Initial Finance Documents for TKD Woodworking

Therefore, I have done some reading on financial documentation for small businesses and side hustles, and so I have started creating those documents for TKD Woodworking. I will be using accrual based accounting (vs. simpler cash-based) to track my finances.

The three basic finance documents for a business are:

  1. Budget/Profit & Loss Statement: A document, which shows, by month, the amount of money you are bringing in and the money you are spending to create the products/services. This is what many people think of when they do a family budget.
  2. Net Worth Statement:  A listing of the assets the company possesses (real estate, machinery, raw materials, etc.), the cash and accounts receivable (what is owed the company), as well as the debt and accounts payable (bills the company owes). All of this rolls up to the overall value of the company for that “snapshot” in time. 
  3. Cash Flow Statement: With the accrual based accounting system, you often log in expenses and income after a sale. This leads to better tracking and tax accounting, but can lead to a major issue. You may be actually spending cash, but not accounting for it in the P&L statement until months later. You need a third report, cash flow statement, to track the in/out flow of cash in the business – or you may run out of cash while still appearing to be “profitable.”

Each of these reports are linked and effect each other (ex. you can spend money in the cash flow, and increase the net worth statement with inventory, but not affect the P&L statement until you sell the items). The idea behind them is to record the base/start, and track them as the year progresses – in order to look for variances and changes, which need to be addressed. Once the year is up, they are the foundational documents for figuring out taxes.

For my P&L statement/budget, I arrived at a sales plan that assumed I’d start selling halfway through the year, and sell three (3) of each item I’m building. Based on that and current spending (remember, I’m having to purchase raw materials – which impacts my cash flow – but not getting real credit for it re: taxes until I sell something) my P&L looks like this:

Area Annual
Sales Revenue $3,518.94
Cost-of-Goods Sold Expense ($1,148.71)
Gross Margin $2,370.23
Operating Expenses ($1,407.58)
Earnings before interest and Income Tax $962.66
Interest Expense $0.00
Earnings before income tax $962.66
Income Tax Expense ($362.03)
Net Income $600.63

For the Net Worth, I am in a little bit of a pickle. For most companies, the equipment and workspace would be considered part of their assets. However, I am using my shop at home (in my garage) and the machinery (table saw, band saw, etc.) that I already own. The result is that my net worth is actually rather low to start. I am adding in the initial startup case ($3,000 – cost of some checks) and the material costs for the inventory I have built so far.

Assets
2/15/2020
Cash $2,973.65
   
Accounts Receivable $0.00
Inventories $232.42
Prepaid Expenses $0.00
Subtotal of current assets $3,206.07
Property, plant and equipment $0.00
Accumulated Depreciation $0.00
Cost less accumulated depreciation $0
Total Assets $3,206.07
Liabilities and Owner’s Equity
2/15/2020
Advanced payments from Customers $0.00
Accounts Payable $0.00
Accrued Expenses Payable $0.00
Short-term notes payable $0.00
Subtotal of current liabilities $0.00
Long-term notes payable $0.00
Total Liabilities $0.00
Owner’s Equity – invested capital $3,232.42
Owner’s Equity – retained earnings $0.00
Total Liabilities and Owner’s Equity $3,232.42

Another interesting feature of this for the future is that if I purchase tools/machinery in the future for the company and eventually leave/sell out – I will need to separate those items from my personal equipment. More paperwork!

Finally, the cash flow. I have started tracking what I have spent so far, and my expected cash outflows going forward. I put in roughly $639.60 before I started up the company in early February (for inventory, training, some tools, etc.) – so I added that to my initial cash pile.

Cash Flow from Operating Activities Annual
Cash collections from revenue $3,639.60
Cash payments for Expenses ($696.19)
Total $2,943.41
Cash Flow from Investing Activities
Investments in new long-term operating assets $0.00
Cash Flow from Financing Activities
Increase in short-term notes payable $0.00
Increase in long-term notes payable $0.00
Issuance of additional capital stock shares $0.00
Cash distributions from profit to shareowners $0.00
Total $0.00
Net Increase of cash during year $2,943.41
Beginning Cash Balance $0.00
Ending Cash Balance $2,943.41

The last two things I did for the company’s financials is setup a separate business account at a bank (where the $3K was deposited) and to get a business credit card – where I will charge all my future business expenses. As I noted previously, you need to keep your business and personal charges separate if you want to be successful in this (and prevent the possibility of being sued and losing your personal assets).

