As solopreneurs, we wear many hats in our business: customer support, copywriter, salesperson, and CEO. As we bounce from field to field trying to get our tasks done, we’re often bogged down by industry jargon. And the worst part of jargon is this: We get sucked into a rabbit hole of research trying to understand how these complex terms relate to our business.
One of the industries that is chock-full of jargon is the accounting and finance industry. In my opinion (and I think you might agree), it sometimes feels as though they’re just trying to overcomplicate things. Here’s looking at you, IRS.
This became especially apparent recently, as I was working with my friend Jenny on the launch of a new service, adding in-home cooking classes to her current catering business. As she was trying to work through the financial side of things, she kept running into over-complex formulas and explanations that didn’t relate to her solopreneur business.
We worked through her questions and I gave her basic explanations of some of the most important accounting terms, how to use them in her business, and why she should be sure to look at these items. I thought maybe an explanation could help you, as well.
Here are the main accounting topics we worked through and examples of how these relate to her new service launch:
Fixed costs
- What it is: Costs that will not change, regardless of how much you sell (rent, website hosting, utilities, salaries, etc).
- Why it’s important: Fixed costs are often overlooked but they can creep up and quickly take a big bite out of your profits.
- When you should review it: Monthly, to make sure your costs aren’t creeping up
As this is a home-based business and an extension of an existing business, Jenny’s fixed costs aren’t too high. They include things like her website hosting, her advertising budget, and her own salary. We were able to estimate that her fixed costs would be approximately $2,500/month.
Variable costs
- What it is: The cost you have when you actually sell a product (materials, hourly wages, shipping, etc).
- Why it’s important: Without knowing your complete variable cost, it can be very difficult to price a product or service appropriately.
- When you should review it: Also monthly, to make sure your costs aren’t creeping up
For Jenny, included in her variable costs is the food she buys for each cooking class as well as payment to the assistant she hires on an hourly basis to help with each class. We concluded that her variable costs total for each student is $20.
Contribution margin
- What it is: Sales (income) from each product or service sold minus variable costs.
- Why it’s important: This will tell you how much money from each item that you’ve sold can be used to cover other costs (like fixed costs). I use this as my first test to see if I’ve priced things high enough.
- When you should review it: When reviewing your pricing or launching a new product/service
Jenny charges $60 per student and her variable cost per student is $20, leaving her with a contribution margin of $40 per student ($60 - $20). That means that for every student she has in class, $40 can go toward covering her fixed costs and hopefully making a profit!
Breakeven
- What it is: The point where you have sold enough you are no longer losing money. To get this, you’ll take your fixed expenses each month and divide by your contribution margin.
- Why this matters: This one is seriously a big deal. This is the point where you will either have a business that makes money each month, or loses money each month.
- When you should review it: Also when reviewing your pricing or launching a new product/service
Jenny has pretty low fixed costs since she’s running a home-based business. Her breakeven point each month is $2,500 fixed costs / $40 contribution margin = 62.5 students each month. This means that in order for her business to not lose money, she needs to have approximately 63 students in her classes each month. If she sees more than 63 students in a month, she’ll have a profitable business.
Return on investment (ROI)
- What it is: When you spend money, or invest, in a business you want to be sure that you’re making that money back, and then some. How you measure that is by using the return on investment. It is the sales you received from an investment minus the cost to fulfill those sales, divided by the cost of the investment.
- Why it’s important: Use this calculation to make sure that the money that you’re spending on your business is working for you.
- When you should review it: Before making an investment in your business such as new equipment or a marketing campaign
To advertise her new classes, Jenny is doing a sponsored post with a local food blogger that has a significant following in her city. The cost of the sponsored post is $750 and Jenny hoped that she could bring in 40 new customers from it. With that estimation her return on investment would be:
40 customers * $60 income per customer = $2,400
40 customers * $20 cost per customer = $800
($2,400 - $800)/$750 = 2.13
In other words, for every $1 that she spends on the advertising campaign she expects to get $2.13 dollars back. A pretty solid investment.
Understanding accounting jargon
At first overwhelming, these accounting numbers can be used pretty easily to evaluate your revenue and costs, and help make pricing decisions for your solo business. While accounting certainly isn’t the most fun aspect of the solopreneur lifestyle, having a foundational grasp on things like fixed versus variable costs, break even and contribution margins, and return on investment can help make sure you’re growing a healthy business that is paying you what you deserve.
Latest posts by Erica Gellerman (see all)
- Accounting Jargon, Decoded for the Solopreneur - February 9, 2016
- Breaking Through Mental Money Barriers as a Solopreneur - October 29, 2015
Wonderful post!! 🙂 Accounting definitely feels like one of the hardest parts of running a business, but this post gave some great insights!
This is a super helpful post and something anyone in a service or product business needs to understand.