Constructing a Profitable Model

Constructing a Profitable Model

Module 3: Constructing a Profitable Model

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🎯 Our goal in this module is to find a way to increase your Net Profit (before taxes) figure from the last module.

Quick Intro to P&L

Remember, our overarching goal is to find at least one way that you can start your business and make enough money to quit your current job and continue paying your monthly living expenses, at the very minimum.

We started out by working through our simple Napkin Math calculation:

Sales  Costs=Net Profit\text{Sales}\ -\ \text{Costs}= \text{Net Profit}

(Before taxes)

  1. First, we estimated Sales for the first year of operating your business—ultimately, about $100,000.
  2. Then, we estimated Costs for your first year of business—about $94,733.
  3. Finally, plugging these numbers into our basic Napkin Math equation resulted in a Net Profit of $5,267 projected for your first year in business (given all of our assumptions so far and the model of selling to Specialty Food Stores).
📍
Note: This bottom line number is significantly lower than our target amount of $100,000 Net Profit (before taxes), but that's okay, for now.

Working through this Napkin Math helped us to begin clarifying our initial thinking about this potential energy bar business with numbers backed by some quick research.

Far too many new business owners ignore this first step and charge boldly into starting their new business without even considering their practical financials.

Normally, it doesn't take long before this approach results in major cash flow problems that can become fatal for a new business.

👏
So, congratulations! You're already a step ahead of most new business owners!

Now, let's take our Napkin Math to the next level and try to find a way to increase that bottom line figure (Net Profit before taxes). 

Let’s see if $100,000 Net Profit could possibly be within our grasp. 😉

In order to do this, we'll use a tool with more structure than our basic "Napkin Math" spreadsheet—enter the Profit & Loss Sheet (a.k.a the Income Statement).

🔎
The Profit & Loss Sheet is a key financial management tool that can help you measure your profitability (monthly, quarterly, or annually). Will you be making money or losing money over time? We’ll be using it here to structure your Napkin Math.

Basically, the Profit & Loss Sheet organizes and categorizes your Sales revenue, Cost of Goods Sold (or Cost of Sales), and your Operating Expenses (all the costs required to operate your business).

It then automatically calculates:

Sales Cost of Sales=Gross Profit Gross Profit Operating Expenses=Net Profit\text{Sales}\ - \text{Cost of Sales}=\text{Gross Profit}\\\ \downarrow \\ \text{Gross Profit}\ -\text{Operating Expenses}=\text{Net Profit}

(Before taxes)

*Gross Profit is just the amount of money you have available to pay for your Operating Expenses (after subtracting your Cost of Goods Sold from Sales).

Here’s what a Profit & Loss Sheet would look like using our Sales and Costs estimates from the last two modules:

Sales
Specialty Food Store Sales
100,000
Total Sales
$100,000
Cost of Goods Sold (COGS)
Product Ingredients
50,000
Packaging
12,500
Display Boxes
8,332
Total COGS
$70,832
Operating Costs
Rent
12,000
Vehicle Operating Expense
8,775
Shipping Boxes
3,126
Total Operating Costs
$23,901
Net Profit (Before Taxes)
$5,267

We'd love to see this bottom line number (Net Profit before taxes) exceed $1 million dollars, but for sure it needs to be greater than your current income, if you plan to quit your job and continue paying your monthly living expenses while you focus on building your business full-time.

For this example, our target is for your Net Profit (before taxes) to be $100,000 or more.

If we can create a scenario, using our "Profit & Loss" spreadsheet, where your business model generates at least $100,000 Net Profit (before taxes), then you can start taking action to bring this model into reality as you move forward with building your business.

📍
Note: We didn’t include your Startup Costs from Module 2 in the Profit & Loss Sheet above on purpose. That’s because Startup Costs like the cost of renovation, kitchen equipment, and a delivery van are actually investments to enable you to “operate” your business, so we will not include them on your Profit & Loss Sheet. We’ll return to these Costs later when we get into Cash Flow and create an even more powerful tool for managing your business financials.