With the finances in order, it is time to move onto my next steps for the business. Those consist of:

  • Creating a website and building a marketing plan (March)
  • Complete building of samples to determine time/cost for each as well as potential shipping costs (April)
  • Acquire sufficient insurance to protect myself and the business (May)
  • Begin selling on Etsy, Craig’s List and Craft Shows (June)

I will let you know how I am progressing

I hope your own efforts are bearing fruit!

Mr. 39 Months

Opposition Research for TKD Woodworking

So, I’ve done some of the work, built three different items (two types of cutting boards and a photo frame). I’ve got plans for another frame (pretty cool) and some boxes. Now that I’ve built some items, I know the material costs, labor time, and my estimated overhead costs. With that, I can start determining estimated sales cost for each item in order to recoup my time/costs. Time to do some opposition research!

One of the big places to sell arts & crafts online is Etsy.com (I’m sure a lot of you are aware of it). You can purchase a wide range of items, of all shapes and sizes, crafted by people throughout the world. It’s a major “side hustle” location, and lets you create your own Etsy store, where someone can click on and see all the crafts you sell. You can check out your competition there for their prices, quality, and variety of items – and compare to what you are thinking of offering. What did I find out?

I have to improve my game a lot!

Obviously, the items I’m starting with are very easy to make and sell, so there will be a lot of people to compete with. In addition, it’s a worldwide market place, so I will be competing with labor costs that might be well under my estimates (I’m going with $20/hr. for my time). They may also have the ability to setup and make large runs, which can bring down the cost-per-piece of an item. Still, what I’m seeing is impressive:

  1. Costs are all over the board. There are items similar to mine which are selling for 50% – 200% of what I was going to ask
  2. Quality looks pretty good. I definitely can’t try to sell stuff that is not up to par
  3. There are a lot of sellers with 5-star ratings, so when I’m first starting out, I’ll be behind the curve
  4. The options some of the sellers have are tremendous. One person lets you pick the wood your cutting board will be made out of, the pattern, etc. Other ones do personal engraving. All of this for competitive costs to what I was thinking of charging.

I know I’ll need to build a bigger assortment in order to both compete and to see what sells. I’ll also need to look into making items which aren’t as generic as cutting boards.

At least I’ve got an idea of what I’m up against!

Mr. 39 Months

Financial Advisor meeting #5 – Final Sad Trombone & comment on Financial Samurai

I’ve included several posts about our recent meetings with a financial advisor

Well, our advisor had some major family health issues with a loved one (cancer), so needless to say, it took a while to get our final report. We got it yesterday, in the form of a large, 3-ring binder, full of lots of data, analysis and recommendations. There was analysis of cash flow, net worth and draw down for several scenarios:

  1. Base scenario of both of us continuing to work for 4 more years, till I hit 60 and Mrs. 39 Months hits 62
  2. Scenario where we pull out more than the minimum from our 401K from 60-70 in order to reduce our RMDs
  3. Scenario where we I leave my current job, and get a much lower paying job that I love that earns $40K a year, and work at it till I hit 67
  4. Scenario where we have a major health issue requiring long-term health care when I hit 80
  5. Scenario where we retire the July (my FI date)

The analysis was very comprehensive. It was also very disheartening. In the first three scenarios, they all ended up pretty close to the same, we end up running out of money when we are 94/96 (i.e. three years before my target “death” date of 97/99). The major health and my July 2020 scenarios pretty much had us running out of money in the mid-80s. Since Mrs. 39 Months family has lots of her Aunts living into their 90s and 100s, that doesn’t seem like a good bet for us.

So why the difference? What has the advisor’s numbers coming in so much under my original planning? I’ve identified some callouts:

