Back of the Envelope (or Napkin)

Speaker: Jay Lanagan, Lanagan Inc.

You’re at a bar talking your business idea over with friends, and you’re wondering if your brilliant idea of selling the Latest Greatest Widget could be a profitable business. You grab a napkin and start jotting down some basics that will help you figure out whether your idea should stay on that napkin, or if it’s worth you going all in.

Here’s where a “back of the envelope” (or in this case, “back of the napkin”) analysis comes in handy: how many widgets do you have to sell to make “x” dollars, or meet a specific goal, like quitting your job? How many widgets do you have to sell to break even?

Right now, you figure you can make up to 100 widgets/week to sell at $50/widget = $5000 max/week x 4 weeks = $20,000/month x 12 months = $240,000/year.

Sounds great! BUT, now you have to factor in ALL of the costs to produce your widgets. Once you’ve factored all of these inputs into your calculations, you will have arrived at your net profit; that is, what you are taking home after you have paid everyone and have accounted for all of your costs.

Inputs to consider (fixed vs. variable costs)

• Materials costs to make your widgets (including packaging)
• Customer acquisition costs
• Rent and utilities if you have a space, insurance
• Taxes, employee wages, other payroll, W-2 financials (e.g. social security, self-employment taxes). Common pitfall here: if you’re performing a task that you would eventually want to pay an employee to perform, it’s important to factor in that cost now!
• Variable costs like renting booth spaces at local markets to sell your widgets
• Start-up costs (one-time, infrequent purchases)

Note that you may not know the exact dollar amount for all of the inputs you need to consider. Some you can figure out with a simple Google search or other research; other numbers will be your best guess. In fact, it may be useful to overestimate your costs a bit, and underestimate your selling capacity. As awesome as your widgets may be, you’re probably not going to sell at your max capacity just starting out.

Considering these inputs will also help you figure out if there are areas where you can cut costs to maximize your profit margins. Can your widget production costs come down with scale?

Finally, running these numbers will help you set goals; goals that may even feel a bit scary. You may even find yourself in an existential crisis, asking yourself, “How am I going to sell the 1 million widgets I’d need to afford a single employee? By the way, am I ever going to be able to pay myself? What if I actually don’t have a business at all? What is the meaning of life?

But then you will take a deep breath, remind yourself of how passionate you are about the Latest Greatest Widget, and commit to working through the tough questions — which may even lead you to rethink your entire business model — and that’s ok. The idea is to get a clearer picture of your financials; this will help you anticipate some challenges before you’re faced with them and make reasonably-informed decisions about next steps…like deciding whether to crumple your napkin and go home, or go all in and make your Latest Greatest Widget dream a reality.

April Khadijah Inniss- eek MD