all right welcome to financials for
startups so in this video we're gonna be
walking through how to conduct a basic
financial feasibility trying to make a
decision on whether or not there is a
potential for us to execute on the idea
that we have so the kind of target for
this video if you're kind of wondering
if this is for you is someone who is
considering starting a business maybe
has gotten a little bit of market
feedback seems to be kind of supportive
of furthering the idea but we need to
evaluate it from a financial standpoint
so if you're kind of in that position
let's say this is going to be a helpful
video for you because at the end of the
day we want to know does the idea pencil
out if we go through the energy of
launching the business and doing all the
different things that are required in
order to launch a business are we going
to be profitable and can we be
profitable based upon our current idea
so this is gonna be a pretty
quantitative type video so I encourage
you to kind of stop and start depending
upon where we're at and if you need to
kind of go back and review a couple
things but the ultimate goal that we're
gonna finish with is we're gonna make a
determination as to the financial
feasibility of the idea in a more basic
sense can we make money and doesn't make
sense for us to exert the energy into
launching this thing so there's a couple
of things that we have to get through
first before we can do this type of
analysis so the first thing that we need
to be able to figure out is we have to
figure out how much money we make by
selling one of our products or services
so there's a lot of different terms for
this the one that I typically use is the
economics of a unit and so we're
essentially just trying to figure out is
if I sell one item whatever that
whatever that looks like for you can we
make money what does it cost us
to actually create this product or offer
this service so what are all of the
costs that go into it
and then ultimately what am i pricing at
what's that difference if we can't make
money from selling the actual unit
itself then we're gonna have a lot of
problems because from a business
standpoint there are a lot of cost that
we have to go into so just to kind of
highlight some of those things when
we're operating a business there's a lot
of different expenses that we have
generally speaking we put those into two
categories so the first category is what
we call a variable cost now a variable
cost is exactly what it sounds like
it varies but it varies specifically
based upon our sales so these are
expenses that will increase as we sell
more of something so the way to look at
this is if we were to is if we were to
develop a little graph here and on the
bottom axis this is gonna be revenue and
this is going to be our costs variable
costs kind of go up like this so they go
up in proportion to what our revenue is
and that's because we need to incur
these in order for us to be able to sell
an actual product so just as a basic
example I owned a coffee roaster so we
import roast and then we package and
distribute coffee to a wide variety of
locations so for us let's say if we were
to try to figure out how much money we
could make on a bag of coffee and so
we'll just pick any you know pick a 12
ounce bag of coffee we would need to
know what are the variable cost what are
the costs associated with selling that
one unit and so for us you could say
obviously our variable costs include
coffee beans because it's really hard to
sell a bag of coffee without the beans
itself I mean I've tried to do it
doesn't really work out that well and we
need an actual bag to put the coffee in
if we need a label if it's not already
on the bag we need an actual label
itself and then we need some labor right
we need someone who is going to roast
the coffee we need someone who is going
to fill the coffee into the bag and then
seal it and then package it and get it
ready for shipment so all of these
things would be considered
our variable cost because I cannot get
around incurring these expenses if I
ultimately want to sell a bag of coffee
and that's where this line here kind of
comes into plays because the costs are
gonna go up as my revenue increases as
well now in terms of the variable cost
there's a couple of different types
right so under variable cost I'm gonna
write variable cost here there's a
couple of different types that you'll
want to consider and every business it
looks a little bit different I'll kind
of explain kind of how that looks so the
starting points are the first ones I
should say are ones we kind of talked
about and that's what we call direct
materials so the direct materials are
the physical goods that go into
producing your product or offering your
service so physical goods here would
include the coffee beans the bag and the
label right those are all physical items
that we have to crew we have to put
together and their component goods and
we have to use those in order to create
a finished product the next type of
variable cost is what we call direct
labor
now our direct labor is the time that it
takes for us to pay someone or the the
rate of pay that they receive from
having to do something so in this case
we're having them create one bag of
coffee so we want to know the time
associated with creating that bag of
coffee and all of the processes that go
into place and are associated with that
