Author Topic: Product costing and overhead application  (Read 1168 times)

Offline nateo

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Product costing and overhead application
« on: February 03, 2013, 10:40:49 PM »
I've read a lot of business plans for breweries over the last few years. I've noticed that all of them use a volume-based overhead rate, usually the number of barrels brewed. For a manufacturer like a brewer, who has a lot of overhead, but relatively little direct material or labor costs, using production volume to determine applied overhead will distort the cost of your products.

The main cost-driver in a brewery is the brewery itself and the equipment, not the labor or materials used.

I guess that makes intuitive sense, because you're paying for that brewery and that fermentor every day, whether it has beer in it or not. So the 21-day beer costs you a lot more to make than the 10-day beer.

I made a very simple spreadsheet to project the number of brews per month, assuming 4 fermentors, 4 beers, and only brewing on the weekdays.

(These are very rough figures, with some rounding, just to show how fermentation time affects cost per barrel in an activity (time) based costing system)

Fermentation time, # of batches per month
Blonde 10 days, 3
IPA 14 days, 2.2
Weiss 10 days, 2.7
Tripel 21 days, 1.4
4 days unused

Direct materials cost per bbl:
Blonde $21
IPA $34
Weiss $21
Tripel $42

Overhead per month:
Depreciation $2000
Salaries $2500
Utilities/maintenance/misc $1500

Total overhead = $6000
BBL per month = 93
4 FV * 30 days = 120

Cost per barrel (OH + direct materials) w/volume-based overhead
OH = $64.52 per barrel
Blonde $83.7
IPA $96.17
Weiss $83.7
Tripel $104.7

Cost per barrel w/time-based overhead
OH = $50 per day, per fermentor
Blonde $71
IPA $104
Weiss $71
Tripel $147
Cost of unused capacity (4 days) - $200

Why does any of this matter? If you can get your cost per barrel down on the blonde and weiss, you can lower the selling price, making it more competitive, and perhaps selling more.

This will also show you if you should be charging more for the tripel, or other beers that take a long time to brew.
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Online mtnrockhopper

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Re: Product costing and overhead application
« Reply #1 on: February 04, 2013, 07:55:58 AM »
Very interesting - thanks. I suppose the other worry is that if you underestimate the cost of the triple then you might underprice it. A popular style that's underpriced would sell well, but not make you much (or any) money. That could ruin the business.
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Offline nateo

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Re: Product costing and overhead application
« Reply #2 on: February 04, 2013, 09:46:30 AM »
Very interesting - thanks. I suppose the other worry is that if you underestimate the cost of the triple then you might underprice it. A popular style that's underpriced would sell well, but not make you much (or any) money. That could ruin the business.

It used to be everything manufactured needed a lot of labor/machine hours, so it made sense to allocate your factory overhead to units based on how many hours you spent making it.

What you're describing is exactly what happened to the big auto makers. Some of the components they made in-house looked like they were profitable under their old cost-accounting system.  When the auto makers switched to activity-based costing, they realized those units were more than 30x more expensive to make in-house versus subcontracting them.

Basically, they had a few really profitable lines, and a lot of unprofitable lines, but their costing system couldn't tell which were which.

Around 2009 the Financial Accounting Standards Board introduced a requirement that you need to treat excess unused capacity as a period expense, instead of a per-unit expense (cost of goods sold). The automakers would have been able to avoid bankruptcy if they had had a clear idea of how much their products actually cost to make. Investors would have been able to make better decisions, as well, if they knew how expensive it was to have so many factories sitting idle.
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Offline nateo

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Re: Product costing and overhead application
« Reply #3 on: February 04, 2013, 09:57:58 AM »
And I'm not saying that activity-based costing is the best/perfect way to allocate overhead. My point was more that when you pick a way to apply overhead, that will affect how much you think your products cost. It will also affect what decisions you make, for better or worse.

