Flow (00:11:03)
Explanation of how gross profit margins translate into cash flow for product sales.
Impact of Sales Channels on Profitability (00:12:21)
Analysis of how different sales channels affect overall food business profitability and cash flow.
Importance of Growing Profitable Channels (00:15:04)
Discussion on the significance of focusing on the most profitable sales channels for financial sustainability.
Debt Management in Food Businesses (00:18:18)
Exploration of how large corporations manage debt and its implications for smaller businesses.
Strategies for Financial Sustainability (00:19:49)
Advice on building a low-debt business by focusing on profitable sales channels and strategic planning.
Action Steps for Founders (00:21:16)
Encouragement for founders to assess their food business profit margins, cash flow, and operating costs for better financial management.
Community Engagement and Episode Wrap-Up (00:22:38)
Invitation to join the community for further discussion and announcement of the next episode.
Full Episode Transcript
Sarah Delevan: Today on the podcast, I'm rethinking how we talk about and understand cash flow in food businesses to answer a question that is on many founders minds, and that is how do I scale my production without taking on more debt and another big loan? Let's get to it.
I was recently forwarded a portion of an email from a fellow consultant in the industry, and she sent it to me because she felt that it aligned with the conversations we've been having about the good food revolution, and it directly related to food business finance. And I want to share that portion of an email that I got with you here. So the email read, my challenge continues to be, how do I scale my production so that I can support my future sales growth? I feel I need to take out another big loan to grow my business to the next level, and that scares me. I've already invested a significant amount to get the branding and foundations for the business, but did not anticipate the expense for taking the business production to the next level. In your experience, how do most companies do it? I sat with this email for a while because a there's a lot of emotion in that, right? You never like to hear that a founder with a seemingly young business is already frustrated financially and feeling overwhelmed by the idea of more debt. And what really stood out to me in the email was where they said, I have already invested a significant amount to get the branding and foundations in place for the business, but I did not anticipate the expense for taking the business production to the next level. And I think this part echoes back to the lack of transparency in the industry and how things really work, and a lack of transparency about how expensive it can be. When I speak to other consultants in the industry, we share common findings, right? What are we hearing from founders? How can we support them better? And overwhelmingly, we hear that founders are unaware of what it costs to sell through distribution and traditional sales channels, and how the margins in those channels affect cash flow, especially if that founder has never, you know, worked inside the industry before.
00:02:58 It's also very common that we hear founders say, I didn't know what I didn't know. In fact, I'm a former founder who said that when I started my food business, there was a ton that I didn't know, and I was relying on business books and the internet. And so many of us in the industry now are doing the work that we do to help shorten the learning curve and help founders to know things that they need to know before it's sort of too late or before they've gone too far. And we also hear from countless founders that this is a volume game, and once I scale my business, I will be profitable. And all of these things, this lack of transparency, this, you know, lack of information, this belief that volume is the answer to cash flow. This all culminates with many founders launching their businesses without proper planning and without a really solid understanding of how much money and how much time it will take them to reach their business and their financial goals. So as an industry, we put a ton of emphasis on margins, right? Because that's how we do business.
00:04:16 The retailer takes a margin, the distributor takes a margin, everyone takes a margin. And we talk about profitability, but we're not talking enough about cash flow. And we've not been talking about it in a way that I think is crystal clear for founders and would be founders to understand, so that you can really, truly make informed decisions about your business and the investments that it will take to succeed. Your margins impact your cash flow and the profitability of your business, but how your margins affect those things, I think, has been misrepresented. So we've been led to believe that if we've got a positive product profit margin, right, we're making money on the sale of our product and we sell through our inventory. Then naturally, there will be money to make more product and to scale our business. But the truth is that that is not always the case. I've talked for years about the fact that having a profitable product is not enough to build a profitable business, and now it's time to take that conversation a step further and to make margins and cash flow easier to understand so that you, as the founder, know why and can determine how much debt you'll need to take on to grow your business.
00:05:53 Now, before we dive into sort of the meat of this episode, I want to make sure that we're all on the same page with some of the terminology that we're going to be using. So really quickly. We're just going to cover a few things. If you take in information like this better visually or by reading, you can hop on over to our YouTube channel. Just go to YouTube and search for the Good Food CFO podcast, and we're going to have some slides, mixed in with the video feed, so that you can actually see this information and some of the financial examples that we're going to talk through. So first we'll start with revenue rights. Top of the barrel. It's the thing that gets people most excited. This is the money that you earn from the sale of your products. Then we've got our cost of goods sold. And this is the cost of our ingredients, our packaging, our production labor, or our co packing costs if we work with a co-packer to produce your products. Next we've got gross profit margin.