so we're looking specifically at the
time that it would take to create that
and going through that process right
from roasting the coffee to packaging it
and ultimately getting ready for
distribution now on top of this we also
have what we call other variable costs
and this is a very broad category but
ultimately other variable costs include
costs that are associated with the sale
but ultimately don't fall into these two
categories here so a couple of examples
include credit card processing fees
which we often forget about
include shipping expenses which can
especially for my business can be pretty
sizeable depending upon what you're
sending into what location could include
sales commissions if we're paying
somebody else a fee to be able to sell
our products and a couple of other
things and so these are things that we
obviously want to include as well
so when figuring out our variable costs
we're going to add all of these things
up and we're gonna figure out how much
it would cost us to actually produce an
actual product so let's kind of go
through some calculations just so you
can see how this would work so let's say
I'm gonna make a list here and let's get
a little bit more room and I'm gonna say
we've got coffee beans and we've got a
bag and we've got a label so we have to
figure out what our expenses are now
since I obviously run this business I'm
most familiar with the cost so I'll kind
of just make those up but for your
business you're gonna want to think
about all of the different costs that
you have and you're gonna want to get
prices for those I would not encourage
you to do like a just a basic search
online and go with anything you find
because what you'll find is a lot of
those expenses one might not apply to
you so they're purchasing things in bulk
and you might not have the capital to do
that upfront the other thing is you
might not want to meet the minimum order
quantities that many of those expenses
are associated with so you might have to
purchase 10,000 units and you might say
well like I don't have the financial
flexibility to do that so the best way
to do it is either to talk to somebody
who operates a similar business and they
understand what the costs are or to pick
up a phone and actually call suppliers
and get a quote and that's the best way
to do this because you're going off of
actual data versus what you think it's
going to cost you and oftentimes we
undershoot those expenses so for coffee
beans and the bag and the label let's
say that for 12 ounces our coffee beans
costs us $3.00 per pound and the bag
itself is 50
cents and the label itself is ten cents
and then we also have labor so I'm gonna
do first though is I'm just gonna add
all these up here because these are our
direct material expenses right so this
is gonna be our direct materials per
unit so here we've got three dollars and
sixty cents that's how much we have in
direct materials now we need to figure
out our other variable costs right or
not our direct labor I'm sorry
so our direct labor in order to figure
this out you would actually have to try
in time how long it takes right so we're
altering out time multiplied by wages is
ultimately what your direct labor is
going to be so we're not gonna go
through that process because if you
understand kind of basic arithmetic you
can get that no problem so we're gonna
say that the labor itself adds an extra
dollar to the actual price so that's our
direct labor per unit is $1 well now we
have to figure out our other variable
costs right the ovc as we commonly refer
to them as so there's a couple of things
here for my business specifically we we
sell things through multiple channels
and so sometimes we incur credit card
processing fees sometimes we don't but
we price assuming that those credit-card
transaction fees are there because I'd
rather build those into the price of my
product versus later on trying to do so
and then you're raising prices on
customers which historically they do not
like that the other thing that's
important is because you're pricing
yourself largely based on these figures
and if we don't incur if we don't accrue
them and incorporate them into our
pricing then oftentimes what can happen
is we're not making as much money as we
think we are so it's important to
include those now a credit card
processing fee varies but the simplest
one at least for I'll put CC for credit
cards that I've seen is 2.9 percent of
the transaction plus a 30 cent
transaction fee now if you're selling
something that's not very expensive
that's a
pretty big percentage right if you're
selling something that's several hundred
dollars then it's not going to be as big
of a big of a portion of your revenue
base but if you're selling something
that's not very expensive you can't
really absorb this 30 30 cent
transaction fee as much so just as an
example let's say that we're gonna sell
coffee at $15 so you've got a $15 bag of
coffee and we're gonna pay 2.9 percent
in the processing fee which is going to
be 43 cents plus that 30 cent
transaction fee that means that roughly
74 cents is going to go just towards the
credit card processing fees so at a $15
item that's a pretty significant
percentage of the overall value of the
product right which is why we certainly
want to calculate those as well so let's
add all these three up now for your
business you're gonna want to make sure
