Combining costs when running a business
In our Moneywise article “Calculating and Managing Overhead” on October 20, we featured the hypothetical business narrative of the Smith family matriarch's dream of the whole family owning a successful pizza operation. Understand, readers, that this is an illustrative composite example of the thousands, millions globally, small businesses providing services and products to the public.
We focused on a pizza business because, well, almost everyone loves pizza. Plus, it seems easy to understand what the overall business plan entails.
Illustrating other business operations, such as clothing, jewellery, dry goods, services, and the like is more detailed due to changing customer trends, managing inventory turns (the number of times an item sells in a month), fitting, sizes, tastes, colours, obsolescence, shrinkage, theft, and so on.
For success, a pizza operation simply must produce great tasting, emotive, pizza each time, every time, on time and at a competitive price.
Small businesses are the life blood of any economy, a fact stressed by the Bermuda Economic Development Corporation, which held a symposium this week for families who own businesses to come together — not to share specific operating data, but to communicate and provide support on various challenges that all small businesses face, such as interrelationships, succession and estate planning, and economic conditions.
Today, Moneywise covers firstly a mea culpa from me — Lordy, an accountant who miscalculated numbers on the chart posted two weeks ago. Thanks to a sharp-eyed reader who spotted that.
Secondly, we focus on the variable costs, the cost to produce each pizza for mass consumption.
Why variable? Because you are only paying for the unit cost of production. A slow pizza day uses less raw ingredients than say on a rainy weekend when everyone stays in and orders out so that they can have pizza to enjoy with their downloaded movie.
Furthermore, costs of production, just like many other consumption items, and expenses in life are subject to change without notice, thus variable for two reasons: unknown production factors, eg there is a shortage of cheese, or sauce, along with how many pizzas should be produced at any given time.
The chart with this article, which now has corrected numbers, includes the estimated variable costs to produce a certain number of pizzas per month. The toughest question is — how many pizzas should that be?
What's in a pizza? Flour, pizza sauce, water, yeast, cheese, pepperoni, bit of olive oil and sugar, plus other select toppings — olives, peppers, onions, mushrooms and so on. Let's not forget: napkins, boxes. Seems a no-brainer! In the words of my favourite chef, “The Barefoot Contessa”, Ina Garten, who with a big smile on her TV show would say: “How easy is that?”
Ideally, the recipe to prepare should follow, but we are not cooking, we are calculating costs. Thanks to some very good friends who shopped for Moneywise, we figured the cost of the basic raw ingredients for one 16-inch pizza at $5. It may not be perfectly accurate, but it will suffice for our purposes.
The variable cost of $5,000 per month assumes the whole sale cost to produce one pizza at $5 each with an average of 40 sold each day (25 days in a month — the family has to have Sundays and a bit of down time).
However, we are not at yet. Breakeven pricing equals the total cost of fixed overhead costs (see prior articles) and your variable costs of production. Each pizza must cover part of the fixed overhead, the cost that must be paid whether you sell 100 pizzas a day or four.
The next vitally important step is to calculate what the retail price MamaZina's Pizzarina's should charge for its pizza. Here, it is vitally important to know the breakeven price, what the competition pricing structure is, and the hardest part about whether the family generate sufficient foot traffic to succeed?
Price too low, the business will flourish but stall out. Price too high and the business will stall out. The family must figure out the best price. Should it be $20 for a 16-inch pizza, $25, or maybe $15? Whatever the price, the volume must make break even. You tell me.
It is challenging. Then comes the hardest part, which is actually selling the finished product, and enough of it to cover the costs of operation and generate a profit.
Businesses far too often are castigated for being greedy, selfishly-run insensitive companies, that are geared to make a profit off the consumers who use, buy from, or invest in them.
Here are the straight facts.
A business that cannot turn a profit is doomed from inception. It is not enough to earn sufficient income to pay staff, cover overhead and raw ingredients. Business accounting calls that state — break even — meaning literally no extra cash for reinvestment, equipment, unexpected contingencies, and a return on their investment to the business owners who have put their sweat equity into planning to achieve success.
The business owners have a right to that success. They do not have to share that success with their employees, although successful, shrewd and ethical business people will certainly utilise some profits to incentivise loyal, hardworking staff.
Readers, let me know your thoughts. Remember this is illustrative only, and is not intended to reflect real businesses or families.
Anticipating tough times means contingency planning for business owners. In a few weeks we will look at what comes next, and what happens if:
• someone takes ill, blaming it on the pizza;
• the predicted lunch/business crowd does not materialise, leaving significant spoilage;
• the business is vandalised;
• a delivery person is assaulted;
• an employee steals;
• raw ingredients prices escalate unexpectedly;
• fixed overhead dramatically increases;
• one or more of the owners becomes ill or passes?
• Calculating and Managing Overhead:https://tinyurl.com/yb4645q3
• Barefoot Contessa How Easy Is That? https://tinyurl.com/ycu9l7dv
Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Dual citizen: Bermudian/US. Pondstraddler Life, financial perspectives for Bermuda islanders and their globally mobile connections on the Great Atlantic Pond. Finance columnist to The Royal Gazette, Bermuda. All proceeds earned from this column go to The Reading Clinic. Contact: email@example.com