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.

Another step in research for TKD woodworking – shipping costs?

I’ve gone through and determined most of the bills of material for the items I hope to sell. This will establish my base costs to produce (labor, materials, gross margin). One of the other costs, though, is shipping – getting the items to the customer.

For that, I’ve got a variety of ways I could ship product (Parcel with UPS or Fed-Ex, the US Post office, etc.). One of the interesting design features that most folks don’t pay attention to is how manufacturers size items and build packaging so that the items can be shipped as efficiently as possible, with the lowest cost. In my primary job, its fascinating to see companies change the thickness of their cardboard by hundredths of an inch, just to shave off a little cost and weight, or design something so that it is 23-3/16” long in the package (because if its 23-1/4” long, UPS will charge them more).

Most of my items are going to be fairly small, but still, it doesn’t hurt to determine potential costs and benefits of sizing something correctly.

I went to the US post office and checked the costs of their flat rate postage boxes. These you can pick up at the post office, and they will charge you for the box and shipping once you ship something out – just one flat rate. The costs and dimensions of the items are:

No Type Size Cost Length Width Height
1 US Postal Flat Rate Small $7.90 8  5/8 5  3/8 1  5/8
2 US Postal Flat Rate Medium $14.35 11      8  1/2 5  1/2
3 US Postal Flat Rate Medium – flat $14.35 13  5/8 11  7/8 3  3/8
4 US Postal Flat Rate Large $19.95 12      12      5  1/2
5 US Postal Flat Rate Large – flat $19.95 23 11/16 11  3/4 3     

As you can see, the difference in a ¼” can raise your costs significantly. I’ll need to check the rates of other providers to see if I need to adjust my designs. Right now, only one of my items can fit in the small. I need to see what I can do to keep my other designs in the “medium” area.

Just part of the analysis one needs to do when planning to produce items and sell online (or via catalogs or direct mail).

Mr. 39 Months

Bill of Materials

In a previous company, I was a manager of the packaging and manufacturing department for a small auto parts manufacturing/warehouse operation. A key part of that was managing the work flow through 20 different machines, with all their requisite parts, labor and quality standards. Managing all of that can be very complicated, and while software can assist with the scheduling, you still have to have the human interface to plan, shift work, and understand what the software is telling you to do (and make changes when necessary). I actually went back to school to get training in this with APICS (the American Production and Inventory Control Society).

A key aspect of managing the workflow and the inventory was the BOM (Bill of Materials) and Process Flow Diagram. With these, the operators were able to understand all the parts that went into the finished item (the bill of materials) and how to put it together. For every part produced, you needed to have both of these documents, and as you made improvements in the process (something good companies do to keep ahead), you updated the documents.

As I look at pursuing my side hustle, I’ve listed the items that I think I will start with, but now I have to determine how to build the items, what materials are necessary, and what those items might cost. Its only with this information (and an idea of the time/labor to build) that I can come close to identifying how to price my materials.

Here is an example – the tea box I just built for Mrs. 39 Months for Christmas.

I worked through the materials I was going to need to build the item:

Description L W T
Cherry 48      6      1     
Maple 30      8      1     
Poplar 12      6        1/2
Poplar 60      4        1/2
Hinges      
Shellac      

I then had to work out a “cut list” for the final dimensions for each of the parts:

Description Qty L W T Material
Front & Back Pieces 2 13-1/2″ 4-5/8″ 1/2″ Cherry
Side Pieces 2 6-1/2″ 4-5/8″ 1/2″ Cherry
Top Panel 1 12-1/2″ 6″ 1/2″ Mahogany
Bottom Panel 1 12-1/2″ 6″ 1/2″ Poplar
Bottom tray front & back 4 6-1/8″ 3-1/4″ 1/4″ Poplar
Bottom Tray Sides 4 5-7/16″ 3-1/4″ 1/4″ Poplar
Bottom Tray Center pc 2 5-7/16″ 3″ 1/4″ Poplar
Tray bottoms 2 5-7/8″ 5-3/16″ 1/4″ Poplar

Finally, I had to work out the process to build the item:

  1. Joint/Plane/rip/crosscut side, top & bottom pieces
  2. Cut side & back pieces into large blocks to “wrap” the grain around
  3. Cut grooves for the top & bottom – 1/8” (router or tablesaw?) into front, back & side pieces
  4. Cut groove in top piece
  5. Clean up grooves with 1/8” chisel, so bottoms are flat
  6. Cut rabbet in bottom piece with dado set
  7. Crosscut side, front & back pieces to final length
  8. Cut the 45 degree angles in front & side pieces
    • Start from side for grain match
    • Cut first 45-degree for each
    • Put measure on stop block to cut 2nd 45 degree
  9. Dry fit front, back, sides, top & bottom
  10. Sand all pieces (100/180/220)
  11. Glue up bot with painters tape on all four corners, then clamp up after checking for square.
  12. Use bandsaw to make cut for lid
  13. Sand off machine marks
  14. Layout hinge mortises and cut (see FWW article on this)
  15. Shellac finish
  16. Steel wool
  17. Wax over the top

Armed with this information, I can at least try to price out what the materials will cost to build (wood, hardware, finish, etc.)

From there it will be time to determine the labor needed to build – but since that can be affected by the quantity you are building at one time (and thus being able to do the same step for multiple items, saving time). This will be based on the “Economic Order Quantity,” a manufacturing term which considers proposed inventory levels, expected sales, etc. to identify the optimum amount you want to produce at a time. We will handle that in a future email.

So the planning goes on. I’ve been watching some YouTube videos on pricing and marketing your projects. Continuing in the “research” phase of TKD Woodworking.

Move info later. Thanks for all the suggestions!

Mr. 39 Months

Starting Something New

As part of my plan to transition to FI, and to pursue what I want to versus working the rat race, I’ve decided to start working on my side hustles and researching to eventually move into a different field. As many folks have stated in their FIRE journey’s, its not that they want to stop working, its that they want to work in something that they love. That is what I’m going to do, and I’ll try and chart some of my progress here.

One of the areas I want to work at is in starting up and running a business, even a small, side-hustle one. My thought is to start in a small one centered around one of my favorite hobbies, woodworking. My plan would be to make items for sale at craft fairs and online. I also wanted to go through some of the thoughts and work here, including the numbers, so people could get an idea of the process (and offer advice & counsel on what I’m doing, if it fits them).

In reading through the book Street Smarts, written by two individuals who have helped guide entrepreneurs for decades, the first question they ask at the beginning of potential entrepreneurs is “why do you want to create and build this business?” Along those lines, I laid out the reasons why I wanted to start up this business:

  1. Learn how to work business numbers and run a business by them (P&L statements, Expenses, budgets, Capital spending, etc.)
  2. Improve my woodworking skills
  3. Learn to develop website
  4. Develop my marketing skills

Adding/improving these skills would help me move onto the next business I was planning on moving to (more on that at a later date). So what steps do I think I need to start with here?

  • Create a list of potential items I could make and sell, both online and at craft fairs
  • Determine material costs for those items
  • Determine Tools/Jigs necessary to build those items
  • Determine time in would take to manufacture those items

From that, I would at least have some idea of my material costs, and be better able to build a budget. My list of potential items to start is:

  • Photo Holder
  • Picture Frame
  • Cutting Board
  • Tea box
  • Fast boxes
  • Shaker carry box
  • Campaign collapsible bookshelf
  • Craftsman bookshelf

So the next step for me is to work out the other three items for each piece I want to produce. We’ll see how it goes.

Mr. 39 Months