One of the primary reasons to starting a business is to make money, or at least to make money over time. If a business doesn’t make money to be able to cover all the business’ costs, then it is not sustainable and will need to close down.

But, it may be unrealistic to imagine that a new business will make money immediately. Often you need to invest significant amounts of time and money into your business before you see any rewards.

One way or another, it is vital that you understand the money flows within your business when you start. This includes knowing how much your product or service costs to make or produce or provide; knowing how much you may want to invest in marketing or promotions; knowing how much your customers may be prepared to pay; and, ultimately getting a realistic picture of how much you could earn from the business.

Understanding costs
It is vital to understand what it costs for you to make your product or offer your service as this will help you to work out what you need to charge as a minimum price. You should factor everything in, including your time – because ultimately this is the cost of your work or labour.

There are two main kinds of costs – variable costs (costs that change dependent on the quantity of goods produced, i.e. the cost of ingredients in bread or soup) and fixed costs (costs that don’t change but still have to be covered, i.e. the cost of rental or a bicycle).

Take a look at the costing sample below for Dineo.

Her main input were the chicken pieces and the raw vegetables. But she also needed to get transport money to buy the inputs, and to get to the taxi rank to sell her soup. She also needed electricity to make the soup, containers to sell the soup in. And, she needed to factor in wages for herself – in the example below she included a cost of R100 a day for her labour/time.

Here is her costing:

Therefore, the cost of a single bowl of chicken soup was R9.55.

Working out your pricing
Once you’ve got a good understanding of what your product or service costs to produce, then think about your pricing. If you have done your market research, you may have asked potential customers what they would be prepared to spend on your product or service. This is useful information. Also try to see what over people are selling similar products or services for. That will give you an indication of what your customers may be prepared to pay.

Remember that your product or service should at the very least cover your input variable costs (even if they don’t cover your time/labour cost). If the pricing is below this amount, it means that you will be losing money and it would be better to not start the business.

Remember too that you can changeyour pricing to attract customers. In the beginning you may be wanting to offer customers discounts so that they are attracted to your product or service. Customers may think it is risky to buy something new or to try out a new service – so a reduction in price can help to reduce the risk.

Let’s look at how Dineo experimented with different pricing:

In this example Dineo is seeing how much money she would make in total if she sold her soup at different prices. At R5 per bowl of soup she’d cover the costs of most of her inputs but not the cost of her labour. At R8 per bowl she’d just almost cover her labour in full. And, at R10 she would cover her costs completely.

She may decide to have a special the first week to sell her soup at R8 a bowl in order to get customers to try out the soup, and then raise her price the next week. Do you think this would work?

Making a profit
Profit is the money that is left over once you’ve paid all of your costs as well as yourself. Will your business be turning a profit in three months’ time? If it’s still making a loss over many months, you need to re-examine your business and see what needs to change.

So, the bigger the difference between the costs of running the business, and the sales that you are making, the more profit you will make. This profit you can use to invest more in your business or to save personally too.

Businesses generally work out their profit through a Profit and Loss statement. See Dineo’s example below for an idea of how it works. This is for the period of a week.

In this example, she sold 250 bowls of soup in total. 100 of these were at the promotional price of R8, and 150 at the standard price of R10. She had to cover all her costs, including her daily taxi fare to sell her soup as well as taxi fare for two trips to the market to buy her ingredients. Her electricity cost went up as she was making soup five days in the week. She also needed more containers.

As the example shows, she was able to not only pay herself (R600 for six days work), but she also made a profit of R775.

This may sound like she’s got a winning formula – and we hope that she does – but remember, she may not sell all her soup in a day, some may go to waste. Can you work out how many bowls of soup must she sell to make sure that she doesn’t lose money?

This is called the ‘breakeven point’. It is the point at which your sales (price x the quantity of goods sold) is equal to your costs. To work out the breakeven point, you take the total expenses and divide it by the price of the soup. This will give you the number of bowls of soup that need to be sold in order to cover the costs.

So, R1525 (her total expenses) divided by R8 or R10 dependent on whether she offers the promotion or not.

• If she sold all soup at the promotional price of R8 she’d need to sell 190 bowls to breakeven
• If she sold all her soup at the standard price of R10, she’d need to sell at least 153 bowls to breakeven.

Try it out for yourself!

Thapelo’s business: Maths tutoring
Now let’s think about Thapelo’s business which is very different. He’s offering a service so he doesn’t have many input costs. But he did need to invest in the textbooks upfront. Those would be his fixed costs that he would need to cover over time.

In a month (approximately four weeks) Thapelo would run 20 afternoons of tutoring sessions (as there are five weekdays and four weeks). He was charging parents R10 per lesson and he had 10 students in each class. Each afternoon he ran four classes. That means that each afternoon he would earn R400 in tutoring fees.

His inputs are: his time/labour (including his knowledge of maths concepts), the 10 textbooks at R200 per textbook; and, the cost of the stationery (R500 per month). He also needed a venue (in the beginning he was using a room at the library and he paid R100 per afternoon for the space) and he would have needed to cover his transport costs of getting to the lessons and back home again (R20 for the round trip).

Here is a profit and loss statement for Thapelo for month (calculated at 4 weeks).

As you can see in the first month Thapelo has been able to cover the cost of the textbooks (this is a once-off cost as he won’t need to buy them every month) as well as his other costs, and he has made a profit of R300.

Remember that we have assumed that all the learners come to each of the classes and that each tutoring session is full. This may not happen in reality and so his profit may not be as high as this. (Can you work out what the minimum number of students he needs in a month in order to make a profit?)

However, if his classes are full and there is a growing demand, then he may think it is good to expand and train some other maths tutors to help him out. That way he could still pay them for their labour, and still earn a profit.

What have we learned?
Make sure you understand your costs, and that you know what your customers can afford to pay (your pricing). Remember that you should always factor in for your labour (time and effort) even if you can’t afford to pay it. Think about your business over time. It may not be profitable in the short-term but if you can invest in it (like Thapelo did by buying the textbooks), it may be sustainable in the long-term.