Going for the jugular

You are really excited about your business idea. You really, really, want it to work out and have already done all the prelims. Everything looked good and said, nay screamed, “go ahead”.

You know the crunch though, is the figures. At the end of the day they will have the last word about what has by now become “your precious baby”. Like a pregnant fairy, you carried this idea around in you, nursed it through a rocky preliminary feasibility study and some trying marketing surveys and watched it take shape to where you are now – ready to take the final leap.

These trusty surveys revealed to you the price prospective customers are willing to pay you and from this, you settled on a final selling price that was a happy medium from all the different responses you got.

Your feasibility study showed you how big your market was going to be – you worked out your market share and decided there were enough people that would buy what you had to offer at a specific price. This you knew was critical to determine, because if you over-estimated your market, you would invest too much in capacity.

This automatically led you to realise that if your selling price is too high, people will not buy which of course could mean that your margin between production costs and said selling price, will be too narrow.

And you know that without these two crucial sets of preliminary figures of price and the number of saless, no true financial viability study would have been possible.

So, you’re all set to get your stats. Problem is, you were never the number cruncher of the class…So, what now?

Fortunately, there’s…

 …Tim.

Tim Landau is a young man with a vision. He comes from a long line of cabinet makers and “sucked wood milk” from his infancy. Now that he’s all grown, he wants to set up his own cabinet making business, starting with producing specialty chairs with woodcarving on it. He’d add other products to it later on, once the endeavour became successful.

This avid water sports lover already figured out that he’s going to work out of his garage, thereby minimising on overheads like rent, electricity etc. (also called fixed costs). All that was added to this was his monthly payback on some woodworking equipment and the operating costs of producing the chairs, like extra electricity etc.

So his fixed costs came to:

Electricity – $500

Insurance – $200

Security – $200

Payment loan for equipment – $500

Total = $1,400 per month

How to avoid busting your chops

According to his market research he could possibly sell 100 chairs per month, however, Tim knew that it was always better to start small and build up from there. Overestimation of his market could and would! lead him to invest too much in capacity and thereby risk everything because he won’t be able to cover his fixed costs. So he planned on selling at least 20 chairs per month for starters.

So, all he now had to reckon was what it was going to cost him to make every chair (also called variable costs).

So Tim listed the following materials:

Wood – $150

Varnish – $10

String – $20

Screws – $10

Glue – $10

Direct labour – $100

Total direct cost= $300

He therefore had to net more than $300 to make a profit. (Called gross profit because he must still pay the overheads or fixed costs before he can take what’s left for himself or make as profit).

It was also critical to determine the size of his market, because an over-estimation of it will lead him into investing too much in capacity. And thereby bust his chops because he won’t be able to cover his fixed costs. Unnecessary costs, trapped in capacity, would put him out of business.

Based on the info from the market research, he fixed the selling price per chair at $500.  Thus, his gross profit would come to $500 – $300 = $200.

However, it was clear to him from earlier calculations that he would need to at least sell 7 chairs per month to break even. Nervously the sums played musical chairs in his head:

$200 x $7 = $1,400.

So, assuming he sold his 20 chairs, he would:

Gross profit = $4000 per month (20 chairs @$200 each)

Minus Fixed costs = $1,400

Net Profit = $3600 per month

Enough to cover what he should cover. Great! Why, he’ll even survive if he had his selling price all mucked up and he had to lower it to $400.

Dreaming is essential to health

But, he considers working from his garage initially, as a mere stepping stone to his much envisioned “Ye Olde Cabinet Making Factory”.

Yet Tim was wise enough to realise one had to crawl before you could walk. Had he jumped into working from a factory from get-go, aiming to make and sell 100 chairs per month, his figures would probably have looked something like this:

Fixed Costs per month:

Electricity – $1000
Insurance – $500

Security – $200

Rent – $5000

Loan repayment – $1000

Total = $7700

In order for him to break even then, he would have needed to sell 38.5 (imagine that), in practise 39 chairs, to cover the overheads of $7700. Being able to only sell 20 chairs at a gross profit of $4000 (20 x $200 each), out his profit loss, he worked out would have been:

Gross profit ($4000) – Fixed costs ($7700) = Loss (-$3700).

Well, was he ever glad his dad taught him business savvy. Had he not exercised that, they would have hauled his rear to jail just as sure as God above made His good sun to shine on both righteous and unrighteous. Meanwhile…

…his dream was in the process of becoming. Little by little. It’s what kept him going.

*****

What keeps you going?

Until next time!

Elmarie is a wordpreneur for theEntrepreneurialBusinessSchool(Pty) Ltd and a freelance creative-, web- and copywriter.

Resources

1. EntrepreneurialBusinessSchoolManagement Course.

2. Bekker, M. Thanks Mauritz. You have the knack of making the challenging world of entrepreneurship, exiting and so much easier.