  • Original vs. Adjusted Budget: My original budget had us spending $72K/year, but after going deep into conversation with Mrs. 39 Months, this was revised up to $78K/year. Only $6K, but it does add up
  • Social Security & cost-of-living adjustments: I used the reports that came from social security to estimate our payments, but the reports assume you continue to work till you hit your retirement age (67 for us). Stopping at 60/62 reduces it, and stopping in July 2020 would reduce it even more. In addition, the advisor assumed a Social Security increase of 2% a year (below his inflation rate, see below), so the money will slowly be losing it purchasing power. I just assumed a straight line that would match inflation. Seeing the current state of social security in the US, I can’t say I disagree with the advisor
  • Inflation: My original planning just took inflation out of the picture. I used historical investment returns post-inflation (i.e. the returns I used had historical inflation already taken out). The advisor used a 3.25% inflation rate and a 6% for medical. I can’t really argue with the assumptions –  they do appear somewhat logical to me.
  • Return of investments: This is where I have real issues with the advisor. Based on our asset allocation (about 60% stocks, 40% bonds/savings) he came back with an estimated return over 40 years of 5.3% (i.e. only 2% above inflation). Since the average stock return from 1926 – 2018 is almost 10%, I found that too low. I’ve asked him to do another scenario with a 7.2% return (more in line with a 60/40 split)
  • Lifestyle spending: I have asked him to drop some of our lifestyle spending (travel, dining out, etc.) by 35% starting at age 75. I just don’t think we’ll be traveling or partying as much in our 80s and 90s.

We’ll see how this works out with the changes, but overall, I have to say I’m a little disappointed in the results, though not in the process. I believe the advisor is being very conservative in a lot of his assumptions – which appears to be the opposite of the FI community. Let’s face it, we are all very optimistic go-getters!

This sort of falls in line with news that the FI community found out about recently from the Financial Samurai blog last week. He wrote that he was planning to go back to work after 7+ years of early retirement. In his post, he listed his reasons (I invite you to read the posting) and I’m sure many of the readers could see his points (though his budget is way out of line with mine, since he lives in San Francisco). If you read closely, I think a lot of his reasons are non-financial. He just misses being around folks, the comradery, etc. It goes back to all the warnings that run through a lot of our community postings – you need to retire “to” something, rather than “from” something.

So, since I enjoy many of the aspects of my work, I am not too “bummed” about the potential of having to work longer in order to achieve “Fat FIRE.” We will see where the journey goes.

.

Mr. 39 Months

Investment Update Feb 2020

Only 5 months to go!

After its stellar performance in 2019, a lot of folks expected a “pullback” in the market. For January, it appears the market agreed, and the S&P 500 dipped 1.0%, from $3,257.85 to $3,225.52 (Note, it has since rebounded to $3,327.71, or up 2.1% for the year). Like most folks, I was intent to just “let it ride” and even if 2020 was a “null” year with limited growth, it was better to be in the market rather than trying to time the market.

As you know, the allocation for my retirement accounts (IRAs, 401K, etc) is pretty much index funds, spread out between the  S&P 500, small-cap, international, REITs and bonds. I did rebalance my portfolio at the beginning of the year, similar to what I did back in July 2019. As expected, this resulted in me selling some stocks, and purchasing some bonds and REITs – items which actually did very well in January.

Retirement Accounts: Remember, my allocation for these is:

  • 30% Bond Index Fund
  • 17.5% S&P500 Index Fund
  • 17.5% International Index Fund
  • 17.5% Small Cap Index Fund
  • 17.5% REIT Index Fund

My 401K doesn’t have REIT option, so its just 25% for each.

S&P was down a little, but the Small caps were down about -2.0%, and International was down -3.2%. Bonds were up +2.2% and REITs were up about 1.0% – so the items I sold at the beginning of January, I sold high, and the items I bought, I purchased low – the big goal for any investor. My 401K account, since it doesn’t have a REIT option, did not gain the benefits from it.

My dividend account allocation original allocation was:

  • 25% Dividend Stocks
  • 25% REITs
  • 50% Bond Index Funds

However, I got tired of getting poor results from my heavily weighted bonds (the stocks were actually returning more dividends than the bond funds) so I changed it to a 50% dividend stocks/50%  REITs allocation. For January, the result was a dip of about -1.9%, though this could be just the timing of it all. The stocks have already rebounded in February, and I’m going to be getting higher dividend payments – so it should be good.

For January, I’m down about -0.26%. My bonds and REITs helped make up for the poorer stock performance, which is what you have those things for. February is shaping up well, so I’m looking forward to seeing what comes of that.

Hope your January was good, and the year is starting out well!

Mr. 39 Months

Determining Cost for your product in a side hustle

As an Industrial Engineer/Supply Chain professional who has run a few manufacturing operations, I thought I would go through some of the basics on how to determine the price for an item you may be manufacturing. I’ve already covered how to estimate the size of a production run on your product (EOQ), so we’ll assume you have done the math. I’ve also covered the fixed costs for an operation, which you will need in order to determine the sort of gross margin you’ll need to charge in order to meet your profitability goals.

