Business ownership requires more than skill in creating a product or talent at providing a service. Overseeing the finances of your company is key to survival and success. Understanding basic business math is necessary for profitable operations and accurate record keeping. Knowing how to add, subtract, multiply, divide, round and use percentages and fractions is the minimum you need to price your product and meet your budget. If math is not your strength, partner with someone who can take over that role or hire a trusted employee to help your operation stay in the black and grow responsibly.
Calculate Production Costs
Before you formally establish your business, you must estimate the cost to manufacture or acquire your product or perform your service. Adding all expenses associated with making or buying items helps you realize if you can be competitive with other companies and profitable enough to sustain your business and make a reasonable income. In addition to the standard costs of production, such as materials and machinery, add accompanying expenses, such as shipping, labor, interest on debt, storage and marketing. The basis to your business plan is an accurate representation of how much you will spend on each item.
To ensure you can operate your business and produce enough cash flow to invest into your enterprise, you must charge enough for your product to be profitable. Markup is the difference between your merchandise cost and the selling price, giving you gross profit. If your operations require a large markup, such as 70 percent, you may not be competitive in your industry if other companies sell the same items for less. Once you have determined your markup, one way to calculate the retail price is to divide using percents or decimals. For example, if a product costs $10 to produce and your markup is 35 percent, subtract .35 from 1 (or 100 percent), which gives you .65, which is 65 percent. To calculate the price of your product, divide 10 by .65, which rounds to $15.38.
If you want to determine the net profit for a certain time period, you will need to subtract returns, costs to produce an item and operating expenses from your total amount of sales, or gross revenue, during that time. Discounts on products, depreciation on equipment and taxes also must be calculated and subtracted from revenue. To arrive at your net profit, add any interest you earned from credit extended to customers, which is reflected as a percent of the amount each person owes. Your net profit helps you understand if you are charging enough for your product and selling an adequate volume to continue to operate your business or even expand.
To analyze the overall financial health of your business, you will need to project revenue and expenses for the future. It's important to understand the impact to your accounting records when you change a number to reflect an increase or decrease in future sales. Estimating how much an employee affects revenue will indicate if you can afford to add to your staff and if the profits realized will be worth the expense. If a competitor starts selling a cheaper product, you may need to calculate the amount by which your volume must increase if you reduce prices. You may need to know if you can afford to expand your operations to improve sales. Using basic business math to understand how these types of actions impact your overall finances is imperative before taking your business to the next level.
- SBA.gov: Financial Projections
- Universal Class: Business Math 101
- Dustin Ryen's Blog: How Math is Used by The Modern Marketer
- Food and Agriculture Organization of the United Nations: Determining Manufacturing Costs, Profits and Loss
- CalculatorSoup: Mark Up Calculator
- U.S. Securities and Exchange Commission: Beginners' Guide to Financial Statements
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