FIXED AND VARIABLE COSTS

Costs are critical when it comes to setting your prices. Obviously you need to know how much something has cost you to produce before you know how much to charge. There’s no point in taking a wild guess, or even an educated one, because it’ll probably be far more than you think. Costs are divided into categories:

Fixed costs

These costs remain the same and are not affected by your level of work (how many items you are producing or number of customers you have). They include:

• business rates
• insurances
• vehicle running costs
• rent or lease charges
• cost of employing staff.

Semi-variable costs

These are costs that vary and are probably not known in advance. They are affected by your level of business activity. They include:

• office or admin costs, such as power, heating and lighting
• phone bills
• postage
• advertising, promotions, marketing
• vehicle maintenance and servicing
• fuel costs.

Variable costs

These costs vary directly with the output of your business – for example, food costs for a restaurateur or the cost of wood for a furniture maker.

You also need to include your own earnings in there somewhere. Which sort of cost it is will be decided by how dependent you are on your business to keep afloat. If you have to take out something each month then it’s a fixed cost: if you can afford to only take out cash when there’s some spare then it’s a variable cost.

BREAK-EVEN POINT

Once you’ve established your costs you can work out your breakeven. The formal definition of the break-even point is when the volume of sales creates sufficient revenue to equal total costs. In English it just means the point at which you go into profit. So this will be a combination of costs or overheads, plus the cost of your raw materials, plus an amount for your time, equalling what you’ve made in sales.

MARK-UP

Once you’ve got your break-even you can decide on your mark-up.

This is usually expressed as a percentage of the break-even. For example, if you can make a stained glass window at a break-even price of £100 but decide you want to sell it for £150, your mark-up is 50 per cent.

There’s no magic formula for deciding on your mark-up: many factors will decide it. But it basically boils down to a couple of words that underpin the whole structure of our economy: supply and demand. If a customer wants your product, they will pay for it. If there’s a plentiful supply then you’ll have to charge less in order to attract the customer. But if there’s less supply and the demand is still there you can charge more. Or look at it another way: volume sales equals lower mark-up.

Millions of words have been written on supply and demand, whole forests felled to supply the paper, thousands of jobs supported by its endless analysis and application, even wars fought over the principle of a demand-led economy. You can spend a lifetime considering it (and plenty do).

But ultimately your mark-up mostly still depends on a lot of guesswork and what you think you can get away with. Look at what your closest competitors are doing, don’t be too outrageous or too greedy, or too timid for that matter, and settle on a percentage that seems about right. And congratulate yourself on not wasting months reading economics text books.

MARKET TESTING

This means going out and selling a little of whatever it is your business does before committing yourself wholeheartedly to the venture. If you want to be a dry stone waller then start off by advertising in the local paper and see what response you get. Or if you hope to be producing marmalades and chutneys on a commercial scale, try out a small batch first at the local farmers’ market.

What you’re doing is demonstrating you can sell your goods or services at that price. If your business needs outside finance then your business plan may have to show you’ve done your market testing in this way.

DISCOUNTING AND MONEY OFF

This can be awkward. Some ruthless people have a policy of absolutely no discounts for anyone at any time, arguing that an upfront approach like that saves embarrassing negotiations and is at least fair all around. But done correctly, discounting can be a valuable way of keeping existing customers happy and at the same time drumming up new business. Whatever you decide, you have to be consistent. Don’t discount for one family member and not another. It’s best to come up with a policy before you start trading and then stick to it.

Whether to offer discounts will depend a lot on the type of venture you’re going into. These are some of the options:

