Napkin Math Part 1

Napkin Math Part 1

Module 1: Napkin Math Part 1

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🎯 Our goal in this module is to begin thinking through your business idea with numbers (sales, costs, net profit, etc.)

Quick Intro

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:

Click the box above to visit website.
Good News: As a small business owner, you will only need to know a handful of financial and accounting terms to build and manage a successful, profitable business.

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).

Cost of Sales

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.

Gross Profit

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.

Operating Costs

Commonly referred to as Operating Expenses - these are all the costs for running your business day in, and day out.

Net Profit (Before Taxes)

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.

Profit & Loss Sheet

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.

Startup Costs

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."

The basic math is...

...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 least at first glance.

Note: Many entrepreneurs start building their businesses with this level of Napkin Math. But with just a little more detail, we can get a much clearer picture of the real opportunity for building a successful, profitable business.

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.

It all begins with figuring out what it will take to get your business to the point where you can leave your current job, earning at least as much "Net Income" as you have now.

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.


Note: The concepts and steps that I'll be guiding you through are applicable to any business idea...
  • Brick-and-mortar
  • Online
  • SaaS
  • Coffee shop
  • Interior design firm
  • Food truck
  • House washing service
  • Consulting services
  • 3-D printing
  • Precision equipment design
  • Manufacturing
  • Craft brewery/distillery
  • Construction business
  • Etc.

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:

Napkin Math:

(Before taxes)

The large and looming question is: Will your business be able to replace your current income?

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:

Target Net Profit (before taxes):

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.

Note: Napkin Math should be fun and easy, and this process is powerful and foundational to your future success.

If you’re struggling or frustrated with any of this, please let us know, so we can help get you back on track.

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.

Question: How much will one of your energy bars sell for? Let's say from your research, you believe each energy bar would sell for $4-$5.

Good. Let's err on the conservative side and say that you will sell them for $4 each.

Question: How many bars will you need to sell in a year at $4 per bar to reach $200,000?
$200,000 ÷$4 per bar=50,000 bars\$200,000\ \div \$4\ \text{per bar}=50,000\ \text{bars}

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).

Question: Does that sound reasonable to you?

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).

4,166 bars per month ÷ 24 work days per month173 bars per day4,166\ \text{bars per month} \ \div \ 24\ \text{work days per month}\approx 173\ \text{bars per day}

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.

Question: But wait, where will customers find your energy bars, if they want to buy one?

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.

So, in this scenario, if you plan to use Specialty Food Stores to sell your energy bars to customers but still want to keep the final price to consumers at $4 each, you will need to sell your energy bars to stores for only $2 each.

Wow, that really puts a dent in your Sales Revenue—cutting it in half.
  • 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.

Quick Recap of Step 1
  1. We started by choosing a target Sales figure for your first year in business—$200,000.
  2. 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.
  3. 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).

(Click triangle toggle to view)

⚡Action Step

Think through your business idea and estimate Sales for your first year.
We have created a simple Google Sheet for you to organize your Napkin Math. After you enter estimates for Sales and Costs, this sheet will automatically calculate your Net Profit (before taxes)! Check out our 🗂️ Resources section at the bottom of this page to access our Google Sheet.

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.

🗂️ Resources

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

Napkin Math Google Sheet
Napkin MathFinancialsBizActually
A simple Google Sheet to organize your Napkin Math! (Created by our Team)

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© 2022 Terry Cornelison | DIY Startup Bootcamp is a initiative.