00:06:57 Now this is the difference between your revenue and your cost of goods sold. In other words, it's your revenue minus your Cogs. So it's also sometimes just called your gross profit or your margin. Customers have a gross profit margin. Your products have a gross profit margin. Your sales channels will have a gross profit margin and your business will have an overall gross profit margin. And all of these things are important to know. There's also something called gross profit dollars. And this is your gross profit margin just represented in dollars instead of as a percentage. So for example, you might have a 60% product gross profit margin, and that may be the equivalent of $5, right? Depending on how much your product cost to make and what you sell it for. Your business may also have a 60% gross profit margin, and that might be equivalent to $50,000 gross profit. Dollars are what you use to make more units of your product and to pay your operating expenses. Last on the list is operating expenses. So these are all of the expenses that you have associated with running your business that are not related to making your product.
00:08:25 So your insurance is your office rent, any labor that's not related to production, some of your marketing and your advertising expenses, etc.. Now that we've talked through the definitions and we understand the terms we'll be using throughout this episode, I want to share some industry benchmarks for direct to consumer, wholesale, direct and traditional distribution channels. Now this is something that I typically do not share outside of one on one or small group sessions, because these are benchmarks, they are not recommendations, and they are certainly not a set of one size fits all targets because every business is different. But I feel that within the context of this episode, it's important to lay out these benchmarks and to use them within the examples that I'm going to be presenting. So note that these are minimum channel margin benchmarks for a business that's selling through all three of these channels. And remember that your unique situation and your goals will result in different specific targets for your business. Okay, I'm going to start with the most profitable channel. And that's going to be your DTC channel.
00:09:47 So minimum here we want to see a 70% gross profit margin. Typically. Then we're going to go to Wholesale Direct. That's adding you know sort of one link in the chain between you and your product. And there we're going to list a minimum margin of 51% right or higher. And then distribution. That's two links in the chain between you and your final customer. And there we typically like to see a minimum gross profit margin of 40%. Now let's talk about how these gross profit margins translate into cash flow and how that cash flow can get used in your business. So when we sell a unit of product, the objective is to generate revenue to earn back the money that you spent to make the product. That's your cost of goods sold, right? We also want to earn money to make more product and to pay for our operating expenses. So let's say that we make a product and it costs $1.25 to produce. And let's say that we sell it to a retailer for 250 The retailer puts it on the shelf for $5.
00:11:03 Our gross profit margin is calculated based on what we sell the product to the retailer for. And in this case, we've got a 50% gross profit margin. Our gross profit dollars is 125. Now, if you're listening very carefully or you're looking at the slides on YouTube, you can see that 125 is exactly the cost to make our product. That means that we've earned exactly enough money to produce one more unit and nothing else. To reiterate, we've paid our cost of goods sold, so we've paid back what it costs to produce the product we sold. And we have just enough to make one more unit. When our margins are above 50%, we have enough money to produce one more product, right? One more unit of product, and we've got money to put toward operating expenses or the growth of the business. Right. Scaling up production. If our margins are below 50%, we're not earning enough money to produce one more unit of product. We've only got enough money to produce a fraction of a unit.
00:12:21 Now, in our example, what our, you know, our example business here, we're talking about a product that costs $1.25 to make that is selling on the retail shelf for $5. And we're going to make the following assumptions. One is that we're also selling it on our website for $5, and that through the distribution channel, our distributor is taking 25% margin and our retailer is taking a 40% margin. What that gives us is that 50% gross profit margin in Wholesale direct, a 75% gross profit margin in direct to consumer, and a 44% gross profit margin through distribution. Now, when we sell our product to a distributor and we earn that 44% margin, our gross profit dollars is $1. It costs $1.25 to make our product. We've just earned back enough to pay that dollar 25. Right. Our our cost of goods sold. and $1, which is $0.25 short of enough to make another product. So what we know now is that distribution is not earning enough money, right. Enough gross profit dollars to maintain the distribution channel, let alone to grow it.
00:13:52 Right. It's sort of draining money from our business in a way, and it's going to require either outside funding or funds from another channel that we sell through. And in our case, we're selling through Wholesale Direct and D to C. Now our wholesale direct channel is earning us 50% margin, which we know is just enough to make one more unit of product for that channel. So there's nothing to contribute to distribution and there's nothing to contribute to our operating costs. That means that DDC is doing the heavy lifting within our business, because it's got a 75% gross profit margin. It's the only channel that can contribute money to distribution, right? That extra $0.25 per unit, that distribution needs to make another unit. And it's the only channel that's contributing to paying our operating expenses on our channel. What we're going to see is our overall gross profit margin, right. Or what we also call our blended margin for all three channels. So in our example, let's assume that we're selling pretty evenly across all three channels.