• Open with discounts. The first 20 customers in your shop get 50 per cent off.
• Fixed discounts for repeat business. If, for example, you run a personalised guided walking company, offer a five per cent discount to returning customers. Accommodation providers can do the same.
• Customer loyalty. Do you supply hanging baskets, bulbs or plant stocks to the same customers, month after month? Again, offer them a discount or perhaps money-off vouchers if they spend over a certain amount each season.
• Loyalty cards. It worked a dream for Tesco and it can work for you. This is something that needs a bit of thought, so if you’re starting out at the very beginning it may not be at the top of your priority list.
• Encourage existing customers to help you find new ones. Reward them with a discount, money-off vouchers or something free.
• Haggling. Force yourself to overcome that British loathing of haggling because encouraging it is good for business. If you sell your handmade garden seats with a 30 per cent mark-up then you have scope to cut the price.
• Use haggling to make other sales. Sell them the garden seat with 15 per cent knocked off and throw in a couple of hanging lanterns at five per cent below their marked price. You know what your break-even is (the customer won’t) and as long as you stay within it you’re making a profit.
• End of day sell-offs. If you’re selling perishables (bread, fresh cream sponges) or are at a one-day craft or Christmas fair or farmers’ market, you may want to sell off stock cheaply rather than throw it away or take it home again. This is a more difficult decision. On the one hand any sale is better than no sale, but on the other you don’t want to encourage customers to hang around like vultures waiting for the cut prices.
• Sales, end of season or otherwise. It’s such a devalued word now, thanks to year round ‘sales’ on the high street, that it’s debatable whether they’re ever worth it.
• Customer credit. It’s probably best to avoid this if possible. There may be a few instances where it’s good business practice to be seen to be trusting your customers to settle their bills weekly or monthly. Perhaps the goodwill generated on something like a home grocery/deli delivery service would outweigh the risk of some customers not paying. On the whole though it’s probably safer and potentially less embarrassing for bills to be settled as they’re incurred.

Once again it’s all about balance. Sales and discounts attract business and consumers do expect them. But equally you probably don’t want to become known as the discount warehouse king. It’s better to sell five items at 25 per cent profit rather than 20 items at five per cent profit. In other words, think profit rather than turnover.

SALES FORECASTS

Sales forecasts sound like something only engineering or double-glazing companies should be doing. Not true: sales forecasts are equally valuable to the reflexologist, home baker or wood turner. Forecasts help you manage your business by making sure you are as prepared as you can be. This probably sounds boring and unnecessary, especially if you’re going into a creative market (will you even be reading this chapter?). But nothing is more irritating than losing sales because you don’t have enough stock or running out of money when a few months previously you had some spare.

Forecasts help you predict the likely patterns of your business, which means you should find it easier to:

• ensure smooth cash flow
• ensure you always have enough stock or goods
• ensure you never run out of time
• or if you do, give you time to find a helper or assistant

• identify any future problems.

Many existing businesses draw up a sales forecast once a year. Brand new businesses usually do one before they start trading. If you are writing a business plan, then a projected sales forecast is a non-negotiable element. Any would-be backer, mentor or adviser won’t take you seriously without one.

A sales forecast may sound like one huge amount of guesswork, but if you’ve done your market research thoroughly and have checked what your competitors are up to, it should end up being more accurate than you ever thought possible.

There are lots of ways of doing a forecast. What’s important is that the forecast is clear, relevant to your business and preferably put together on a computer spreadsheet. A spreadsheet, used properly, does all the adding up for you, puts everything in date or any other order you want, is easy to correct and can be updated constantly. If you can’t use spreadsheets it’s definitely worth taking a few hours to learn. Ask a friend, look on the internet, buy a book or go to an evening class. If desperate, you could do a forecast by hand on graph paper or use a manual typewriter, but it’ll be much harder work and will look amateurish.

Where to start

It helps if you first break everything down into categories.

• Customers. How many do you think you’ll have when you start trading? Presumably you’ll have one or two, at least, lined up in advance. How many customers would you realistically hope to have after one month, six months and a year?

• Return custom. Depending on your product or skill, would you expect these customers to buy from you only once, weekly, monthly, annually?
• Sales. How much are your customers likely to spend per visit?
• Monthly sales. Are any times of the year likely to be busier than others?
• Lost customers. Realistically, how many customers do you expect to lose a year? It could be because your product or service isn’t right for them or because they may be tempted elsewhere.

If you start thinking of a sales forecast in the abstract, it’ll be a meaningless jumble of figures. But once you start answering specific questions relevant to your business, it will begin to make more sense.

Example One: selling vegetables

An organic veg box provider has five customers lined up before he starts trading. Through word-of-mouth and local newspaper advertising he expects those five customers to grow to seven after the first month, to 25 after six months and about 50 after a year. The box scheme is offered weekly and costs £6 per box. At Christmas, half the customers order larger boxes at a cost of £9 per box. Our box provider guesses he’ll lose ten per cent of customers a year because they’ll drift back to supermarkets or move away.

