Revenue growth and gross margin percentages are key metrics to owners, managers, suppliers, customers, and investors of companies in the brewery, distillery, and beverage space. However, companies often encounter challenges when allocating expenses in line with US GAAP, which could result in improper reporting and disclosure of these metrics.
Analyzing and Evaluating Expenses
Costs incurred during normal operations typically fall into one of three areas: contra-revenue expenses, cost of goods sold (“COGS”), or selling, general, and administrative expenses (“SGA”). Companies should examine expenditures incurred in fulfilling contracts with customers and distributors for several factors that would indicate they should be presented net of revenue, in COGS or SGA, in line with Accounting Standards Codification (‘ASC’) 606, Revenue from Contracts with Customers. These standards are subject to significant judgment, and often, companies default to recording all manufacturing costs as COGS and all other costs incurred outside of the manufacturing process as SGA, which could overstate both revenue and margins.
Which Expenses Should Be Offsetting Revenue?
Typical costs that require analysis can come from contractual pricing arrangements, including agreements such as rebates and discounts, price or margin protection, tiered pricing, or nonrefundable upfront fees. Expenses can also be derived from services the customer or distributor provides that might not be separated from their purchases, like advertising, free samples, customer support, shipping and delivery, or options to purchase other items. While these expenses do not always result in a presentation net of revenue, it’s common to see these types of services and spending, especially with distributor contracts, required to be included as a reduction to revenue. Therefore, all these expenses should be carefully evaluated, and the company should have documentation of its policies and procedures around these arrangements to ensure consistency.
Common Mistakes with COGS
When evaluating expenses for the cost of goods sold (COGS), companies often fail to identify indirect expenses and overhead that should be included in COGS along with their direct manufacturing costs. Indirect production costs to consider include indirect materials and supplies, supervisory labor, employee benefits, cost of quality control and inspection, warehousing costs, depreciation and maintenance for production equipment and facilities, utilities, and insurance for the production facility. Additionally, if the company has a tap room or restaurant, costs of kitchen equipment and food and drink preparation should also be considered for COGS presentation.
Without careful evaluation, expenses can be reported in the incorrect line items, presenting inflated revenue and gross margins. Companies will want to evaluate expenses before they consider obtaining debt with financial covenants or equity financing, as investors could be in for a surprise.