It might show you that you're actually losing money on your fancy barrel-aged beer. It also might make you want to cut fermentation down to 5 days to save money. All you can do is try to pick an application strategy that makes the most sense, and be aware of its limits, especially how it might distort your decision-making.
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Offline majorvices

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Re: Product costing and overhead application
« Reply #4 on: February 04, 2013, 10:31:28 AM »
So, it's an interesting cost analysis but I could turn all of those beers over in 7-14 days in fermentor and 3-5 days in BBT.
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Offline nateo

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Re: Product costing and overhead application
« Reply #5 on: February 04, 2013, 10:42:28 AM »
So, it's an interesting cost analysis but I could turn all of those beers over in 7-14 days in fermentor and 3-5 days in BBT.

7-14 days is a huge range. My point is, if one beer takes 14 days in a fermentor and one takes 7, the one that takes 14 days costs you more money to make.

If all of your beers have the exact same time requirement, an activity-based system may not be the best. If some take 7 and some take 14, than it might be appropriate.
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Offline bluesman

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Re: Product costing and overhead application
« Reply #6 on: February 04, 2013, 10:53:40 AM »
Intersting analysis.

What size/#vessel brewhouse are you considering? What goes into your material cost analysis? Efficiency used?

How did you arrive at your assumed depreciation?
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Product costing and overhead application
« Reply #7 on: February 04, 2013, 11:15:43 AM »
So, it's an interesting cost analysis but I could turn all of those beers over in 7-14 days in fermentor and 3-5 days in BBT.

7-14 days is a huge range. My point is, if one beer takes 14 days in a fermentor and one takes 7, the one that takes 14 days costs you more money to make.

If all of your beers have the exact same time requirement, an activity-based system may not be the best. If some take 7 and some take 14, than it might be appropriate.

I can tell you from my experience I brew Wed. and Friday or saturday (double batch later in the week) and I don't really look at any beer taking up more than 10-14 days in fermentor regardless of style. Sometime the bottle neck comes at the BBT or available kegs but usually style does bot determine length of time in fermentor with a few exceptions. We do have a couple extra BBTs for wood or extended aging.
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Offline nateo

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Re: Product costing and overhead application
« Reply #8 on: February 04, 2013, 11:32:58 AM »
Intersting analysis.

What size/#vessel brewhouse are you considering? What goes into your material cost analysis? Efficiency used?

How did you arrive at your assumed depreciation?

It doesn't really matter. It's just to show a point. Those are just random numbers. My point is, if you're assigning costs to something, there should be some rational connection between the costs and the reason those costs were incurred. That's the whole point of cost accounting.

You can pick any basis to apply your overhead. It's really easy to track direct material cost. When factory overhead is so much larger than your material cost, how you apply overhead matters a lot.

If you pay the same rent every month, does it make sense to allocate rent to beers based on the number of beers made?
Should you allocate rent based on pounds of grain used?
Number of times you scrub the floor?
Number of hours your busboy worked?
Number of days used?

Only one of those has any direct relationship to the nature of the cost incurred.

In a real activity-based cost accounting system, you can break your whole business down into hundreds of component tasks, and have different cost drivers for all of them. There comes a point where the cost of adding complexity to your system outweighs any potential cost savings, though. Where that point is depends on the business.
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Offline anthony

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Re: Product costing and overhead application
« Reply #9 on: February 04, 2013, 12:23:27 PM »
I think folks are getting bogged down in specifics, the general idea is that many start-up breweries are using simply the cost of the materials to manufacture the beer. But a more accurate way to price the beer might be including the other activities involved (milling the grain, racking the beer, bottling/kegging, cleaning/sanitizing vessels, etc.)

For the barrel aged beer example, you could take a barrel aged beer and subdivide it into discrete sub-activities so that instead of just including grain+barrel, you would include storage costs, time for babysitting the barrels, etc.

If you're a one-man show brewing a few different ales at a nano-brewery, this isn't going to be that worthwhile of an exercise. If you have 4 or 5 employees of different salary levels working on different beers with some non-interchangeable duties assigned, you're going to learn a lot more from the exercise.