and again go through all the direct
labor think about your other variable
costs and all of your direct materials
so I'm going to move down here and I'm
going to list all these so we've got
direct materials per unit which means
per bag sold in this case of three
dollars and sixty cents we've got our
direct labor per unit of one dollar and
then we've got our other variable cost
per unit of 74 cents now in reality for
this other variable costs we of course
in Cru shipping expenses one many times
that we ship especially over a certain
value so that's something that we would
incur but for this example I'm not going
to include those just for simplicity
sake so the result of this is going to
be our total costs of goods sold per
unit which I'm going to abbreviate as Co
GS or cogs is the common terminology so
if we bring back our calculator here and
we clear this and we've got three
dollars and sixty cents plus one dollar
plus seventy four cents that's $5.34
that we have in
costs so there we go we've got the first
part done we now know exactly how much
it's going to cost us to produce an item
we've covered all of the variables
involved and so we should feel pretty
good about ourselves because we have a
good understanding of what it's going to
cost us to make so the next thing we
need to do is we've got to go through
and figure out what we call a
contribution margin is now a
contribution margin I'm going to change
pen colors here so our contribution
margin is the amount of money that
contributes to covering our fixed costs
and I will explain what fixed cost
represents so don't worry about that if
that's a little unclear right now we
will go into that so the first thing is
we're going to figure out how do we
calculate our contribution margin so I'm
going to move up so I have a little bit
more room here and let's choose a
different color I'm getting kind of
tired of the white and so we're gonna
have our price per unit
oops and since we calculated our credit
card processing fees off of $15 per unit
I'm gonna say that our price is $15 even
and then we are going to deduct our cost
of goods sold per unit and that of
course is going to be the $5.34 and the
difference this is what's going to be
our contribution margin per unit or I'm
gonna abbreviate simply as cm per unit
so that we could use a calculator
fortunately I can do somewhat basic math
and we've got nine dollars and 66 cents
so this is our contribution margin per
unit so every item that we sell we make
nine dollars and 66 cents so assuming
that we've cow
the totality of all of our variable
expenses you could simply take this
number and you can multiply it by the
number of units sold and this will tell
you what your gross margin is how much
money we actually made now another
terminology if you're in accounting if
you have an accounting background this
contribution margin per unit is often
referred to as our gross profit so just
to explain the terminology I use the
terms contribution margin per unit
because from a start-up sense it's
really helpful for us to make the
connection that this money is what's
available to cover what comes next and
that's going to be our fixed expenses so
what I would encourage you to do at this
point is stop the video and do some
research on your own and try to get up
to this point to where you have a
contribution margin or gross profit per
unit figure which for us is this nine
dollars and sixty six cents and do the
calculations on your own again I would
encourage you to try to get as realistic
numbers as possible so that involves
picking up the phone and calling
potential suppliers contacting other
people that run businesses that operate
in a similar space oftentimes you'll
find these individuals to be very
forthcoming with information so having a
conversation with someone is a great way
to get information as a third kind of
option if you absolutely for whatever
reason can't do the first two you can
look online but again just the word of
caution is a lot of times those figures
are not entirely accurate and the last
thing that you want to do is make a
decision as to whether to move forward
with an idea based upon inaccurate data
so that's what I'll say there so now
that we've got this figure we're going
to figure out what we call our fixed
costs so I'm going to change pen colors
again here and we're going to talk about
fixed costs
now the way that fixed costs work and
again we're kind of we have the two
categories right you've got variable and
then we've got fixed so fixed costs
actually remain the same so they are not
tied to production so that example that
I gave you
moments ago where we had the chart and
on the bottom axis we had revenue and on
this axis we had costs the way that
fixed costs kind of work is they sort of
go like this
they stay flat and they temporarily
increase it looks really bad let's try
this again so they stay flat they
temporarily increase and they stay flat
for another period of time so notice
they're not directly tied to our
production much like they are variable
cost for variable cost kind of just go
sort of like this so fixed costs are
different and the reason for that is is
that a fixed cost primarily are things
that we would term to be like overhead
so a great way for remembering fixed
costs is by the acronym USA III Rd this
represents fixed costs and so we have
utilities we have salaries we have
advertising which encompasses really all