His sales forecast could look like this:

	Customers	£6 per box per wk	Monthly total (four wk months)
Jan	5	30	120
Feb	7	42	168
Mar	10	60	240
Apr	14	84	336
May	18	108	432
June	20	120	480
July	25	150	600
Aug	29	174	696
Sept	35	210	840
Oct	42	252	1,008
Nov	46	276	1,104
Dec	50	150 (£6 boxes)	600
		225 (£9 boxes)	900 ________
Annual projected income:	£7,524

By January of Year Two our box provider has been proved right and he’s lost ten per cent of his customers. He’s back down to 45 customers but has increased box prices by five per cent or 30p. And he’s confident he’ll still be picking up new customers at a rate of four or five a month. In July of Year Two he decides to introduce two new ranges, organic beef and free range eggs. His sales forecast for that year will look very different to the first year.

Example Two: selling soft furnishings

A soft furnisher plans to sell her cushions, scarves and gift bags at craft fairs. At her first fair she’ll be happy if she sells a couple of scarves and some bags. By her sixth fair (in about three months), her presentation and selling technique should be better and she’s expecting to sell several cushions and many more scarves and bags. By the end of the summer she hopes to be much better at picking fairs that suit her products. And if all goes well, by the end of the year and in time for the Christmas rush, she’s also hoping to start selling the more expensive quilted or fake fur throws for beds and sofas. Her sales forecast could look like this:

	Cushions £20	Scarves £10	Gift bags £5	Throws £100	Monthly total
Jan		20	25		45
Feb	60	100	45		205
Mar	140	120	65		325
Apr	180	150	80		410
May	200	140	70		410
June	180	120	60		360
July	140	80	40		260
Aug	140	60	35		235
Sept	200	100	65		365
Oct	220	110	80	100	510
Nov	220	190	110	200	720
Dec	260	220	155	500	1,135 ________
Annual projected income:				£4,980

The sales forecast turns out to be quite accurate. By the start of Year Two our soft furnisher is beginning to realise that she can make almost as much money in the three months in the run-up to Christmas as she can in the rest of the year combined. So she’s probably far better off using the summer months to refine her designs and make more cushions, scarves, bags and throws to sell in the lucrative autumn and winter months. And she’s added another couple of lines, mittens and linen laundry bags. Or our soft furnisher could think about widening her product range to include items which would sell well in spring and summer, perhaps sarongs and lightweight shawls.

Either way, in the meantime a couple of local independent shops have agreed to take her scarves. They sell well, and by the beginning of Year Three she’s decided that her next big goal is to open her own small shop, perhaps in Year Five or Six, and maybe even expand into upholstery.

And our soft furnisher is continuing to do her annual sales forecasts, making sure the business is continuing to show steady growth; that she has enough stock at the right time of year to meet demand; and that she spends her cash wisely throughout the year, even though the bulk of her income is increasingly coming from just three or four months in the autumn and pre-Christmas rush.

Future sales forecasts

Your first sales forecast will be drawn up before you start trading. Subsequent ones should be drawn up towards the end of your trading year so you have as many actual sales as possible to base your figures on.

Forecasts for later years will become more sophisticated as you build on the early data by adding new factors. Thoughts for Year Two and beyond:

• Customers. Are you likely to keep your existing customers? Will those customers spend about the same, less or more with you?
• New ranges. Are you thinking about including new ranges, perhaps a new treatment, pottery range or line of furniture?
• Existing ranges. Do you expect to still be selling the same products or skills throughout the year? Do you already suspect (having done your research) that there may be less demand for some, maybe because it’s freely available elsewhere or perhaps because it’s too expensive?
• Taking on staff. Yes, you’ll have to pay them, but will you recoup that money and earn more in increased sales?
• Advertising. Do you expect there to be increased demand every time you place an advert in your local paper? Does it follow that it will be quieter between the adverts?

• Prices. Do you expect to keep your prices steady for the next year? If not, what will be the impact of (presumably) higher prices? Do you think a ten per cent rise in prices will mean a five per cent drop in customers?
• Outside economic influences. Are interest rates likely to rise which would make your borrowing more expensive? Rate rises could also mean a reduced demand for luxury goods or services which are traditionally the first to go when people need to save money. Or is a recession looming?
• Other outside influences. The previous summer was a wash-out so are you expecting fewer tourists to stay at home this summer which means fewer bookings for your holiday cottage or tailored walking holiday company? Has there been another food scare that will impact on your catering business?

Alternative sales forecast method

The other way to do a sales forecast or plan is to think of how much money you’d like to make in your first year and then work backwards in trying to achieve it. In other words: ‘I’d like to make £10,000 profit in my first year, therefore I need X number of customers a month who each spend Y amount on Z products or services.’ In practice this doesn’t work unless you’re lucky and just happened to have plucked the right figure out of thin air.

