To run a profitable winery, it is vital to understand how much profit you are making per bottle of wine sold. You will need to be able to determine and understand what you can sell your wine for and how much that wine costs to produce.
While the market will dictate how much you charge for your wine, you control how much it costs to make it, as long as you understand what is included in the costs and have a mechanism to track it.
An accurate calculation of the costs to make your wine increases the likelihood of operating a profitable winery. Although this sounds like a simple endeavor, there are challenges. From determining which costs to include, to tracking all expenses through the production process, getting to a final dollar value takes time and careful consideration.
The Basic Terminology
Before we can start discussing how to value your winery inventory, let’s define two key accounting terms.
Cost of Goods Produced (COGP)
Commonly known as wine in process or cost of inventory, all costs involved in the process of making wine are included. This includes things like:
• Raw materials
• Overhead allocations
Whether direct or indirect, all costs from planting through to bottling the finished wine are included in COGP.
Cost of Goods Sold (COGS)
The COGS is the cost of the wine sold in a specific period. You’ll need to match the cost of the inventory you sold to your revenue. A simple way to put it, for each bottle of wine sold, how much did it cost to make and get it into the hands of the customer.
Now that you understand the two primary accounting terms related to production, we need to dig deeper into the different ways to develop a value for your COGP, starting with the groups of costs involved.
Winemaking generally involves three main types of costs.
• Direct materials
• Direct labor
• Overhead allocations
Direct Materials in Winemaking
Calculating materials cost is reasonably straightforward. It is the cost, including tax and delivery fees, to acquire your materials and get them to your production area. This includes raw materials like grapes and packaging materials like bottles and boxes.
Segregating these costs makes the allocation of overhead (which we’ll discuss a little later) a little easier and more accurate. And it makes sense for blended wines. You’ll be better able to track the component costs.
While you may initially record the cost of grapes separately (if you are farming, this will be more complex than if you are buying grapes), it will be added to the other expenses, such as fermentation and cellar costs, to get to your bulk wine cost.
Direct materials don’t include materials consumed in production. For example, light bulbs or air filters in your production facility are manufacturing overhead.
Labor in Winemaking
Labor required to turn your raw grapes into a finished bottle of wine should be included in inventory costs. You’ll want to include not only salary and wages but also benefits and payroll taxes.
Owner or executive compensation is difficult to classify. While they are involved in the winemaking process, they also work in other areas, like administration and finance. For these individuals, determine how much of their time is involved in the winemaking process and apply the percentage to their total payroll costs. Using reasonable estimates is acceptable.
Overhead in Winemaking
Costs incurred to keep your winery operating but aren’t direct materials or labor are overhead. Overhead costs are usually aggregated into cost pools and allocated based upon the number of bottles produced.
Examples of overhead include property insurance and taxes, building repairs and maintenance, utilities, and administrative staff wages.
With your bulk wine value, adding expenses for your direct labor and overhead gets you to the total cost of the finished, ready-to-sell wine.
After you’ve tabulated the total inventory costs, you’ll need to consider how your wine inventory moves. This cost-flow is your inventory valuation method and impacts your COGS, income taxes, and balance sheet ratios for lending requirements. Choose the other that best suits your production process.
COGP/Inventory Valuation Methods
This method involves tracking each item from the time of purchase through to when the wine is bottled. Meticulous record-keeping, data collection, and data segregation make specific identification highly accurate.
Starting with the calculation of exact juice or wine yields for each varietal vintage, even getting detailed down to which vineyard or vineyard block, you then track the juice into the individual barrels for each lot, parsing and combining as barrels get blended.
Weighted or Average Cost
When costs are intermingled and difficult to specifically identify, using the average cost method may work best. Using the average or weighted average for consumable supplies like yeast and sulfur or general costs like storage is appropriate.
First-In First-Out (FIFO)
Another valuation method is the FIFO method, which assumes that inventory moves such that the oldest stock (the first in) is the first sold (the first out).
Last-In First-Out (LIFO)
As you might guess, the LIFO method assumes the newest inventory items (the last in) are the first to be sold (the first out). This is unlikely the case in the wine industry since older vintages are typically sold before newer ones.
Specific identification and FIFO are the most commonly used valuation methods for wineries.
Using LIFO for tax purposes requires you to use it for financial reporting purposes. This can be achieved while still using the specific identification or FIFO method by recording a LIFO reserve on your books.
Recent changes in the tax code for expensing of certain winemaking costs make consulting with your CPA very helpful.
Regardless of which inventory valuation method you use, use it consistently. Consistency is required for U.S. GAAP reporting and makes spotting an error easier.
Valuing winery inventory is challenging and unique. It requires specialized knowledge acquired through years of experience. The professionals at Protea have decades of experience helping winery owners with complex accounting and tax issues. Reach out today to see how we can help you.