The simple equation is basically Price = Cost of raw materials + Cost of Labor to build + Gross Margin

I’ll use a recent cutting board project I made as an example.

With that, the first thing you need to do is to determine what you want to try to price, and create a  bill-of-materials (the items which go into your product) for that item. With this you will be able to determine the cost of your raw materials. In this example, I used a simple piece of maple (a good item for a cutting board) and used a can of finish for cutting boards and bowls. I didn’t put in any additional money for sandpaper, brushes, etc.

DescriptionLWTBFCost
Maple12811$10.50
Finish    $2.00
 $      12.50

The next step is to try and determine the steps and labor necessary to build the item. When I did my EOQ analysis, it came out to be about 4 per run, so that was the plan. I determined the steps, and as I built the 4 boards, I timed how long it would take. When I totaled it, I added a 15% PF&D (Personal time, fatigue and delay) factor to the time for breaks, delays, etc. This is fairly common in the manufacturing industry. The result was:

Simple Cutting Board Lot Size 4
STEP DESCRIPTION SECONDS TOTAL TMU’s
1 Get Wood Down from Storage 58.2 1,617
2 Crosscut four (4) pieces with handsaw to rough size 120.0 3,336
3 Joint edges on 4 pieces 122.0 3,392
4 Plane 4/4 wood down to 3/4″ thickness (four pieces) 911.0 25,326
5 Rip & Crosscut to final dimensions 706.0 19,627
6 Setup Router Table 825.0 22,935
7 Rout roundovers on both sides of Four (4) cutting boards 325.0 9,035
8 Setup Drill Press for hole 180.0 5,004
9 Cut hanging holes of four (4) cutting boards 184.0 5,115
10 Setup small router to roundover hanging holes (4) 241.0 6,700
11 Cut roundover on hanging holes (4) 136.0 3,781
12 Sand cutting boards to 400 grit (100/180/220/320/400) 2,169.0 60,298
14 Clean off boards with mineral spirits or denatured alchool 120.0 3,336
13 Apply 1st coat of finish to four(4) cutting boards 534.0 14,845
14 Apply 2nd coat of finish to four (4) cutting boards after 8-12 hours 534.0 14,845
15 Sand with 400 grit – four (4) cutting boards after 8-12 hours 433.8 12,060
17 Clean off boards with mineral spirits or denatured alchool 120.0 3,336
16 Apply 3rd coat of finish to four (4) cutting boards after 8-12 hours 534.0 14,845
    TMUs 229,432.8
  Standard Fatigue Allowance: 15.5%
  Seconds Per Unit: 2385.0
  Avg Units Per Hour: 1.5

A “TMU” is an engineer’s term – it is a “Time Measurement Unit” and 27.8 TMUs = 1 second. So it took me roughly 2 hours and 40 minutes total to build 4 of them, or 0.667 hours/40 minutes to build one. At $15/hour (what I’m paying myself) this works out to $10 for labor.

Finally, I looked at my gross margin, what I’m using to help pay for all the fixed expenses. I’m using a 40% margin goal, which is about middle of the road for manufacturing. This is going to be used to cover my liability insurance, website, machinery purchases, etc.

So the equation looks something like (12.50 + $10) * 140% = $31.50

Based on this analysis, I could sell this item for around $31.50. In looking at Etsy, however, I’m seeing similar product selling for $50-$60. I’ll have to research to see how much of a “cut” Etsy takes, and if shipping is part of the price.

I hope this was useful.

Mr. 39 Months.

Changes to Income Account due to four years of lessons

AS you know, I have been using my father’s inherited stretch IRA to experiment with creating an income generating account. It is similar to what folks used back in the day for their retirement – using stock and bond dividends to create a stream of income, and one with lower taxes (due to the lower taxes charged on dividend income).

I have been following the results of the account since I started it in late 2015, and after four years, here are some of the results.

Asset % of Portfolio Annual Growth Annual Dividends Total Annual Returns
Income Stocks 25% 10.4% 4.4% 14.8%
REITs 25% 13.0% 5.1% 18.1%
Bonds 50% 3.3% 2.1% 5.4%

As you can see, the Stocks and REITs have paid a significant amount out over the last four years, even with the dip in 2018. Even their dividends have beaten the yield of the bond funds. A lot of this is due to the low interest rates currently being paid on the market, and unfortunately, I do not see much relief on the horizon for this. Even if rates did start going up, it would penalize existing bonds, due to their lower bond rates (i.e. why buy a 2% bond from 2019, when I can get a 3%+ bond in 2021?)

