As long as this simple formula was respected and followed, things work very well for business owners: You had a product which costed you 50$, sold it for 75$, therefore earned 25$ in profit. And that's all the money you had in your pocket and so, the only money available to you for doing things. There was nothing more to it than that.
Profit = Sales - Costs
It’s a formula that still holds true both in small businesses, like yours, as well as in the world’s largest companies, the difference being that many additional factors are taken into consideration nowadays to calculate it.
How much does it really cost to manufacture your product?
In many cases, though it seems so basic a concept that needs no explanation, business owners don’t realize production cost goes far beyond the cost of raw materials plus the money you pay for the actual manufacturing process.
Your office rent, money paid for electricity, telephone, and Internet services, your salary and that of your employees, and many other additional costs, should be included as part of your production cost, and they all add up.
And it’s important to keep this in mind, because every expense not included in your production cost and taken into consideration while calculating your product’s sale price, will come out from the only place possible: your profit.
Note that the formula remains the same: Profit = Sales - Costs.
And at what price you need to sell your product then?
It’s very simple to avoid surprises. If you include into the costs of manufacturing your product, all the expenses it actually carries along and then you add up your expected profit margin, then you will know with greater accuracy the price at which you need to sell your product or service.
And you can also come to know at what price you cannot sell it, which is even more important, because more often than not you might end up offering incentives and discounts without realizing how much they can affect your actual profits.
For instance, when you go to a bookstore and buy a pack of letter size paper, in the money you’re paying for it at the counter, all costs incurred by the manufacturer to get that paper package delivered to your hands are included. You are even paying up for the truck used to deliver the merchandise, believe it or not.
For many people this expanded concept of "production cost" comes as a surprise and they’re unable to see it clearly.
That is why we get to learn of so many cases of entrepreneurs who get to the end of the month believing it was a successful one because they had huge sales and it turns out that, in the end, the numbers are not what they expected them to be or even ended up losing money.
What do you really have to do to make money?
If you look at the formula at the beginning of this post, the only way for you to make money is to bring in more money than what goes out (sales always bigger than expenses).
You need to learn how to play with the money you actually have, and that’s why it’s so important to have this formula in mind every day while managing your business, no matter what size it is, regardless of what product or service you sell.
Well, perhaps I shouldn’t exaggerate and say every day, but it's definitely an equation that should overall drive how you manage your business.
If at any time, you detect the money you're earning begins to decrease it might only be due to:
- An increase in costs.
- A decline in sales.
- A combination of both.
In your case, do you know how much your business operation costs each month, how much it costs you every day? You know how much money you're making even before you meet with your advisor or accountant?
Related article: Today’s big challenge: From abundance to shortage.