Napkin Math Part 2

Napkin Math Part 2

Module 2: Napkin Math Part 2

Share on Facebook or LinkedIn

🎯 Our goal in this module is to begin thinking through your costs and include them in our Napkin Math.

Remember, our basic Napkin Math goes like this:

🔎
Napkin Math:
SalesCosts=Profit\text{Sales}-\text{Costs}=\text{Profit}

(Before taxes)

We now have a rough Sales estimate for your first year of doing business: $100,000.

The Next Step: Estimate your Costs for your first year in business.

💡
As we identify costs, we’ll put them into one of three categories:
  1. Cost of Sales—these are the costs for creating (or purchasing) the product or service that you will be selling to your customers.
  2. Operating Costs—these are the costs related to running your day-to-day business.
  3. Start-Up Costs—these are other costs or investments that may be required to enable you to set-up and operate your business.

We’ll sort these as best we can during the napkin math exercise, but the main thing at this stage is to think things through and identify as many of the major costs as we can.

Cost of Sales

Let’s start by thinking through your Cost of Sales (also called Costs of Goods Sold or COGS).

For this energy bar business, we will be purchasing the raw materials and creating the bars from scratch.

Question: So, how much do you think it will cost you to make one energy bar (let's just focus on ingredients for now)? This is a rough initial estimate, but based on your research, let's say it will cost you about $1 worth of ingredients to make one energy bar.

Excellent! So your Product Ingredients Cost will be:

50,000 bars ×$1 per bar=$50,00050,000\ \text{bars}\ \times \$1\ \text{per bar}=\$50,000
Question: What about packaging costs for your energy bars? Let's say from your initial research, in order to preserve the freshness of your bars and to meet FDA requirements, packaging will cost you roughly 25 cents per bar (this cost should decrease as Sales increase). Packaging costs include printing and labeling the FDA-required Nutrition Facts.

Okay, so your Packaging Cost will be:

50,000 bars ×$0.25 per bar=$12,50050,000\ \text{bars}\ \times \$0.25\ \text{per bar}=\$12,500

Normally, when we buy energy bars from the store, they are displayed on the shelves in boxes with about a dozen bars per box (even though we buy the bars individually). Let's assume this will be the case for your bars.

Question: So, in addition to the individual packaging costs, about how much will it cost you to package your energy bars in display boxes? Let's assume you will package 12 energy bars per display box. From your research, let's estimate that it will cost you roughly $2 per display box (of 12 energy bars), including printing and labeling. This cost will decrease with higher volume of sales.

Okay, so your Display Box Cost will be:

50,000 bars ÷12 bars per box=4,166 boxes50,000\ \text{bars}\ \div 12\ \text{bars per box}=4,166\ \text{boxes}
4,166 boxes×$2 per box=$8,3324,166\ \text{boxes} \times \$2\ \text{per box}=\$8,332

We’ll put these costs into Cost of Sales (or Cost of Goods Sold). This is what it will cost you to make, package, and display your energy bars:

Cost of Goods Sold (COGS)
Product Ingredients
50,000
Packaging
12,500
Display Boxes
8,332
Total
$70,832

Your product is now ready to be purchased by your customers.

Note that...

$70,832 ÷50,000 bars=$1.42 per bar\$70,832\ \div 50,000\ \text{bars}=\$1.42\ \text{per bar}
💡
So, each time you sell one of your energy bars for $2, it costs you $1.42 to make that bar, package it, and display it on the shelf of a Specialty Food Store for purchase.

Start-Up & Operating Costs

Now, let’s think through some of your other costs (Start-Up and Operating).

Question: Where are you going to make your energy bars? Since you're just starting out, it's tempting to do everything from home. However, due to local and state health codes, let's say you're looking into renting a space that used to be a bakery and renovating it to meet your business needs as well as government food safety standards. Rent will be $1,000 per month ($12,000 per year); Renovation costs will be about $8,000 (including sinks, shelving, and everything required for food safety).

Let’s quickly organize these costs in a table:

Operating Costs
Rent
12,000
Total
$12,000
Start-Up Costs
Renovation
8,000
Total
$8,000

We’ll keep adding to each table as we think through more of your costs.

Question: What about equipment?

Let's say initially you will make your bars in batches, but as your business grows, you will consider switching to a production line process.

So, you want to start out with high-quality equipment that you can continue to use as your business grows.

From your research, let's say the startup equipment you need will cost between $20,000-$25,000.

This will include walk-in coolers for storing finished products (before you deliver them to stores).

Let's use the higher potential cost for our estimates—$25,000.

Let’s add this cost to our table:

Operating Costs
Rent
12,000
Total
$12,000
Start-Up Costs
Renovation
8,000
Equipment
25,000
Total
$33,000

Okay, just a couple more questions to think through, for right now.

Question: Will you have enough space in this facility to store all your raw ingredients and packaging materials?

Let's say, for now, the space you plan to rent and renovate will be large enough for the first year or two of operating your business.

Question: After you make and package your energy bars and place them in display boxes, how will you get them from your business location to each Specialty Food Store where customers can buy them?

Since you want as much control as possible over the quality and consistency of your products, let's say you plan to deliver your bars to Specialty Food Stores yourself.

After researching your options, let's say you decide to purchase a late-model, used van for about $15,000.

(Leasing was also an option, but you decided that owning your own van with a warranty contract would be a better solution for now.)