marketing type expenses we have
insurance we have interest and we have
rent and then we have depreciation so
I'm going to speak to each of these but
I at least want to make sure that you
have them available so you can start
figuring out what your fixed expenses
are now similar to similar to your
variable costs the way that you want to
get fixed costs is again by trying to
get actual data so we're going to go
through these and then we'll kind of
talk through some ways to get some of
the different data sets but as you see
them they're all pretty pretty standard
for the most part as far as what
information is included so for utility
utility's is one of those categories
that refers to quite a bit in fact so
utilities can include everything from
your phone and internet which is usually
a pretty big priority to your
electricity or gas as well if you have a
physical location you're gonna pay the
city for like trash removal and
different services and even water and a
host of other things so sitting down and
thinking through all the utility
expenses is really really important now
just if I can go back and kind of relate
this to the fixed costs the reason we
call them fixed is because as your sales
increase these typically stay the same
right so if you if your sales double
your utility bill doesn't double as well
right that's pretty good that it doesn't
in fact so instead it goes up within a
relevant range right once you grow to a
certain extent you kind of get to a
period to where you've outgrown your
existing bandwidth speed let's say
you've hired like twenty more people and
you realize that your wireless internet
is not going to accommodate that many
users so you would temporarily increase
your expenses one time and then you
would operate for another period of time
before you actually had to increase your
expenses we also have salaries here and
so this is going to represent really
those salaries that aren't tied to
production so remember earlier direct
labor will be a variable cost so this is
pretty common with owners or managers
who aren't a part of the production
process if you're gonna pay yourself a
salary this is where it would come from
and I although you might not pay
yourself a salary initially it's really
important that when you're doing the
breakeven that you add in a salary here
because chances are you're not gonna
want to take a vow of poverty for too
long
right you you want to make money right
that's why you're starting the business
you want to draw a salary you want to be
independent and you want to give
yourself a financial incentive to
continue to invest your time so make
sure for the financial purposes that
your calculator
including a salary so you have an
accurate representation of how much
money you'll have to make in order to
cover all these expenses next
advertising expenses so this goes
without saying when you open up your
doors people aren't automatically gonna
flock to your business when you start
your online website people aren't
automatically gonna come to your website
you have to have a mechanism for drawing
them in whatever that looks like and a
lot of times those mechanisms cost money
so make sure that you're allocating a
fair amount of resources to advertising
so that you can get traffic or visits or
shoppers to make sure that you can
obviously do business
next thing insurance really important
from the most basic sense you're
probably going to want to get a general
liability policy but depending upon the
type of business you operate you might
need other types of insurances so you
really want to do a lot of research here
to figure out the types of insurances
that you should be carrying to make sure
that you're accurate you're you're
adequately covered in the event of some
kind of issue whatever that may be again
kind of similar to the other other
examples I gave it's always good to pick
up the phone contact an agent and get a
quote based upon your situation or if
somebody is operating a business that's
in a fairly similar space they might be
willing to provide you with the
information what they pay for their
insurance that you can use as kind of a
baseline now interest here I'm going to
put an asterisk because we're only gonna
pay interest if we have any debt so if
you start your business with debt your
interest you're gonna have to pay
regardless of anything plus the
principal payment so you'll want to
include that and then we have rent here
of course if you're going to be
operating out of your home you probably
don't need to include to include rent
but if you're if that's a temporary
situation you might want to allocate
some money here so that you're doing a
fair amount of so that the analysis is
accurate right there's at a certain
point you're gonna outgrow your house
and your garage and those types of
things so figuring out what rent and
what the cost is would be pretty helpful
I recommend in this area looking at Luke
net which is a commercial website that
you can use to find different properties
and it can be very very helpful for
figuring out square footage and pricing
and you can use that as sort of a gauge
this depreciation figure I'm gonna say
don't really worry about at least the
beginning depreciation is an accounting
expense so if you purchase equipment we
have to depreciate it over a period of
time because it has a limited useful
life and it's not an actual cashflow