00:15:04 So 33% of our sales comes from all three of our channels, right? That would give us a blended margin of 56.3%. So that's enough to make the same number of units of product that we just sold, plus 6.3% left over for our operating costs and to put toward scaling our production. If our most profitable channel, our DTC channel becomes less than 33% of our overall sales, meaning sales in that channel simply drop on their own or the other channels grow above 33%. We're going to see our blended margin go down if DTC grows above 33%, meaning that the DDC channel grows, you know, on its own, or we see distribution and wholesale direct sales decreasing, we're actually going to see our blended margin start to rise and move up. Something radical to think about is what if we dropped our least profitable channel. right? So if we got rid of distribution, our sales per channel are going to adjust a little bit. So maybe the split becomes 60% wholesale direct and 40% De to see our blended gross profit margin would jump to 60%.
00:16:33 Whenever our gross profit margin goes up, it means improved cash flow in the business, and it means that our business has become more sustainable. This is why I so often talk about growing your most profitable channels, and why I get frustrated when founders say, but there is more volume and distribution than my wholesale, direct and DTC channels. And I think I can hear some of you saying that right through the speakers right now. But my question is that while it may be true that there is more volume in the distribution channel, is there positive cash flow within the channel? And at what point, if ever, does 44% gross profit start to make you money? When does making 6% less than what it costs to make another unit of your product become sustainable, let alone profitable? It can't do it on its own, right? When we talk about volume based businesses, we're comparing ourselves to big business or to highly leveraged businesses. They utilize debt as part of their financial strategy to increase their returns. And that's totally okay, right? It's a it's a way of doing business, but it's something that I think we need to be more transparent about and very clear about.
00:18:18 So as I was putting together this episode, I did some research and found that General Mills, in their unaudited 2022 fiscal report, states that they have over $10 billion in long term debt compared to their annual revenue of $18.9 billion. And at the end of the fiscal year, they reported having a 27% debt to asset ratio. And what that means is that 27% of their assets are funded by debt or funded by creditors. And when we think about assets, we're thinking about buildings, we're thinking about equipment. And we're also thinking about inventory of product that can be raw materials, that can be packaging, or it can be finished goods. So if you want to build a business based on the volume, it's going to require personal or outside investment and managing a fairly large amount of debts. Now, I don't want to go too deep into this, specifically in this episode, but you can indeed have debts on your balance sheet and have a profitable business. You can have positive cash flow. You can pay yourself, you can pay your team, you can be profitable, but you also have that debt.
00:19:49 If you want to build a low debt or a no debt business and be what we call financially sustainable, then you have to focus on selling through your most profitable channels, or even only profitable channels. It will still require investment upfront, right? And it may require debt from time to time to take your business to the next level, right, to sort of make a big run of product, right, to sell to that big new customer that's coming. But it won't be constant and it won't be required to simply keep your business afloat. When we started this episode, we started with a question how do I scale my business without taking on another big loan? And for many businesses listening, it won't be possible to avoid another loan, a line of credit or outside investment to grow your business. But knowing your margins and how they affect cash flow, creating a profitable growth strategy and creating a plan so that you understand exactly how much money and how much time it's going to take to reach your goals can give you confidence to keep moving forward.
00:21:16 If you are listening right now and you are struggling with cash flow or trying to understand how much money do you need to grow, I encourage you to start this work today. First examine or identify if you don't yet know what your product margins are, what each of your customer margins are, what your sales channel margins are, and what your business gross profit margin is. Then see how your sales are divided across channels, and if there's anything you can do in terms of your pricing or sales strategy to improve your gross profit margin and your cash flow position. Lastly, get clear on what your monthly operating costs are and if you generate enough gross profit dollars to cover them. If not, you'll have to determine where operating funds will come from as you ramp up your sales. Having a plan or a financial forecast is extremely helpful for laying this all out and setting goals that you can feel good about your next steps, and better about taking on debt if you need it. In a few weeks, we've got an episode planned that will focus on this exact topic.
00:22:38 But in the meantime, if you've got questions or you want to discuss this more, I invite you to join me in the free community where you can post your questions or join me for a live Q&A event. The link is in the show notes and it's also on our website. If you found this episode helpful and you want to spread the word about how to rethink about cash flow and your margins. I invite you to subscribe to this podcast and to rate and review it. That and sharing on Instagram or LinkedIn with the hashtag the Good Food CFO are the best way to get the word out about the show and to help other good food founders find us. I will be back with a special bonus episode next Tuesday, and I hope to see you then.
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