Okay, $15,000 for a used van. You will also have to factor in the cost of operating and maintaining your delivery vehicle.

For a rough estimate, let's say that you will put 15,000 miles a year on your van—this includes product deliveries as well as picking up raw ingredients and packaging materials to bring to your facility.

Using the U.S. 2022 IRS allowable business vehicle mileage rate of 58.5 cents per mile, we can estimate your annual vehicle operating expenses at:

15,000 miles ×$0.585 per mile=$8,77515,000\ \text{miles}\ \times \$0.585\ \text{per mile}=\$8,775

Let’s add these costs to our table:

Operating Costs
Rent
12,000
Vehicle Operating Expense
8,775
Total
$20,775
Start-Up Costs
Renovation
8,000
Equipment
25,000
Van
15,000
Total
$48,000

You will probably also need some cardboard boxes to pack your energy bar display boxes for delivery. Let's factor this into your Costs estimate.

Question: What do you think your average order size will be for Specialty Food Stores, initially?

For now, let's just make a conservative guess and say that, in the beginning, these stores will order 4 display boxes of your energy bars, at-a-time.

Until you have more accurate information, let's say you will package those 4 display boxes inside one cardboard box for delivery to each store.

According to our earlier estimates, you will have about 4,166 display boxes of energy bars to sell during your first year of business.

That means you will need 1,042 cardboard boxes for "shipping".

4,166 ÷ 4=1,0424,166\ \div \ 4=1,042

The cost per box will vary depending on the quality of your cardboard boxes and whether you decide to add printing and labeling to the boxes.

From a quick Google search, let's say you should be able to find the boxes you need for $1-$3 per box.

Let's err on the conservative side and use the $3 per box estimate.

1,042 shipping boxes ×$3 per box=$3,1261,042\ \text{shipping boxes}\ \times \$3\ \text{per box}=\$3,126

Let’s add this cost to our table:

Operating Costs
Rent
12,000
Vehicle Operating Expense
8,775
Shipping Boxes
3,126
Total
$23,901
Start-Up Costs
Renovation
8,000
Equipment
25,000
Van
15,000
Total
$48,000
Question: Will you have a partner in this business?

Partnerships in business can be tricky. Let's say, for now, you will be the sole proprietor of your business.

However, let's say you have a good friend who is interested in your business idea and wants to help you get it off the ground.

She has small children and is not ready yet to leave her current job and take on the risk of starting a new business. But, she will help you out part-time, and if things go well with the business, she may even join you as a co-owner and partner down the road.

Question: Will you be paying your friend a salary or an hourly wage?

Even though you want to pay your friend, let's say she refuses to accept any payment for the moment since, from her point of view, she is helping out a close friend and learning about business.

For now, this is fine, but we'll want to revisit this situation later on.

Question: Besides your friend, do you think you will be hiring anyone to work in your business during the first year (for example, to drive your delivery van or help clean up your facility and prep your ingredients)?

For right now, let's assume you will be able to handle everything on your own (with some part-time volunteer help from your friend).

If the business takes off, and you can't keep up with orders on your own, we can look into hiring some employees, at that point.

Bring It Together

Okay, we're almost finished with our initial Napkin Math. You will certainly discover other costs as you do more research, but let's collect all your Costs estimates into one large table and see where we are.

💡
Important: We’re going to set aside all of your Start-up Costs for now. They will be dealt with a little differently than Costs of Sales and Operating Expenses. There is a reason for separating these costs from Costs of Sales and Operating Expenses that we’ll explore a little later on.  For now, the important thing is to be aware that these costs exist and to keep track of them like we did above. We’ll bring them back into our calculations when we talk about Cash Flow.

Cost of Goods Sold (COGS)
Product Ingredients
50,000
Packaging
12,500
Display Boxes
8,332
Total
$70,832
Operating Costs
Rent
12,000
Vehicle Operating Expense
8,775
Shipping Boxes
3,126
Total
$23,901
Total Costs
$94,733

Now, let’s plug $94,733 into our Napkin Math calculation from earlier:

$100,000 Sales  $94,733 Costs=$5,267 Net Profit\$100,000\ \text{Sales}\ - \ \$94,733\ \text{Costs}=\$5,267\ \text{Net Profit}

(Before taxes)

😱
This doesn't look too encouraging...but don't worry just yet. I have worked with thousands of businesses and have seen plenty of situations that looked far worse than this after an initial Napkin Math "reality check". I have also led several "turnarounds" of existing businesses that looked totally hopeless from the onset.

Now, at least we're beginning to see more clearly what it will actually look like to start your new energy bar business, according to your initial thinking.

We're not finished yet, but this is about as far as we can go with our initial Napkin Math.

⚡Action Step

Think through your business idea and estimate Costs for your first year.

Start by estimating the costs for starting and operating your business (Cost of Sales, Operating Costs, and Start-Up Costs).

  • Enter these numbers into our Napkin Math Google Sheet. We’ll keep Start-Up Costs separate from your other Costs for now.
  • If you have multiple products or services, be sure to include the Costs of Sales for each.
  • Include brief notes to explain your Costs of Sales and Operating Costs estimates.
🗂️
Check out our “Resources” section at the bottom of this page to access our Napkin Math Google Sheet.

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

Give Us Feedback

❇️
Help us improve this module. Use the form below to tell us what content you’d like us to add or modify. (If you can’t see the form below, try refreshing the page)

← Previous

Next →

💠
https://startup.bizactually.com/

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