After a lot of soul-searching over the holiday season, I have decided to walk away from bonds in my investment portfolio for income. I know a lot of you will be saying “about time!” in this regard, but I felt I wanted to experiment and learn from this. I believe four years of getting sub-standard income returns is enough here.

Therefore, I have gone back to my broker and re-adjusted the plan.

  • Going with a 50/50 split between stocks and REITs
  • Going to keep my iShares (PFF), even though their growth has not been as good as other income stocks. That is because their dividend is very high (it has averaged a 7.2% yield year-over-year, and a 7.5% growth, so it’s about the same as my 14.8% average for stocks)
  • Going to try the “dogs of the Dow” strategy, where every year you start with the ten stocks in the Dow 30 who have the highest yields. This should be because their stock price is down in comparison to the dividends they pay. The idea is that, over the year, they should bounce back to the average yield of the Dow, which means the stocks will go up, while the dividend stays the same (or goes higher)
  • The “Dogs of the Dow” strategy calls for you to review at the end of the year, sell the stocks that are no longer in the top 10 for yield, and buy the new ones.

Based on this, my stock purchases will be equal dollar amounts:

Stock Current Price  Est. Dividend Yield
Dow  $    47.18  $       2.80 5.93%
ExxonMobil  $    64.74  $       3.60 5.56%
IBM  $  138.62  $       6.63 4.78%
Chevron  $  110.39  $       5.00 4.53%
Verizon Communications  $    59.91  $       2.49 4.15%
Pfizer  $    40.16  $       1.52 3.78%
Walgreens Boots Alliance  $    52.23  $       1.87 3.57%
3M  $  175.63  $       6.06 3.45%
Cisco Systems  $    47.47  $       1.52 3.20%
Caterpillar  $  135.73  $       4.27 3.15%

I will report on how this is going over the year.

Mr. 39 Months

TKD Woodworking – Legal and Insurance Issues

Some of the items involved in setting up a business involve legal issues and liability insurance. As you prepare your side hustle, you want to make sure that it doesn’t impact/endanger your personal finances and lifestyle. The worst thing that could happen would be for you to have a liability issue, and find your homeowner’s or personal insurance doesn’t cover it – or to find a state or local government suddenly “interested” in what you are doing, and potentially issuing taxes and penalties. Better to get it right “out of the gate” and account for it in your pricing.

Registering your Business

One of the first items in registering your business, if you intend to make a profit. Of course, most states (as well as the federal government) want to make sure they get their cut of your profits. Typically, you need to register your business, and there are all sorts of legal classifications:

  • Single Proprietor: Simplest one, where it is you in business. Easy to do, but not good for shielding personal assets.
  • S-Corporation: The big one, which most companies are. A lot of paperwork, but very good for handling large amounts of money and shielding people within the organization
  • LLC – Limited Liability Corporation: This is the standard one that most “side hustles” end up going with. It has the benefit of lower fees, lower paperwork requirements, and shielding personal assets from liability. This is what I’m choosing to go with.

Don’t try to get around this, and not pay! You may survive for a while, but eventually they’ll get you, and they will go back years in order to get their cut (and add penalties as well).

My state (New Jersey) has the ability to register your LLC online (most states do) and the fee is $125. It gives you the opportunity to test your name out to see if its already taken. This basically records the name of your business entity, registers it for tax and employer purposes, and allows you to do work for the state (if called upon). My plan is to register as an LLC in the next couple of weeks.

The next step is to set up a separate account at my bank for the business, once it is registered. One of the ways that a lawyer could “pierce the veil” of protection of an LLC, and sue the personal assets of the owner, is if the owner does not keep the finances separate. By opening up an account specifically for the LLC, it will also better assist me in managing the finances of it.

Finally, I need to look into liability insurance. Since I am planning to produce a product (and some products like cutting boards will involve food) there is always the potential of liability. In checking with my insurance company (also my bank, USAA) I found that my homeowner’s and Umbrella insurance policies would not cover me if I sold a product and it was defective. For that, I’ll need liability coverage for my LLC. This is another of those fixed costs I wrote about earlier.

All these details! I’m trying to write about them all in the hopes that it will assist others in their attempts to build side hustles and pursue their own FIRE journeys. Good luck!

