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.
- Legal Costs: My thought is to incorporate as an LLC, and this will cost some funds – both upfront and ongoing.
- 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
- 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.
- 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.