Module 1: Napkin Math Part 1
🎯 Our goal in this module is to begin thinking through your business idea with numbers (sales, costs, net profit, etc.)
Finance and Accounting has its own language with a vocabulary of literally thousands of words or terms with which to communicate. Just for fun, take a quick look at Investopedia’s online dictionary with over 13,000 definitions that you might hear your finance and accounting friends using:
Financial Terms Dictionary
Investopedia's comprehensive financial terms dictionary with over 13,000 finance and investment definitions
By the time you complete Phase 2 of our DIY Startup Bootcamp, you should be fluent in the basic vocabulary that you will need to launch your business. After that your accountant will help you with any additional terms and concepts that you will need as your business grows and matures.
For the next few modules, we’ll be working with the following terms:
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Also referred to as Revenue or Income. Generally speaking, this is the money coming into your business from the sales of your product(s) or service(s).
Also called Cost of Goods Sold (or COGS for short). These are the costs required to create the product(s) or service(s) that you will be selling.
This is the amount of money that you will have available to pay all the costs of operating your business.
Subtract your Cost of Sales from Sales to get Gross Profit.
Commonly referred to as Operating Expenses - these are all the costs for running your business day in, and day out.
This is the amount of money that you have left over at the end of each day/week/month/year of operations.
Subtract Operating Costs from Gross Profit to get Net Profit.
Also called Income Statement. This is the form that we use to keep track of Sales, Costs of Sales, Gross Profit, Operating Costs, and Net Profit.
These are other costs or investments that may be required to set-up your business, such as purchasing or building operation facilities, furnishings, equipment, vehicles, etc.
What is “Napkin Math?”
So you're finally getting serious about starting your own business. What's the first step?
Many, if not most entrepreneurs that I have met and worked with begin with their own version of “Napkin Math”.
It starts out something like this:
"I'd love to make a million dollars, but for sure I need to make enough money to replace my current income so that I can quit my job and continue paying my monthly living expenses."
...before taxes 😳😭
So, if you have Sales of $200,000, and your Costs are $100,000, you'll have $100,000 Profit (before taxes) left over.
Looks promising...at least at first glance.
In these next few modules, I'll walk you through a quick, fun, and powerful process that you can use to evaluate and plan your next business venture!
You'll even be able to use this process to modify and improve your business model throughout your journey as a business owner/manager.
As I guide you step-by-step through these first few modules, I'll be using a real-world example of a start-up business producing and selling organic, artisanal energy bars for local customers.
- Coffee shop
- Interior design firm
- Food truck
- House washing service
- Consulting services
- 3-D printing
- Precision equipment design
- Craft brewery/distillery
- Construction business
In the future, I'll create even more walk-throughs of this process with various business examples.
We’ll begin with some Napkin Math. Remember the basic calculation:
According to the U.S. Census Bureau, the 2021 annual household income was between $67,000 (median) and $97,000 (average), so we’ll use $100,000 a year as the target Net Income (Net Profit) to determine if your business could potentially support you in the manner that you have (or would like to) become accustomed to.
So, we’ll enter $100,000 as the Profit (Net Profit before taxes) that you need to make:
Next, we can either start looking at what your Costs might be, or we can begin by estimating Sales. It doesn’t really matter where we start.
The important thing is to start thinking about exactly what it will be like to create and operate this business.
Everything that you will be doing in your business will either bring money in (Sales), or send money out (Costs), and as we look closely at how your business will operate, we will discover the things that you will need to do, which will enable you to estimate your Sales and Costs.
Keep in mind that Napkin Math is a rough draft, a first look at the potential of your business idea, so rough estimates of Sales and Costs are okay initially.
If your business looks promising, then your Sales and Costs estimates will become more and more precise as you move through the startup process.
Let’s Start With Sales
Step 1: Create a rough Sales estimate for your first year in business.
All we need here is a starting point, a number that will enable you to begin the math.
As you will see, it will be very easy to change or adjust any number you choose as you move forward.
I have found that just doubling the amount that you have decided on for your Net Profit target is a pretty good place to start for Napkin Math.
In this case, your Net Profit target is $100,000, so we’ll use $200,000 for our initial Sales projection.
Remember that for this example, you're thinking about starting a business producing and selling organic energy bars.
Good. Let's err on the conservative side and say that you will sell them for $4 each.
So, you will need to produce and sell 50,000 energy bars over a 12-month period.
That's about 4,166 bars a month (50,000 divided by 12).
If you just took Sundays off and produced energy bars 6 days a week, that would be about 173 bars a day (4,166 bars per month divided by 24 work days per month).
Let's say that's doable—especially since you will most likely be scaling your recipes to produce bars in relatively large batches (like professional bakeries).
Great! So Annual Sales of $200,000 seems to be inside the realm of possibility.
Let's say your initial plan is to sell your bars to Specialty Food Stores (Food Coops, Trader Joes, Whole Foods, etc.)
Okay, but if you sell your energy bars to these stores for $4 each, then they will have to increase the price to their customers.
In fact, it's very likely that Specialty Food Stores will want to mark up your energy bars 100% (doubling the price they pay you)—after all, they have to make money too.
This means that it would cost $8 rather than $4 for a customer to purchase your energy bars from the store.
Frankly, this may be considerably more than what your customers are willing to pay for an energy bar.
- Maybe you can produce and sell twice as many energy bars at $2 each?
- Or, maybe customers would be willing to pay a little more for your bars?
- Or, maybe you can sell your bars directly to customers at $4, cutting out the Specialty Food Stores?
We'll take a look at these and other options shortly. But for now, let's be conservative with our Sales estimate and stick with using the $2 sales price to Specialty Food Stores.
- We started by choosing a target Sales figure for your first year in business—$200,000.
- Then, we performed a few simple calculations to check to see how realistic this figure is. Assuming you will sell your bars for $4 each, we found that you will have to make and sell 50,000 bars to reach $200,000 in sales, and we determined that's doable.
- However, since you're initially planning on selling to Specialty Food Stores that will probably mark up your bars by 100%, we realized that we need to take this into account. So, in order to keep the final price of your bars to $4 each, while factoring in the 100% store markup, we figured out that a more realistic Sales estimate for your first year in business is $100,000 (50,000 bars x $2 each).
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Think through your business idea and estimate Sales for your first year.
Start by estimating Sales for your first year of business (this is will be a rough estimate, but that’s okay for now).
- Enter this number as Sales in our Napkin Math Google Sheet.
- If you have multiple products or services, you can list each of these here.
- Include brief notes about how you came up with each Sales estimate in the “Notes” column.