Without a clear understanding of overhead and profit starting off in self employment will be a real nose dive. If the following sounds true then read on; you have much to learn!
Annette got an order to make six sets of scrubs. She cut material and sewed for a straight 12 hours, completing the entire order in record time. She was also got a killer buy on the material she bought for this order. It only cost her $50.00 for the material and there was enough left over to make another one another day. The nurse who paid for these felt like she got a good deal on these really nice looking, hand-made scrubs at $180.00. She said she would recommend Annette to everyone at the hospital where she worked. Great! Annette did the math: $180.00 - $50.00 = $130.00! That’s $130.00 in profit! Not bad for 12 hours of working in the privacy of your own home she thought.
What is wrong with this picture?
- As a self-employed person, you must pay yourself first!
Figure an hourly wage that is fair and competitive for your line of work considering the conditions and the hours that you work. Base it on what you could find another person, just as capable of sewing, to accept for working in their own home, at a good pace. $8.00 per hour sound good? Yeah, this gig beats the hell out of WalMart! 12 hours at $8.00 per hour is $96.00 that along with the $50.00 in material, needs to deducted from the gross sale before you can claim any profit.
- Figure in your overhead costs!
In this scenario Annette doesn’t have a lot of overhead. She doesn’t rent space in her own house. She is not shelling out a lot of money to repair and maintain equipment. She has no need of business insurance and licenses. She does her own book keeping, and the accountant that has been doing their taxes for years doesn’t charge any extra for filling out a Schedule C –Profit and Loss for a sole proprietor. For other self employed people the costs for these things, and many things not mentioned, can be very high. Some overhead is “fixed” that means you have to pay the same amount no matter how much you have in sales. Rent is a good example of “fixed” overhead. Heat and utilities is another. It costs a restaurant the same to keep a hundred diners warm and out of the dark as it does ten. Fixed overhead is scary for this reason. It can cause some small businesses to collapse because they fall below the “break even point.”
Supplies are an example of overhead that fluctuates with the amount of gross sales. Thread and sewing machine oil, even electricity in this case will vary in relation to the amount of scrubs being made and sold. Many small business insurances are like this. Liability insurance will be base on gross sales. Workers compensation insurance is usually a percentage of your payroll payout.
- Figure in your overhead time!
Most small businesses tend to ignore the amount of “non-productive time” spent on shopping for materials, bidding projects, cleaning their work area or business vehicle, keeping the books, searching for new ideas and learning new techniques, marketing their goods and services and the list could go on and on. In Annette’s case, just shopping for the material comes to a good percentage of the sale.
Let’s refigure this project and come to an accurate amount for both overhead and profit:
Material- $50.00
Labor- 12 hours x $8.00 per hour = $96.00
Gross profit- $180.00 – $50.00 = $130.00 - $96.00 = $34.00
Overhead costs- $8.00
Value of overhead time- 2 hours x $8.00 per hour = $16.00
Net profit- $34.00 - $8.00 = $26.00 - $16.00 = $10.00
Residual profit- Word of mouth advertising from a happy customer, and $7.00 worth of left over material. With very small businesses It helps not to split hairs too finely, and calculate every smallest penny, but don’t ignore the benefits of these “leftovers” either. They can balance out the little costly things that don’t get accounted for along the way.
As percentages of sales, it looks like combined overhead and profit is 18%: 5% for profit and the remaining 13% to cover overhead expenses and overhead time. This is in line with just about any business no matter what size. OH & P generally runs in the 15% to 25% margin for a $30,000.00 per year one woman sewing operation (gross sales) to a 3 million dollar per year Construction Company. The total net profit in this example is $10.00. Annette made $112.00 for her 14 hours of productive and non-productive time, and $10.00 profit after putting aside enough to cover the overhead that will keep her business running and keep her into a job…Working for her self.