Using the Profit & Loss Sheet (along with a few more tools that we'll create in later modules) will help eliminate the fog of not really knowing where you stand with your business and your money.

These tools will enable you to plan, measure, and manage your business with confidence and competence.

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Good News: You do NOT have to study finance, learn accounting, or even keep the books for your business, but you will need to know how to use the numbers generated by your business and organized by your accountant to help you make key decisions as the owner/manager.

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Moreover, we’ll make it fun and easy for you!

More Operating Expenses

In the last Module we created estimates for a few potential operating expenses (Rent, Vehicle Operating Expense, and Shipping Boxes), which is a great start.

But most businesses incur a much wider range of operating expenses from Advertising & Marketing to Utilities.

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Next Step: Identify as many potential expenses that you can imagine yourself incurring in order to operate your business and include them in our Profit & Loss Sheet.

Let’s walk through a list of common operating expense categories and determine whether or not they apply to your energy bar business.

If we think they do, then we’ll go ahead and create a rough initial estimate for each. (Click each triangle toggle to view)

Advertising & Marketing → $12,000
  • These are the costs for letting potential customers know about you and your business—social media ads, email marketing, website content (including professional product photos), etc.
  • For this example, we’re estimating this cost at $1,000 per month or $12,000 for your first year in business. This is a rough starting point, like all of our Napkin Math estimates at this stage. (You can always update your estimates as you learn more from your research).
  • The SBA recommends between 7% - 8% of Annual Sales (for a business with less than 5 million in revenue) — $12,000 is a bit higher at 12% of our $100,000 Sales estimate, but that’s okay for now.
    • According to a survey by Deloitte in 2021, the average marketing budget (as a percentage of revenue) reported by respondents was just over 13%.
B&O Tax → $0
  • Some States and municipalities have Business & Occupation (B&O) taxes based on your revenues—to start out just Google “business taxes for [name of your state]” or check your secretary of state website (Google “secretary of state [name of your state]”).
  • For this example, we’ll leave B&O Tax at $0 to avoid diving into the details of any one particular State.
Bank Charges → $600
  • These are potential costs associated with your bank accounts—checking, money transfers, etc.
  • For this example, we’re estimating this cost at $50 per month or $600 for your first year in business.
Credit Card Fees → $0
  • These can include the transaction cost and a percentage of each sale where a credit card is used.
  • Since you’ll be selling exclusively to Specialty Food Stores in this first example (not directly to customers who might be using credit cards), we can leave this cost at $0 for now.

Insurance - Health → $6,000
  • You may provide health insurance for yourself or for any employees as a benefit.
  • For this example, we’re estimating this cost at $6,000 for your first year in business, which is about the average individual self-employed coverage according to eHealth.
Insurance - Hazard/Liability → $3,000
  • Most major insurance companies can help you decide the kind and amount of coverage you will need in your business, just call a few companies to get estimates.
  • For this example, we’re estimating this cost at $250 per month or $3,000 for your first year in business.
Janitorial Expense → $0
  • Somebody will have to keep your facility (or office space) clean, and it’s a legitimate business expense.
  • For this example, you’ll be handling all “janitorial” services yourself as the business owner (until you decide to hire these responsibilities out), so we can leave this cost at $0.
Legal & Professional Fees → $5,000
  • For sure you will encounter the need for legal help. You can also use this category to record any potential fees for working with an accountant, management consultant, or any other professional.
  • For this example, we’re estimating this cost at $5,000 for business registration and legal fees.
Licenses & Permits → $2,000
  • What licenses and permits might be required to operate your business? These could include a business license, seller’s permit, building & zoning permits, professional practice licenses.
  • You can start out by Googling or contacting your city, county, and State to find out what exactly applies to you and your business.
  • For this example, we’re estimating this cost at $2,000 for your first year in business.
Office Expense → $1,500
  • You can use this category to record potential costs for day-to-day general office supplies (such as pens, copy paper, printer ink, etc.) or basic equipment (such as a work laptop or computer).
  • You could even use this category to record costs for productivity and team management software services such as Google Workspace, Calendly, Zoom Pro, etc.
  • For this example, we’re estimating this cost at $1,500 for your first year in business.

