Financials
Absorb
Review financials slides
Watch the lecture, follow along with the slides as you watch
How much will it all cost?
There are two kinds of operating expenses you will need to understand. For our purposes, these operating expenses will be direct costs and indirect costs.
# 1
Direct Costs: The actual cost of making or acquiring the product also the actual cost of providing a service. Think of them as "directly related" to being able to offer the product or service. You can't have a business without this expense, it is essentially the value you provide to your customer.
# 2
Indirect Costs: The costs "not directly related" to making/acquiring/providing what you are selling. However, these items are still necessary in order for the business to run. Think of them as everything else related to being able to offer the product or service, you need them in order to operate.
Most likely you are making and/or acquiring more than 1 unit of product or service. This means you will have a batch of your product - this is also your inventory. Your goal is to figure out the following:
How much a batch costs you, this is also the total inventory
How many individual units you can get out of a batch
The cost of 1 unit in that batch
If you are providing a service, you can instead try to figure out how much it costs to provide 1 unit service. Your goal is to figure out the following:
How much it costs to offer the service
The cost of 1 unit
Operating Expenses
These are all the expenses to run the buisness. We split them up into Direct and Indirect Costs.
Example
A sarong company makes a list of the expenses:
Selling at the farmers market. A table costs $20
As part of their marketing plan, they decide to make business cards. This will cost $15. They also decide to make a Facebook page and will run an ad on Facebook for a week, costing them $30.
They will get a Square account to link directly to their bank account so that they can take credit card fees. This fee will be 1% of each sale. They end up selling 160 week 1 so the cost is $1.60.
Initial Inventory - this is the total amount of products they will make to begin with. If they sell close to the initial 50 in the first two weeks, then they will make another 10 to finish out the competition. If they don't sell 50, then they will not make more. Total batch to start - $85. This is a COGS or Direct Cost.
The total operating expenses are $151.60 which include the direct costs of initial inventory and all the indirect costs.
Direct Costs
Direct costs are related to the making/acquiring/providing of the product or service. Think of direct costs as going out the door once the product or service is sold to the customer. You will no longer have that material once purchased.
For example, let's say you are selling cookies. The if you buy to make them create a batch. That batch makes 12 cookies. The cost to make one batch divided by the amount of cookies is the cost for 1 unit. The ingredients to make cookies are part of your direct costs. Once they are sold, you no longer have the ingredients because the cookie leaves you, you don't keep it.
We separate direct costs from other operating expenses so that you can more closely understand the profitability of your product or service. When you are able to see the cost to make 1 unit of product or service, it helps you to know what you should charge the customer, if you should reduce your expenses, or if you should charge more to make more.
Direct Costs Example
A company is selling sarongs for $10 each to put over bathing suits at the beach or pool. They are making them and not purchasing to resell. They plan to sell 50, so make the initial inventory 50 sarongs. To the right is a breakdown of the cost to make all 50, called a batch, and the cost for 1 unit.
They will need to buy 20 yards of fabric, 40 yards of thread, and 100 yards of trim to make 50 sarongs. These are just costs directly associated with making the product. Notice it does not include a website or signage for the company. Those costs will be included as operating expenses.
First get the batch cost, then divide the batch by the number planning to make to figure out 1 unit cost.
Each item is then divided by 50. This is why all 50 cost $85, but 1 only costs $1.70.
Direct Costs are also called cost of product, cost of goods sold or COGs
Example of direct costs:
Watch this video for a custom ring, you'll see that the ring also comes with a lot more items. Would these items be direct costs? Why or why not?
Beads by Becky Direct Costs.mov
Use this template to help you figure out your direct costs. Video on how to use the template:
Indirect Costs
Indirect costs are all the things, activities, and action that cost you money and which you have to do in order to properly run the business.
Each week as you operate the business, keep track of all your expenses.
For example, let's go back to selling cookies. I need a pan to put them on when they go into the oven. Once the cookies are sold, I keep the pan, it doesn't go with the customer. It is part of my doing business, and since I needed the pan to get started, I would include it as part of supplies under indirect costs.
Expenses to consider:
Think about your channel for selling. There are expenses directly linked to your channel. Think about what they may be.
If you are selling at school, you will need:
a sign
decorate the table to stand out from other businesses
If you are selling at a farmer's market or craft fair:
a sign
decorate the table to stand out from other businesses
table fee
If selling online:
a website
Ad to promote website
If you take credit cards via Square or Pay Pal, you will need to show the fee taken out of the transaction.
All of these will show up as indirect costs.
Everyone will need marketing in some way. Some of that may cost money. Be sure to update the bookkeeping for your operating expenses each week so you know how you are doing.
Profit & Loss, AKA P&L or Income Statement
The sole purpose of your business is to make income... revenue... sales... however you say it, it's money.
The sales or revenue is NOT the money that you make, that is the money that comes into the business, it is only once you account for your expenses that you see the Profit - that is the money you make!
You can't start counting the money earned until you subtract what you've spent.
This is why we use the important Net Profit Calculation to figure out our PROFIT (we made money!) or in some cases LOSS (we lost money).
A Profit & Loss is a financial statement that helps us understand if our business is making money like we want. It takes all the revenue and subtracts the expenses.
Another calculation we'll do to make sure we are able to cover all our expenses and start actually making money is the Break Even Point Calculation.
Formula:
Revenue (sales) - Expenses
= Profit or Loss
= Profit or Loss
*remember, revenue is not profit
Key Takeaway
The Profit and Loss helps you to understand the health of your business.
You can see if you need to increase retail price
You can see if you need to decrease expenses - both direct and other operating expenses
You can see if you need to sell more to cover costs
Most importantly, it helps you to understand if you are making money!
KEY EQUATION OR FORMULA:
Revenue - Expenses = Profit or Loss
Expenses are direct costs & indirect costs
Break Even Point
It is essential that you understand the Break Even Point for your business. The break-even point is when total expenses are even with the amount of sales. This tells you exactly how many you have to sell in order to cover the money you put into the business.
You can also think of it as how many units do you have to sell to recoup investment?
The break-even point is when total expenses are even with the amount of sales.
Example:
The sarong company had total expenses of $152. We then divide that by the selling price of 1 unit of product, $10. This comes out to 15.2, meaning they have to sell 16 (because you can't sell less than a whole sarong) to recoup the initial investment. Everything after that starts to be net profit.
total expenses / 1 product selling price = # need to sell
This is useful info to understand because it helps you to see if you will make a profit. If you are not, you need to either reduce your costs, sell the product or service for more, or sell more. It's that simple.
Formula:
Total Expenses divided by
1 unit of product or service's Selling Price (Retail)
=
# Need to Sell to Cover Expenses
Your hustle point!
Bookkeeping
Bookkeeping is keeping track of your operating expenses and revenue each week, to understand your financial situation at any given moment.
Save receipts and keep track of how many units you sell and on what day.
You can keep your own spreadsheet as you go, but you will submit the following template Profit & Loss for your final grade.
For our purposes, we will use a P&L to keep track of everything and it will include the following:
Total Units Sold
Total Revenue
Operating Expenses:
Direct Costs (you will figure out your gross profit for
1 unit in the Direct Costs template)Indirect Costs
Net Profit or Net Loss
Break Even Point