expense though so you're not
specifically paying any money out but on
your income statement depreciation will
be will reduce your taxable income let's
say and your profitability but I
wouldn't really worry about in chances
are you might not have a lot of
equipment at the beginning anyway so
that's something that we don't really
need to worry about at least at this
stage so now that we have an idea about
all the different types of expenses
let's just for the sake of calculations
let's go ahead and we'll add some
different things in here and we can do
some calculations and so let's say that
after all of our research we've gone
ahead and we've figured out how much
each of these things is going to cost us
and I'm going to eliminate interest
because I'm gonna say we're gonna start
our business without any debt which is
always preferred if you can do that
so our utility expenses we've estimated
that those and I'm gonna do this on a
monthly basis because we want to know if
we can cover our expenses month-to-month
and that sort of thing so utilities
we're gonna say that we were gonna spend
$500 per month and let's say you want to
pay yourself a salary and we want to pay
ourselves a $3,000 a month salary which
is fairly modest so that's not terrible
and we're gonna have advertising
expenses we're gonna advertise $500 a
month we've added up all of our
insurances and our insurances are gonna
cost us let's say $500 a month and our
rent is gonna be 1,200
so then we're gonna go through and we're
gonna toll we're gonna tally all of
these up so we're gonna say 500 plus our
3,000 plus $500 for advertising plus
five hours for insurance and plus $1,200
for rent and that's gonna cost us fifty
seven hundred dollars total or five
thousand seven hundred is gonna be our
total fixed expenses all right so at
this point we've got two pieces of
information we have to figure out what
to do with them what we're gonna do next
is we're going to perform what we call a
break-even analysis now this is a very
simple analysis once you have the data
that we can use to help us make a
decision as to whether this business has
a strong chance of actually being
successful so the way that we're gonna
do this is we actually will get some
more room here is our breakeven
represents our total fixed expenses
divided by our contribution margin per
unit so what this represents is this is
the amount of amount of units right the
number of products that we have to sell
to cover all of our fixed expenses so
our total fixed expenses we real we know
are fifty seven hundred dollars now our
our contribution margin per unit I'm
gonna have to scroll up here because I
don't remember that's nine dollars and
sixty six cents so let's go ahead and
say fifty seven hundred divided by nine
dollars and sixty six cents is five
hundred and ninety units give or take so
what this means is that for me to
operate this business
assuming several things one assuming
that all of these variable costs are
active
assuming that these fixed expenses are
accurate I have to sell 590 bags of
coffee every single month just to break
even now that's an important term
because breaking even doesn't imply
profitability this does not mean I'm
making money this means I am covering
these expenses I'm not yet profitable so
the analysis comes in is now we get to
make a decision as to well is that a
realistic figure right if we were doing
projections and we thought man if I sold
50 units a month that would be awesome
right that would be a homerun well
looking at this we'd have to sell more
than ten times the amount of products so
we might this might not be a very good
business model for us right we might
have to look at one our fixed expenses
maybe need to cut some things right the
biggest thing being salary but for your
business your biggest fixed expense
might be something completely different
or we might not have we might have to
revisit our variable expenses maybe we
can find a cheaper supplier for coffee
beans maybe we can find cheaper bags and
we can reduce labor costs there's some
kind of automation
maybe we can increase the price but we
have to take into account will customers
or are they willing to pay the
additional crop price will they accept
that is our product of enough quality
that we can charge more for it and what
our competitors charging and so these
are all different types of analysis that
we can do based upon this figure now in
this example we are I did one product
you might have several products but I
would encourage you to pick kind of your
your flagship product whatever that
looks like and try to do as thorough of
a job as you can by calculating all of
your fixed expenses and doing research
and getting actual verifiable data doing
the same thing for your variable
expenses and trying to figure out what's
your break-even point and seeing if
that's a realistic number and if it is
fantastic that means you can continue to
move forward the financial aspect of it
is looking promising
but if it doesn't match your
expectations then it might
B time to go back and rethink the
business model a little bit and maybe
rethink the different products that
we're offering rethink our fixed
expenses look for opportunities we might
have to be able to trim some of those if
it makes sense but at the very least
it's a starting point for that analysis
and it's only going to help us moving
forward