How can you pay for that expense?

As costs spiral, sometimes out of sight, we’re all considering how we can save money right now. One way I find helpful to look at business expenses is to ask how much sales income do I need to cover this expense?

After all, as a handmade product-based business, your sales are not pure profit. At a minimum, you must buy the materials to make the products you sell. But when you sell a range of products, for example:

• A £100 product that costs £30 in materials,
• A £20 product that costs £10 in materials, and
• A £10 product that costs £2 in materials.

How do you know how much of your sales revenue is going to materials and how much is profit?

• If your £3,000 in sales was all from that £100 product, then your materials cost £900. Your profit will be £2,100 (or less if you have other expenses).
• If your £3,000 in sales was all from that £20 product, then your materials cost £1,500. Your profit will be £1,500 (or less if you have other expenses).
• If your £3,000 in sales was all from that £10 product, then your materials cost £600. Your profit will be £2,400 (or less if you have other expenses).

Your profit could be anywhere from £1,500 to £2,400 – that’s quite a range! And in truth, you likely sold a mix of items. So again, where do we start?

In this blog post, I’m going to walk you through how to look at your total numbers because those are based on the mix of items you actually sell.

A warning

The caveat with this approach is that it doesn’t account for your time. Remember when you’re pricing that you should always build your time into the price from the bottom up – pay yourself! You’re building a business, not indulging in a hobby.

I’ll write a Part 2 of this post in the future to show you how to account for your time as well. But for now, I want to share this simpler version so you have something to get started with.

How many sales do you need to make to pay for that…

• Training course?
• Membership?
• Advertisement?
• Insurance premium?
• Website hosting fee?
• Market stall fee?
• Bank fee?
• Equipment lease?
• Shop rent?

You can use this method whether you’re considering keeping a current expense or taking on a new expense.

How to figure it out

First, create a profit & loss report.

If you’re using accounting software such as Xero, QuickBooks, Sage, FreshBooks, QuickFile, or another, all you have to do is go to the Reports section and find the Profit and Loss report and run it.

If you’re using spreadsheets, it will require more than a couple of clicks, but you can easily do it by following these steps:

• First, decide on what time period you want to look at. The current financial year to date or the most recent year are both good choices. You might decide to look at both this year and last year (each in its own column), depending on what information you have available. On the first row, type the time period.
• Section 2 is for your income. You might break this down by revenue stream, if you have several, or you might not. For this exercise, total revenue is fine. Enter that amount here.
• Section 3 is for your direct expenses. These are expenses you only have if you make a sale. This includes your materials or stock costs, your payment processing fees (but not any monthly charges for these), carrier bags or other packaging, any gifts you include with your purchases, etc.
• Subtract section 3 from section 2. This gives you your Gross Profit. Gross profit is your profit before any overheads (which are covered in the next section).
• Section 4 is for your overheads. These are the expenses you pay whether or not you make a single sale. This includes your stall fees, insurance, testing fees, software, advertising, travel, telephone, website hosting fees, training, memberships, photography, networking, conferences, books and magazines, legal fees, accountancy fees, bank fees, leasing of equipment, rent, energy, and so on. Every single expense in your business that isn’t in section 3 should be listed here.
• Subtract Section 4 from the Gross Profit. This is your Net Profit. Net profit is what you get to keep – your profit after you’ve paid for all your business expenses.

If you’ve never heard of Gross Profit and Net Profit, I covered them in more detail in this blog post.

Once you’ve completed the 6 steps above, focus on your Gross Profit figure.

• Calculate your Gross Profit Margin.

Gross Profit Total Sales Gross Profit Margin

An example

Here’s an example:

• You decide you’re going to look at last financial year’s numbers. Write 2021-2022 at the top.
• You made £12,000 in total sales last year.
• You spent £4,800 on direct costs including materials, carrier bags, boxes for posting, and payment processing fees.
• Your Gross Profit was £7,200.
• You spent £3,000 on overheads including market stalls, advertising, insurance, testing kits, legal advice, and your home working allowance.
• Your Net Profit was £4,200.
• Your Gross Profit Margin is:

Gross Profit Total Sales Gross Profit Margin

£7,200 £12,000 0.60 60%

How much sales income do I need to cover a monthly expense?

Use your Gross Profit Margin to work out how much sales income you need to cover an overhead.

Overhead Gross Profit Margin Sales Needed

For example, you’re wondering whether to subscribe to a software that costs £10.99/month.

To cover this expense, you’ll need

Overhead Gross Profit Margin Sales Needed

£10.99 0.60 £18.32 per month

Now, compare what you sell and how much you sell it for with how much time the software saves you.

For example, if your average order value is £20.00, then you need just one sale per month to pay for the software.

Let’s say it takes you 2 hours to make a £20 product, list it on your website/Etsy/Folksy, etc, advertise it, package it, ship it, and do the bookkeeping for the sale.

Does the software save you at least 2 hours per month? If so, then this is probably an expense you want to keep.

How much sales income do I need to cover a one-off investment?

Or for another example, let’s consider a one-off fee: a training course for £500 to help you get more sales.

To cover this expense, you’ll need

Overhead Gross Profit Margin Sales Needed

£500 0.60 £833.33

If your average order value is still £20 as above, then you’ll need 42 sales to cover this expense.

That sounds much more feasible to someone who makes 1,000 sales per month versus someone making 50 sales per month. Remember, you still have everything else to pay for!

Return on investment

With this investment, we also want to consider the return on investment. There are many ways to do this, but one way would be to ask, “If my sales increased after taking this course, how many months would it take to pay back the investment?” Or you might ask, “What impact might I see on my sales after 1 year?” Let’s answer both.

Let’s say you’re currently making £1,000 per month in sales, and the training course boasts that you could increase your sales by 10% every month going forward.

In addition to the £833.33 in sales you’ll need to cover the £500 course price tag, remember that to make time to work through the course and implement the training, you’ll have less time to make, promote, pack, and ship, so you will make less sales initially. Let’s say you can expect to spend half your time on the training course for two months.

What impact might I see on my sales after 1 year?

By mapping it out this way, you can see that if you can use the training to increase your sales by 10% each month above your current £1,000/month, then you will be almost £5,700 better off one year from today, even after paying for the course and putting the time into it.

How many months would it take to pay back the investment?

You can also see that Month 8 is where your total sales for the year (“Year to date,” bottom row) with training surpass your sales without training, so the answer to this question is 8 months.

You can see the trend of the numbers above a bit easier in this chart:

Conclusion

You can repeat this process with any other one-off investment or monthly expense you’re considering keeping or taking on.

Putting the expense in terms of how much sales revenue you need to cover it helps you then ponder other questions such as:

• Is this expense worth that much in sales for me?
• If it is, how can I increase my sales by that much to cover this expense (if it’s new)?
• How much time must this expense save me to be worth paying for?
• How can I judge value for money or return on investment?

And, of course, don’t forget to ask: is there a cheaper alternative that suits my needs?