Offline nateo

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Re: Product costing and overhead application
« Reply #10 on: February 04, 2013, 12:39:33 PM »
I think folks are getting bogged down in specifics, the general idea is that many start-up breweries are using simply the cost of the materials to manufacture the beer. But a more accurate way to price the beer might be including the other activities involved (milling the grain, racking the beer, bottling/kegging, cleaning/sanitizing vessels, etc.)

It's true that most people don't know what "cost of goods sold" means. My point was that even if you include all the costs that actually go into the cost of goods sold, how you divvy the costs up has a big impact on how much you think your beer costs.

But you're right, if you don't know what "cost of goods sold" means, you should really learn that first.

I think having a clear idea of how much it costs to make your product is way more important for a small startup, because a dollar lost is more likely to ruin your business. If you're a giant company you can afford to be wasteful (for a little while, anyway).
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Offline boulderbrewer

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Re: Product costing and overhead application
« Reply #11 on: February 05, 2013, 09:05:31 PM »
As a person who goes by the seat of my pants thanks for this break down as it brought to light some things I missed. Well done.

Now we need a QB app for breweries.
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Re: Product costing and overhead application
« Reply #12 on: February 06, 2013, 07:20:52 AM »
Very interesting - thanks. I suppose the other worry is that if you underestimate the cost of the triple then you might underprice it. A popular style that's underpriced would sell well, but not make you much (or any) money. That could ruin the business.

It used to be everything manufactured needed a lot of labor/machine hours, so it made sense to allocate your factory overhead to units based on how many hours you spent making it.

What you're describing is exactly what happened to the big auto makers. Some of the components they made in-house looked like they were profitable under their old cost-accounting system.  When the auto makers switched to activity-based costing, they realized those units were more than 30x more expensive to make in-house versus subcontracting them.

Basically, they had a few really profitable lines, and a lot of unprofitable lines, but their costing system couldn't tell which were which.

Around 2009 the Financial Accounting Standards Board introduced a requirement that you need to treat excess unused capacity as a period expense, instead of a per-unit expense (cost of goods sold). The automakers would have been able to avoid bankruptcy if they had had a clear idea of how much their products actually cost to make. Investors would have been able to make better decisions, as well, if they knew how expensive it was to have so many factories sitting idle.

Having worked in the auto industry for over 30 years, I can't agree with most of what you said. The reality was complex, and it was more than accounting that was the cause.

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Offline kylekohlmorgen

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Re: Product costing and overhead application
« Reply #13 on: February 06, 2013, 09:12:58 AM »
So basically: fermentors = lost revenue (if the demand is there).

Your most interesting point is how to put a value to more expensive/labor intensive/time intensive beers. I think most brewers price with their respective markets, but going through this exercise would give you a good idea if you were going to take a loss before you started a project.

You might also tweak it to show the actual cost of switching up something in your process: adding a new yeast strain, adding a new beer style, comparing investment opportunities (buy a fermentor vs something else) etc.
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Offline nateo

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Re: Product costing and overhead application
« Reply #14 on: February 06, 2013, 09:32:36 AM »
So we're all on the same page, here's my source for my automaker comment (we also talked about this in my cost accounting lecture, which I believe is where that "30x more expensive" comment came from): http://www.imanet.org/PDFs/Public/MAQ/2012_Q1/MAQ_Winter_2012_bettinghaus.pdf

Another article about excess capacity costs:
http://www.readperiodicals.com/201006/2062925481.html

An article about Grenzplankostenrechnung (GPK, German cost accounting):
http://www.imanet.org/PDFs/Public/SF/2005_04/04_05_krumweide.pdf

The important thing to note, about GPK, is that Deutsche Telekom has 20,000 cost centers, while Beiersdorf AG only has 12. So these principles aren't just applicable to the biggest/most complex manufacturers.

I know marketing people talk a lot about doing market research to price products, and figuring out the exact intersection of the product price and demand to maximize revenue, but in almost all real-world manufacturers, they set selling prices based on the cost to produce it, plus some arbitrary margin. Like "Cost*130% = retail price." So for those real-world situations, you really need to have a solid idea of cost in order to set your retail price appropriately.
« Last Edit: February 06, 2013, 11:03:47 AM by nateo »
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