This video covers creating a rough estimate of profitability.
- A for-profit business must make money. Why? Well, money is the lifeblood of business. Without it, no matter how wonderful your idea is, it isn't an opportunity. The word for money in business is profitability. At its most simple level, profitability is sales minus expenses. But we need to dive a little bit deeper than that. Now first of all, ask yourself whether you're selling a product or service. How much do you think you can sell that for? In particular, per unit if it's a product or per hour if it's a service.
This number is S in the worksheet. Now we want to calculate or estimate your expense per unit. In other words, how much is it going to cost us to provide this product or to provide this one hour of service? We want to overestimate here because everything costs more than what we think it's going to cost. This number is E. Now using these two numbers, we can calculate the contribution margin which is sales minus expenses.
Take a moment, pause the video, and calculate that right now. Now we need to take a look at your overhead. This is sometimes called the fixed expense. These are things that you're always going to have to pay month in and month out. These are things like rent and utilities or subscriptions or insurance or administrative costs. Again, overestimate how much things are going to cost because things always cost more. Then we can calculate the breakeven number.
At its most basic level, this is overhead divided by the contribution margin. In other words, the breakeven are the number of units that we must sell in order to break even, hit zero every single month. This is a critical number because it lets you know how much you need to sell so that you're not losing money. But we're not done yet. The most important question is how likely are we, in this business idea, to double the breakeven every single month? Why double? Because it's not enough to start a business and just make back the money you're putting in.
We want it to be highly profitable. And by trying to get two times what we're putting in, we're creating a business idea that has a lot of cushion behind it. So how likely is that? Not very likely? Very likely? Maybe? Just put your best guess. By taking a look at these numbers, it will help you understand whether or not this is a business opportunity or just a great idea.
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