The plan of action

If you’re feeling conscientious then you could draw up a sales plan based on your forecast. Most of it should be obvious, but if your business is likely to be complicated or if you’re keen on lists then it may help. As an example, let’s go back to our soft furnisher who’s fairly sure she will sell most of her cold-weather and gift-oriented products in the autumn and the run-up to Christmas. So her 12-month plan could be:

January–March:	Sell off last year’s leftover stock at a discount. Consider what needs changing for the coming season. Source new materials. Produce limited stock for Easter.
Easter:	Identify early season craft fairs and sell lightweight products.
Spring/summer:	Make products for autumn and winter stock. Investigate potential new fairs and seek deals with shops. Build own website.
September–December:	Sell madly in craft fairs and Christmas markets.

SALES FORECASTS: THE EASY MISTAKES TO MAKE

• Being too optimistic. This is forecasting what you hope to sell rather than what you probably will.
• Being completely wrong. Remember that there are physical limitations to what you can achieve. A tree surgeon can only visit so many sites in a day or a food producer bottle a maximum number of chutneys or relishes.
• Forecasting sales to reach your break-even point. Tempting but pointless.

• Having no faith in your own sales forecast. This means ignoring the common sense on the spreadsheet in front of you, which spells out when the busy and quiet times of the year are likely to be and when you’re probably going to be making the bulk of your money.
• Not showing it to someone. It’s vital you show your forecast to either a business adviser or someone who has business experience. They may well pick up on something you missed.

CASHFLOW FORECASTS

Cashflow forecasts will show you where you’re likely to be spending – useful especially in the early days when you’ll feel like a human cash dispenser, spewing out money with little clear idea of where it’s supposed to be going. And later on, when the projected figures become reality, a cashflow forecast will provide a clear picture of the rate of growth of your business.

Despite what the books and experts tell you, you only need to do a cashflow forecast if you’re likely to have a lot of money moving through your business via many transactions, and it’s important that you keep track of it. Note money moving through, not profit. So if you’re opening a medium-sized organic restaurant where you’re likely to have many suppliers, customers and money passing in and out continuously, there’s a strong argument for doing one. But if you’re starting out on a small scale business where your turnover (revenue from sales) is likely to be low or where you’re likely to have few customer transactions, there’s little point. In other words, if you’re keeping a couple of ornamental sheep to knit from their wool or setting up as a hill-walking guide, don’t bother.

A basic cashflow forecast

	Jan		Feb		Mar		TOTAL
INCOME	F/c*	Act*	F/c	Act	F/c	Act	F/c	Act
Restaurant sales	900	750	1,200	1,100	2,200	2,500	4,300	4,350
Takeaway sales	200	150
Frozen meal sales	200	200
Wine sales	400	500
TOTAL	1,700	1,600	2,000	1,800	3,000	3,500
EXPENDITURE
Raw materials	350	400
Wages	500	500
Heating, lighting	200	250
Phone	80	80
Advertising	100	50
Insurance	100	100
Loan interest	250	250
TOTAL	1,580	1,630	1,650	1,700	2,000	1,800
Surplus (or deficit)	120	(30)	350	100	1,000	1,700
Carried f/w		(30)		70		1,770		1,770

When putting together your forecast, fill out the monthly forecast columns in advance of either the start of trading or before the beginning of your financial year. And as the year progresses, enter the figure for what you actually achieved.

It means that at a glance you can tell:

• If you are doing as well as you think you should be.
• If you are on target to make a profit.
• How well or how badly individual lines or segments are doing.

• If your costs are under control.
• If you can afford to spend a little more on advertising or promotions.
• If it’s worth spending more on raw materials to produce more things to sell.

This isn’t just a paper exercise because once you’ve worked out your monthly figures, you need to tie that in with whatever you’ve got in the bank.

PROFIT AND LOSS FORECAST

This forecast uses data from a sales forecast and a cashflow forecast and comes up with a single figure that represents what your annual income is projected to be. It takes the money you expect to earn from sales and deducts all your costs to arrive at that sum. If you haven’t done a cashflow forecast it doesn’t matter because you’ll presumably be keeping a running total of your likely expenditure, so you can use that.

At its simplest, a profit and loss forecast could look like this:

Financial year: 2004–05

Income for year:	£20,000
Less running costs:	£5,000
Less capital allowances:	£5,000 _________
Gross profit before tax:	£10,000

There’s more on profit and loss accounts and capital allowances, plus balance sheets, in Chapter 14.