Payroll → $0
  • This category is where you can estimate the amount earned by any salaried and hourly employees.
  • For this example, we’ll leave this cost at $0 since you won’t be hiring any employees initially.
Payroll Taxes (State & Federal) → $0
  • As an employer, you will pay half of the total Social Security and Medicare taxes that are based on Payroll.
  • You will find the exact percentage that you are responsible for on the IRS website.
  • Like above, we’ll leave this cost at $0 since you won’t be hiring any employees initially.
Phone → $600
  • You can use this category to record the potential cost of your business phone and phone service.
  • If you plan to use a virtual phone number (like Google Voice or a Skype Number) or a more robust software solution (like Nextiva or UniTel Voice), this is where you can record those estimates.
  • For this example, we’re estimating this cost at $50 per month or $600 for your first year in business.
Postage & Printing → $0
  • If you will use brochures, business cards, or other printed literature in your business, this category is where you can record those expenses.
  • For this example, we’ll leave this cost at $0 (for now).
Repairs/Maintenance → $0
  • This category is for the costs associated with repairing and maintaining the equipment that you use in your business.
  • For this example, let’s assume all the equipment you purchase for your facility will include at least a one-year warranty, so we’ll leave this cost at $0 (for now).
Security & Alarm Expense → $3,500
  • This category is where you can record costs for providing security to your office, factory, vehicle, etc.
  • For this example, we’re estimating this cost at $3,500 for your first year in business (which could cover installation and monitoring of alarms and security cameras in your facility).
Utilities → $4,000
  • Usually this category will include costs such as water, electricity, gas, waste disposal, etc.
  • For this example, we’re estimating this cost at $4,000 for your first year in business (mainly for your processing and refrigeration energy requirements).
Website & SEO Services → $5,000
  • This category is where you can record potential costs for the creating, hosting, and optimizing your website plus any other ongoing services related to your website.
  • For this example, we’re estimating this cost at $5,000 for your first year in business.
Miscellaneous → 15% of Operating Expenses subtotal
  • No matter how well you prepare for launching and operating a business, there will be expenses that you either didn’t or couldn’t plan for, so it’s wise to include an “error allowance” to help cover these “fun surprises”.
  • This “Miscellaneous” category will be automatically calculated as a percentage of all your other Operating Expenses.
  • For this example, we’ll use 15% as your Miscellaneous expenses estimate.

As you think through your business scenario, you can add any other expense categories that you think will be necessary for operating your business.

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Your accountant will help you organize everything when you’re ready to actually start operating your business, but for now, just try to identify potential expenses and add them to this section.

Next, let’s include these additional operating expense estimates in our Profit & Loss Sheet:

Sales
Specialty Food Store Sales
100,000
Total Sales
$100,000
Cost of Goods Sold (COGS)
Product Ingredients
50,000
Packaging
12,500
Display Boxes
8,332
Total COGS
$70,832
Operating Costs
Advertising & Marketing
12,000
B&O Tax
0
Bank Charges
600
Credit Card Fees
0
Insurance - Health
6,000
Insurance - Hazard/Liability
3,000
Janitorial Expense
0
Legal & Professional Fees
5,000
Licenses & Permits
2,000
Office Expense
1,500
Payroll
0
Payroll Taxes (State & Federal)
0
Phone
600
Postage & Printing
0
Rent
12,000
Repairs/Maintenance
0
Security & Alarm Expense
3,500
Shipping Boxes
3,126
Utilities
4,000
Vehicle Operating Expense
8,775
Website & SEO Services
5,000
Miscellaneous (15%)
10,065
Total Operating Costs
$77,166
Net Profit (Before Taxes)
-$47,998
😳
Looks like we're moving in the wrong direction and getting further away from our target of $100,000 Net Profit (before taxes)...so what can we do about this?

Testing Alternative Scenarios Fast

It’s pretty clear now that the business model that we’re proposing—selling exclusively to Specialty Food Stores—is not looking too good (given the number of units that we're selling at the price of $2, and given the cost of making and delivering the products to the stores for retail, plus the cost of operating the business).

