Estimate of Costs
To be able to estimate if you will be able to make money from your
business, you must find out what the customer is willing to pay for the
service or product you offer.
You also need to find out how much will the product cost you to purchase,
produce or import.
The difference between the two amounts shows how much money you
have got left to pay your rent, telephone, internet access, marketing and
your own salary (profit of firm).
Example
If you sell CDs at $ 25.- on the internet and promote it like this: “No postage
& packaging”, your calculation could look like this:
Sales price 25.00 $.
- Purchase price at CD company: 18.75 $
- Packaging and padded envelope: 01.00 $.
- Postage: 02.00 $.
= Contribution margin: 03.25 $ (13 %)
This calculation shows you that each time you sell a CD at 25 $. you have
3.25 $ left. This has to cover other expenses than those related directly to
purchasing, packing and dispatching the CD.
This amount is also called the contribution margin or gross profit.
You can also calculate a percentage, then it is called contribution ratio. It is
done like this:
Contribution margin x 100 / sales price
In the above CD example the contribution ratio is:
3.25 $ x 100 / 25 $. = 13 %
Contribution margin when selling service
The contribution margin differs substantially between different trades. The
above example generates a relatively modest contribution margin.
Compare this to a consultant giving management and development
presentation which may pay you 1500 $ per presentation. Here you may
only have 50 $ of direct expenses for the cab taking you to the hotel where
the presentation is held. This generates a 1450 $ contribution margin. (97
%).
But then you probably have considerable fixed costs and you cannot expect
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