Welcome back to our third of six installments about the main parts of writing a business plan. In the previous posts we’ve looked at what’s involved in running a business from a high level and how to build an effective sales and marketing platform. In this post we’ll focus on understanding the finances of your new business.
Understanding Your Cost of Goods Sold
At the core of every business, you have to make sure that you’re selling products and services at a higher price point than what you’re paying for them. The profit margins left over after you deduct the cost of goods sold covers your overhead expenses, and if there’s any money left after overhead costs have been paid then that is the net profit of the business.
When calculating your cost of goods sold, you have to consider all of the costs that your business must pay in order to resell those products and services. This might be direct costs for product that you buy and simply resell, but it could also include materials that you consume in making new products or non-material costs you pay to get the products or materials to your business, like shipping and customs expenses.
But that’s not all that you should include in calculating the profit margin on what you sell, because if you’re a service based business then you might not buy any tangible products or materials. Even if your business only sells services, you still incur costs to deliver those services. Cost of goods for service based businesses typically include employee wages, vehicle expenses if you provide on-site service, tools and other direct costs associated with providing those services.
Calculating Your Overhead Expenses
Overhead expenses are your business costs for everything not included in your cost of goods calculation. The most common types of overhead expenses are salaries of administrative and sales employees, rent or mortgage, office expenses, insurance and health benefits expenses, and professional services fees for accountants, bookkeepers and lawyers. These are all examples of costs you pay for the operation of your business that aren’t directly related to the cost of the products and services you sell.
What Should Your Profit Margins Be?
Unfortunately, there’s no one-size-fits-all answer for what your profit margins should be, it’s different for each business.
Consider a comparison of a convenience store and a custom home builder.
A convenience store might purchase bulk quantities of chocolate bars $0.50 per piece, and resell them individually for $1.00 per piece. That’s a 50% profit margin, which sounds great, but every time they sell a chocolate bar they only make $0.50. With overhead costs that could include rent on a building, wages for people to run the store, and other operating expenses, that $0.50 doesn’t go a long way. The store must sell many chocolate bars (and other types of products, of course!) to cover their overhead expenses and generate a profit for the business owner.
The custom home builder, on the other hand, is selling product at a much higher transactional value so they can still make a good net profit at a much lower profit margin. Say a custom built home sells for $500,000.00. Even if the profit margin after all materials and subcontractors are paid is only 15%, that’s still $75,000.00 leftover to cover the overhead expenses of operating the business. Unlike the convenience store, a custom home builder doesn’t need to sells lots and lots of homes to operate profitably – if they sell ten custom homes in a year that gives them $750,000 to cover their overheads of admin and sales staff, rent, insurance and other business expenses and still make a profit.
How a Bookkeeper Can Help
While it’s difficult to put a specific number on what your cost of good or profit margin should be, you need to make sure that on the whole you’re making money on the products and services you sell. While different people have different ideas on how to start and operate a business, one thing that can’t be argued is that if your business is not making money then it’s only a matter of time before you won’t be able to operate it any more.
Hiring a professional bookkeeper to help calculate and understand what your cost of goods is and which products and services are generating you the most profit is very important to the success of your business.
In the previous blog post, we talked about how to build a sales and marketing platform to help you sell the products and services offered by your business. Once you start selling, though, you have to make sure you’re selling at a profit in order for your business to succeed and grow. Working with a bookkeeper can help make sure that you’re selling products and services at the right price to run a profitable business.
Check back for the fourth installment of this six part series where we’ll discuss the different legal organization types for a new business.
Simply Bookkeeping1 provides professional bookkeeping services for freelancers, solopreneurs and owners of unincorporated and incorporated businesses. We customize our services based on your needs – we only see some of our clients a few hours a month but others we see on a more regular basis. Our services are reasonably priced and we tightly track the amount of time we spend working for you so you only pay for the services you get.
To learn more about us, please visit our website at www.simplybookkeeping1.com or contact Michele Hyde by phone at (647) 668 – 9363 or by email at firstname.lastname@example.org.
Have Your Say
Are you trying to understand calculating cost of goods and profit margins for the products and services you’ll sell in your new business? If so, we’d love to hear from you! Tell us what you’ve discovered as you make your way through this part of writing a business plan. Also, please share this article using the social media share buttons – other people also writing a business plan might benefit from your experience!