💡
Good News: Now that we have projections entered into our "Profit & Loss" spreadsheet, we can quickly look at various options and alternative models to see if there is a reasonable way to make at least $100,000 a year with this Energy Bar business.

If we can’t find a way to make this work here and now, you can move on to investigate other potential business opportunities that might be more appealing, while you still have a roof over your head and food on the table. 😉

So, can we improve the situation by increasing the number of units sold--say double that number?

Let’s take a look.

Scenario 2: Sell 100,000 Energy Bars at $2 Each

In this scenario, Sales become $200,000 (100,000 bars x $2 each).

Each Cost of Goods Sold doubles to match the increase in Sales.

The most obvious (or most likely) Operating Expenses to change with higher sales volume would be:

(Click the triangle toggle to view)

Advertising & Marketing → $24,000
  • Let's double the cost from Scenario 1 to $24,000 ($12,000 x 2).
Office Expense → $3,000
  • Let's double the cost from Scenario 1 to $3,000 ($1,500 x 2).
  • Maybe you decide to purchase a more powerful computer or upgrade your productivity software tools.
Shipping Boxes → $6,252
  • Let's double the cost from Scenario 1 to $6,252 ($3,126 x 2).
Utilities → $8,000
  • Let's double the cost from Scenario 1 to $8,000 ($4,000 x 2).
Vehicle Operating Expense → $13,163
  • Let's increase the cost from Scenario 1 by 50% to make $13,163 ($8,775 x 1.5).

We'll keep all other Operating Expenses the same as in Scenario 1.

Now, our Profit & Loss Sheet shows:

Sales
Specialty Food Store Sales
200,000
Total Sales
$200,000
Cost of Goods Sold (COGS)
Product Ingredients
100,000
Packaging
25,000
Display Boxes
16,664
Total COGS
$141,664
Operating Costs
Advertising & Marketing
24,000
B&O Tax
0
Bank Charges
600
Credit Card Fees
0
Insurance - Health
6,000
Insurance - Hazard/Liability
3,000
Janitorial Expense
0
Legal & Professional Fees
5,000
Licenses & Permits
2,000
Office Expense
3,000
Payroll
0
Payroll Taxes (State & Federal)
0
Phone
600
Postage & Printing
0
Rent
12,000
Repairs/Maintenance
0
Security & Alarm Expense
3,500
Shipping Boxes
6,252
Utilities
8,000
Vehicle Operating Expense
13,163
Website & SEO Services
5,000
Miscellaneous (15%)
13,817
Total Operating Costs
$105,932
Net Profit (Before Taxes)
-$47,596
😭
So, we moved from a Net Loss of $47,998 in Scenario 1 to a Net Loss of $47,596 in Scenario 2.

Clearly, selling more at the same price is not the answer, so let’s run through some other scenarios to see if we can find a business model that could work for you.

The great thing is that using our "Profit & Loss" spreadsheet makes testing different scenarios fast.

💡
Increasing Sales is a common way that many, if not most, small business owners try to increase profits and improve their financial performance.

However, this only works if the underlying problems are “fixed” before adding more Sales. We’ll examine how to make this strategy work for you a little later.

Before leaving the “sell to and through Specialty Food Stores” business model, let’s see what it would look like if we could raise our price to the Specialty Food Stores.

Scenario 3: Sell 100,000 Energy Bars at $2.50 Each

In our first two scenarios, we were selling energy bars to Specialty Food Stores for $2 each. We based this price on two assumptions:

  1. Consumers would likely be willing to pay at most $4-$5 for high-end energy bars (to be conservative with our estimates, we chose the lower extreme of $4 for our price calculations).
  2. Specialty Food Stores would likely need to double the final price to consumers.

In this third scenario, let's use the higher extreme of $5 for the final price to consumers.

Since Specialty Food Stores will most likely need to double the cost that they pay you for your energy bars (in order to make the profit they need), we can increase our price per bar from $2 (in the previous two scenarios) to $2.50.

