Tutorial

By Ed Soehnel

The Money Never Takes Care Of Itself - Part 1 Of 4: Manage The Margins

This is part 1 of 4 in a series that discusses building and using financial

projections. Part of the title for this series comes from E-Myth Revisited: Why
Most Small Businesses Don’t Work and What to Do About It , by Michael Gerber.
I did not get much out of the book, although there were a few thought-provoking
statements, including:

I’ve heard so many would-be business mavens repeat the saddest of noxious
platitudes, “Do the right things,and money will take care of itself.” Let me tell you
this: the money never takes care of itself. Never. YOU have to take care of
money. Daily.

This series takes this statement to heart and takes a detailed look at finances for
a product-based business. This is part 1, which will demonstrate how to use
margins and benchmarks in financial statements for a product business.

Margins Defined

By margins, I mean an expense line item that is relative to net profit, expressed
in percentage. Figure 1 is a basic example with the key margins to which we will
pay attention.

Figure 1 – Margins in a Product Business

In this example, I made numbers equal to the rules of thumb. In general,

wholesale price to a retailer is 60% of shelf-price. This will vary across retail
channels, but on average, it’s 60%. The wholesale price is the gross revenue to
the manufacturer, whereas the retail price is the gross revenue to the retailer.
The retailer pockets the difference between retail price and wholesale price.
COGS, marketing and operations rule of thumbs are 20%, 20% and 40%,
respectively. Again, these vary across industry and company, but if you don’t
know them for your industry, these benchmarks are a good place to start.

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 Tutorial
By Ed Soehnel

The Money Never Takes Care Of Itself - Part 1 Of 4: Manage The Margins

Example of a Pre-Launch Phase Company

Figure 2 is an example of a product business in the pre-launch phase that I am

working with. A detailed set of financial projections are working behind the
scenes to arrive at these margins. Investment costs are separated out. Part 2 of
this series will discuss the importance of separating investment costs from
operating costs.

Figure 2 – Product business in pre-launch phase

The expense margins are lower than average, especially the operations number
and marketing in year 2. We have to ask: Are the expense and/or revenue
assumptions wrong? Is the spreadsheet not making accurate calculations? are
there advantages that the business is able to leverage to reduce the expenses?
Or, is this the norm for the industry? In this specific case, the business is
projecting its ability to leverage certain advantages to reduce costs and the
industry tends to have lower expense margins and a much higher net. This could
be a great business with room to make errors in the expenses because there is
lots of margin to play with.

Feasibility on a Tree Farm

I am currently doing a feasibility study on a tree farm that I am thinking of

starting. It will grow evergreen trees, like the Colorado Blue Spruce, White Fir
and the Ponderosa Pine . One of my first steps is to do a back-of-the-napkin
financial and margin analysis to determine if the business is financially viable.

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 Tutorial
By Ed Soehnel

The Money Never Takes Care Of Itself - Part 1 Of 4: Manage The Margins

Picture 1: This is around a 10 year old tree and priced at $170.

Colorado Blue Spruce

I visited some local retailers to get a sense for retail price of specimens that look
to be 5-7 years old. I know some of the large buckets making up my COGS
because I already purchased 60 tree seedlings this year to see if I can
successfully grow them (see post here about that) I don’t really know my
marketing costs yet, but I suspect they may be low given the way I want to run
the business. My marketing options are as follows: (1) sell to local retailers, thus
my marketing costs are really direct sales efforts to secure these retailers and
pretty low; (2) or, I can sell direct to consumers by advertising myself, in which
case I will keep my marketing costs low by using inexpensive online and offline
guerrilla marketing tactics. I don’t really know my operating costs either. I can
do the labor of planting and tending the trees myself and I should include a cost
to my time, or I can hire someone. More than likely, I will do the labor myself, at
least to start.

Based on what I know, here is what the margin analysis is telling me:

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By Ed Soehnel

The Money Never Takes Care Of Itself - Part 1 Of 4: Manage The Margins

Figure 3 – Margin analysis for tree farm in feasibility stage

Already my COGS are a little higher than benchmark, but that is OK, as they are
not far off. I might be able to get them lower through economies of scale. If I sell
direct to consumers, my marketing costs might go up a bit, but the extra revenue
might be worth it. Operations is a big unknown at this time, because I don’t know
if I will need to hire labor or how to price my time into this if I do it myself. But as
I already mentioned, I will likely do the labor myself,, at least to start. Other
factors to consider include the damaged product rate, in this case the percentage
of trees that die during the growing process. However, there appears to be
enough margin to play with to make this endeavor work, considering these other
factors. I’ll just have to wait a year and see if I can learn how to keep my trees
alive.

Click this link to a spreadsheet so that you can plug in your own numbers.

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