Casting “Shade” on the FIRE Movement

                    

Is it just me, or does it seem like the FIRE movement has been “taking fire” from snipers a lot lately? In listening to the Stacking Benjamin’s podcast this morning on the way to work, they talked about a tweet-storm that was created when Tracey Alloway tweetedOne thing I’ve often wondered- does the financial independence/retire early movement (#FIREmovement) survive the eventual end of the current bull market? The idea of pouring all your money into $VTSAX and living off it for the rest of your life feels like such a bull market thing

Jason Zweig of the Wall Street Journal chiming in with immediately followed this “No, because the fintech companies paying thousands of dollars a month in poorly disclosed affiliate marketing fees to all those “independent” FIRE bloggers will run out of VC cash in a bear market.”

Ouch! The comments and tweets from there came fast and furious, with folks defending and attacking the FIRE movement. Apparently, the tweets succeeded in agitating many folks (maybe the tweet author’s intent) and got the conversation moving again.

It just seems to me that the FIRE movement has been taking many hits recently, partially due, IMO, to the release of the movie “Playing with FIRE.” The ideas of financial independence are starting to pop up, and the result is that it is being both castigated and explored in some depth.

The general consensus on the Stacking Benjamin’s show was that the tweets didn’t really represent the FIRE movement accurately, but also noted that many folks in the movement hadn’t really dealt with a serious market correction (2008-2009) where 50% of their investments drop. The panel noted that this will affect some FIRE people (the ones who didn’t really embraced the concepts), but the ones who are actually following the ideas will probably continue to push on and readjust their end dates while continuing to save towards their goal.

I think that many of the anti-FIRE folks use a “straw-man” argument where they place the FIRE people as checking out of society, sitting on a beach, and sipping mixed drinks. They are going to just sit there for 50-60 years and not do anything else. I do not know about you, but this does not seem to match what I have seen from people in the FIRE world. I see folks that are “type A” and always busy, so once they hit FI, they just keep going. They work in less lucrative but more enjoyable fields, either volunteer their time, or find other activities to keep them busy. My bet is after a couple of years, even those who are taking a break will re-enter the market. So I do not see as much of an issue as the “anti-FIRE” folks.

I guess we will see when we hit our next market downturn. I am betting on 2021 for a dip, but nothing like the 50% drop in 2008-2009. However, my plan would be to just “stick with the plan” in that case.

I hope your FIRE plans include the potential for a market correction, and that they will still work out for you.

Mr. 39 Months

Fixed Costs for a Side Hustle

One of the financial items that a business needs to consider is its fixed costs and variable costs.

Variable Costs are those items, which can “vary” up or down, based on the volume of sales that you have. These might include:

  • Labor (to make the stuff)
  • Shipping (to ship the stuff)
  • Materials (what the stuff is made out of)

 Fixed costs are those expenses you have which do not vary based on the volume of sales that you have. Examples of that might be:

  • Real Estate costs (lease of building, taxes, etc.)
  • Utilities (electric, gas, data lines, etc.)
  • Equipment (production machinery, computers & IT equipment, etc.)
  • Insurance costs (liability, insurance of machinery, etc.)
  • Management (i.e. you will have one manager, whether or not you employ 1 or 10 people to satisfy the sales)
  • Marketing & Sales (while there is some link, you often have to pay for these whether you make sales or not, and might include website & hosting costs)

Starting a side hustle with something I enjoy and have equipment for (woodworking) has enabled me to not have to consider (for the short term) the fixed costs for equipment (I’ll use the tools I already have), real estate (I’ll just use the shop in my garage), management (it’s just me) and most utilities (just part of our normal expenses).

However, there are some fixed expenses that I will need to get a handle on and understand as I start making the case for this side hustle.

  1. Legal Costs: My thought is to incorporate as an LLC, and this will cost some funds – both upfront and ongoing.
  2. Liability Insurance: If I’m making a physical product that can be used (and potentially miss-used) I need to have liability insurance in order to protect my personal assets
  3. Marketing: Here I am looking at two costs. One is the setup and hosting of a website that can have items purchased off it, and the other is the cost of craft fairs and farmer’s markets, where I will sell my wares. Researching these both.
  4. Equipment: While I am using my existing equipment, it will wear out and will need to be replaced. I may also buy additional equipment to improve my processes, so that will need to be included.