Other than this change to Sales, Cost of Goods Sold and Operating Expenses should remain the same as in Scenario 2 since all we're doing is changing the price per energy bar.

Let’s see how this changes things.

Sales
Specialty Food Store Sales
250,000
Total Sales
$250,000
Cost of Goods Sold (COGS)
Product Ingredients
100,000
Packaging
25,000
Display Boxes
16,664
Total COGS
$141,664
Operating Costs
Advertising & Marketing
24,000
B&O Tax
0
Bank Charges
600
Credit Card Fees
0
Insurance - Health
6,000
Insurance - Hazard/Liability
3,000
Janitorial Expense
0
Legal & Professional Fees
5,000
Licenses & Permits
2,000
Office Expense
3,000
Payroll
0
Payroll Taxes (State & Federal)
0
Phone
600
Postage & Printing
0
Rent
12,000
Repairs/Maintenance
0
Security & Alarm Expense
3,500
Shipping Boxes
6,252
Utilities
8,000
Vehicle Operating Expense
13,163
Website & SEO Services
5,000
Miscellaneous (15%)
13,817
Total Operating Costs
$105,932
Net Profit (Before Taxes)
$2,404

Okay, well that certainly helped a lot. We went from a Net Loss of $47,596, to a Net Profit of $2,404.

🎉
Finally, you’re making some money!

So, there could be potential with this business model of selling exclusively to Specialty Food Stores. Of course, we would have to find a lot of customers very early on if we choose this route.

Let’s do some quick math...

We’re estimating that you will sell 100,000 energy bars over 12 months.

  • How many Specialty Food Store relationships will you need to make this happen?
  • Let’s assume that on average, one Specialty Food Store can sell 4 Display Boxes of your energy bars each month.
  • Each Display Box contains 12 energy bars, so that’s 4 x 12 = 48 energy bars per Specialty Food Store per month, which comes to 576 bars per year per Specialty Food Store (48 x 12).
  • 100,000 bars divided by 576 bars per Specialty Food Store equals about 174 Specialty Food Stores.
  • That’s a lot of Specialty Food Stores for you to find and persuade to buy your energy bars! 😱

(Click triangle toggle to view)

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Note: Launching a new product in the marketplace is a time-consuming process, and most sales statistics indicate that it takes multiple visits and time-consuming follow-up sales calls to bring a Specialty Food Store buyer to give your product a try.

It’s also a common practice to spend at least one weekend inside each potential store giving free samples of your product to their customers and getting feedback to help you convince final consumers that your energy bars are worth trying out (instead of what they might otherwise purchase).

Therefore, even though this business model—with Specialty Food Stores being your target customer—may have potential to generate the Net Profit that you will need to replace your current income, it will probably take a few years to get enough new and repeat customers to reach your initial Net Profit goal.

⚡Action Step

Transfer your estimates for Sales, Cost of Sales, and Operating Costs to our Profit & Loss Sheet.

To help you organize all you new Costs and test different scenarios fast, we created a simple Profit & Loss Google Sheet.

🗂️
You can access this sheet at the bottom of this page in the ”Resources” section.

Step 1: Enter your Napkin Math estimates for Sales, Cost of Sales, and Operating Costs into our Profit & Loss Google Sheet.

Step 2: Go through our list of additional Operating Costs and think through which ones might apply to your business. Then add rough initial estimates in the corresponding cells (might take a little online research).

Don’t worry if your bottom line comes out negative or smaller than you had imagined.

💡
We’ll test out even more alternative scenarios in the next modules to increase this Net Profit (before taxes) figure. Our target for this example is $100,000 in Net Profit (before taxes).

🗂️ Resources

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Scroll left-to-right across the table below to view all columns. Click on any item in the leftmost column to open that specific resource page.

🗂️
Resources Core Database

ItemTagsURLPriceDescription
Profit & Loss Sheet
Napkin MathFinancialsBizActually
Free
A simple Profit & Loss Google Sheet to test alternative business models fast! (Created by our Team)

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❇️
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