The fixed costs are covered by a percentage of the revenue you gain from your sale, often covered by the “gross margin” of a business. You need to generate enough sales to satisfy the cost of your materials and meet your fixed expenses as well. That is why the gross margin is so important in business, as it is this “excess” revenue which helps cover your fixed costs, and helps to fund future growth (like when you take on more real estate or equipment costs as your company grows).

For example, let us say that TKD Woodworking has the following fixed expenses:

  • Real Estate: $0
  • Utilities: $0
  • Equipment: $0
  • Management: $0
  • Insurance: $450 for liability insurance
  • Marketing: Twelve (12) craft fairs @$30 each = $360
  • Web-hosting for website: $190

Total Fixed expenses: $1,000/year (I know, I am keeping it simple)

Suppose I am selling cutting boards and picture frames, and each has a variable cost (labor, materials, etc.) of $40. I add a 25% gross margin to this, or $10, and sell them for $50 each.

In order to break even as a business (i.e. no profit, no extra funds for business expansion or new tools, etc.) I would need to sell 100 cutting boards/picture frames: 100 * $10 gross margin on each = $1,000, which is what I need to meet my fixed costs.

Thus, you can see, for a small business, you need to try to achieve your highest gross margin, and at the same time, watch your fixed costs like a hawk! If it is just you in the hustle, you can only do so much (your variable labor costs) so in order to generate profits, you need to keep the fixed costs down.

I am continuing to explore mine, and I will share them with you in the months ahead.

Mr. 39 Months.

How much do I make on an item to sell? Economic Order Quantity

As one is looking at a Side-hustle and trying to start out, once you do some of the preliminary work (determining what to build, material schedule, etc.) one of the first questions that hits you is one than manufacturing companies deal with every day. How much of this item do I produce? What is the most efficient amount to make, in my current conditions.

In manufacturing, this is known as EOQ, the “Economic Order Quantity.” The idea behind it is that you can calculate, based on sales & the cost of carrying inventory, what is the optimum number of pieces you should make of an item at any given time.

The assumptions on which EQO is based are:

  1. Demand is relatively constant and is known
  2. The item is produced or purchased in lots or batches, not continuously
  3. Order preparation costs and inventory carrying costs are constant and known
  4. Replacement occurs all at once

You can already see the problems with this once you are starting out. While you can assume #2 and #4, you have only a vague idea on #1. For #3, you can use your bill-of-materials to determine preparation costs, but how do you calculate inventory “carrying costs” or how much it costs to store the unsold merchandise? Most folks start out with a small number, and see what sells (and how much) and what doesn’t. From there, they build more and just sort of “wing it”

For basic manufacturing, the equation is actually somewhat simple (there are other derivatives, but this is the basic calculation). The idea is that the EOQ occurs at a point where the cost of ordering equals the cost of carrying the inventory. After many years of trial and error, the equation typically used in this situation is:

EOQ = Square root of (2 * Annual Sales * Cost-per-order)/(inventory carrying cost % * Cost-per-unit)

Annual Sales: Total number of pieces you expect to sell in a year

Cost-per-order: Cost for paperwork, scheduling, etc. For major companies, this could be 1 hour of clerical time, or $30 with cost/benefits. For a small craftsperson, this could be 15 minutes to assemble the required design documents and materials, or $5.   

Inventory carrying costs: Expressed as a percentage of the sales cost of your product inventory. Larger inventories mean you have to have more space, thus more cost here. Smaller inventories mean you may not have an item to sell.

Cost-per-unit: The cost for the materials & labor to make the item

So let’s take one of my items, a simple Face grain cutting board.

  • Let’s say I believe I will sell twelve (12) of these a year
  • I’m going to assume that it will take roughly 20 minutes to get the materials, get the documentation and prepare to work. At $15/hr (what I’m assuming for my labor) that comes to $5 for ordering costs
  • When I did my bill-of-materials and process, I came up with a total project cost (materials & labor) of $15.81
  • Let’s assume my inventory carrying costs are 20% to keep that inventory stored (space, heat, electrical, etc.)

So the calculation is square root of (2*12*$5)/(20%*$15.81) = square root (120/3.16) = 6.16

Round that to 6 pieces.

So based on those assumptions, when I make that particular item, I should make 6 of them. This means I’ll be making 6 months work of product each time I fire up the tablesaw for that item.

If my sales plan is that I’ll only sell six (6) a year, that ends up being the square root of (60/3.16) = 4.35 or 4 of them.

Hopefully this is useful for some folks.