jad andbook for Small Business By SCORE Chapter 225 Hyannis, Mass. Series Building America’s: Futurea) ‘Copyright © 1989 by SCORE Chapter 225, Hyannis, Massachuaots. All rights reerved. This publication is protected under copyright. [No part may be reproduced, transmitted or irarscribed without Che permission ofthe auhor, SBA teisins an ievoenble, worldwide, ‘mocenclusive, cayalty Gee. untiited Hoonso to use this copyrighted material ‘While we consider the concens ofthis publication to be of general meni, its sponsorship by the U.S, Small Business Admiistation ddoos not aesevsarly constitute an eraoesement ofthe views and opinions of the authort or the products and services of the companies ‘with which they are affiliated All of SBA's programs and services are extended to the publte on a nondiscriminatory basts.CONTENTS PREFACE oo... ccc ccesecseeeeetees INTRODUCTION .... . STARTING A BUSINESS ... NAMING A BUSINESS . LEGAL STRUCTURE OF A BUSINESS. Soe Propitreip- Partnership. Corporation «. “Subchapter $ Corporations LICENSES AND PERMITS. MANAGING A BUSINESS Management by Objectives Keeping Records . aviewing Records ‘Taking Action Getting Help . Essential Management Practices FINANCING A BUSINESS: Sources of Funding The Lean Proposal ‘THE BUSINESS PLAN RECORD KEEPING .... PRICING SERVICES PROFITABLY Typesof Costs .. Calling the Gostota Sentce PRICING PRODUCTS PROFITABLY ‘Typesof Costs... - Broak Even Analysis ADVERTISING Reasons tor Advertsing Chjectves of Advertsing Adverising Media. Help in Advertising MARKETING Matating Bove Opening... Marketing for an Existing Business .. US. Smal! Business Administration iLOCATING A BUSINESS: Selecting a Ciy or TOW... ‘Selecting an Area Within a Cily or Te Selecting a Speciic Ste .. INSURANCE .... se BB 228 12 24 RETAILING TIPS, Image ......-... Customer Relations, Credit Cards Markdowns Loss Leaders . Pricing Poy. Leases . Protecting Compebiors Empoyees ‘Suppers . EMPLOYEES AND INDEPENDENT CONTRACTORS: or 28 28 MANAGING HUMAN RESOURCES. Recruiting 29 Ineriewing 29 Wages and 0 Training 30 Supecision 30 Terminating Empieyment : COMPUTERS IN SMALL BUSINESS What a Computer Can Do... ‘Aes a Computer Can improve Wal a Computer Cannot Do Buying a Comput... FRANCHISES Detriton . Aavantages Osadvamages .. Osclosure Document. ‘Other Consierations MANUFACTURING COST ACCOUNTING INVENTORY Invertory Record Keeping Invertory Contal... Invertory Stratogi: APPENDIXES ‘A Useful IRS Tax Publications B. Information Resouroes 4“ 4a « US. Sait Business AdministrationSCORE, an acronym for Service Comps of Retired. Executives, san independent, voluntary, nonprofit association. Altiough SCORE is sponsored by, and receives financial aid from, the U.S. Small Business. Administration (SBA), itis mot a constituent of thal oF any other government agency. “The primary purpose of SCORE is to reader a community service by providing, without charge, the expert assistance ofits volunteer counselors to small businesses. ‘Counselors rective no pay for their services. SCORE began ‘n 1963 when certain groups of retired persons, almast spontaneously, began offering assistance {o owners and operators of small businesses in various localities, such as Worcester, Massachusetis; Wilmington, Delavare, and St, Lou's, Missouri. Later in the yea. the 'SBA began to use these volunteers :o supplement its own. ‘small business assistance programs and to recruit more volunteers for that purpase. ‘The respoase was 50 enthusiastic, and the potential of ‘these volumeers so enormous, thal the SBA began to ‘organize local SCORE chapters and administer the ‘rogram. Today, there are more than 400 SCORE INTRODUCTION {In this final decade of the 20th century, small business ‘owners continue to demonstraty their extraordinary capacity wo mobilize resources and generate new jobs. ‘Thero are more thsn 20 million small businesses in the United States, and each year nearly a quarter ofa million ‘new ones are started. Smal! business employs six out of every ten people, accounts forthe majority of new jobs, is ‘more Gexible than big business in responding to shifting markets and is able to bring new produets and services to market much faster than larger companies, ‘Realizing that small business is the backbone of his country's competitive free enterprise system, Congress, 39 1953, created the USS. Small Business Admicistation, SBA defines a small business as one independently owned and operated, and not dominant in its ek. SCORE is part ‘of the SBA’ business development program. ‘To star a new business and remain in business profitably, ‘one must be able to adapt to changes in the population, ‘work force and technology, and tothe demands of ‘lobal marketplace. To address these changing sonditions, sound management and organizational ‘chapters in the United Seates and more than 12,000 volunteers. ‘While its counselors derive tremendous personal gruification from assisting small businesses, SCORE exists solely forthe benefit of the small business ‘communicy. For anyone in, or considering entering into, a small business, SCORE offers many services. These services include private, individual, confidential ‘counseling; training through specialized seminars, ‘workshops and conferences; information from books, pamphlets and SBA publications, and advice on how «0 approach regulatory organizations. local authorities, lawyers, accountants, town officials, etc. Also, SCORE cooperates closely with ether volunizer organizations, -govemment agencies, chambers of commerce, colleges and universities, and other nanpoltical civic associations to enhance the quality of life forthe entire community ‘To locate the nearest SCORE chapter, call your area SBA. office. The number is found in the blue pages under “LS, Government.” You can also call SBA's Answer Desk at 1-800-U-ASK-SBA. Practices are more important than ever before. The ecessity of increasing productivity of employees, the Analyze progress with hard nombers, ‘© Know your break-even point and when you are 02 target in reaching it ‘Have your accountanvbookkeeper prepare ard thoroughly explain financial reports, such as profitand loss statements, balance sheets and cash Dow sheets, in adition to those related to ‘your tax returns + Evea though your objective may not be to socure loan, talk 10 your banker about your business. Know your numbers. © Know exactly how much itcosts you to make a sale, perform a service, make a repair, ets ‘+ Know how muck inventory isn hand, tnventory ismoney. Old and obsolete iavemtory can paralyze your busines, © Solicic regular feedback from customers and make changes based on their suggestions. «+ Join a trade association for your industry. ‘+ Read the same publications that your competitors and customers read. e U.S, Small Business Administration‘© Constanuly serutinize your competitors’ ‘advertisements and read thei sales literanure. ‘+ Ask yourself the following about your competition: Is their business increasing or decreasing? How do you compare as far as quality, price, pnduct line, exclusivity service, reliability, location, warranues, delivery end ‘courtesy are concerted? «Tali regularly aboot business-relazed subjects ‘with other small business owrers. «Review financial and marketing strategies often ‘+ Have regular raining sessions for and regular ‘motivation mectings with your empioyees. + Recognize your own wealmesses and get help in these areas. ‘+ Review the business plan monthly. ‘+ Tell everyone on the payroll exactly what his or ber responsibilities are and what is expected. ‘+ Treat employees as individuals. ‘+ When an employee does a good job, tll hinw or her. + Keep as accurate a set of records as possible. ‘© Analyze your records oftea and talc any appropriate steps that may be indicated. ‘© Take pride in yoor business. Gees) ee ess) ‘One of the leading causes of business failure is insufficient stat-up capital. Therefare, a crucial element for business success is adequale financing. Not only are funds required for start up, but also to cover initial operating losses and provi for growth. ‘Asa general guide, one should have sufficient cash to cover atleast one year’s operating expeascs, which includes the owner's salary and money to make regular Joan payments, Almost al businoss operators hope theit bosiness will grow, yet some fail because, after a successful start, additional capital is not available 1o meet ths increasing financial demands of an expanding ‘wasiness It is crucial that che business plan contain @ etailed snatysis of alt capital requirements, ‘Once you have determined the amount of capital required to both start and continue the business uni] it generates ‘enough cash 10 sustain itself, it is time to find a source of money. Sources of Funding Personal Assets. The best source of funding is your personal resources, such as savings accounts and other marketable securities and investments chat are readily converted ino cash. Even it you do not have sufficient personal funds to entirely finance the business, plan on using those funds, becanse most lenders require that you do this before they will corumit toa oan. Remember, showing others you are willing to use your ows funds indicates your confidence in your business and your willingness w tke the risk. amy and Friends ‘An excellent source of funding is your family and friends. Either can make a capital investment the business in return for partial ownership or asa loan. Usually, family OF friends will lend their money ata lower inerest rate than a commercial lender and with mutually agreeable ‘erms for repayment, {tis very important in your dealings with family and. friends that you carefully review your business plan with ‘them so that they understand all the risks involved. Family and frieads should not be encouraged to invest in your business if they cannot afford to risk their funds. For IRS purposes, detailed recards should be kept of any financial assistance received fram friends ot relatives. ‘Also it is recommended that a writen agreement with the individual providing fonds be prepared. Banks ‘Banks are the mast commen source of borrowed capital Historically, commercial banks have been the single largest source of loans w business. Today, however, both savings banks and savings and loan associations make ‘business loans, tis very important to establish a cordial working relationship with your banker, Pick a bank tha makes Jams to your particular type of business and ane with US. Simall Business Administration 4s‘which you feel comfortable, Your banker can be a valuable partner in helping to determine the right financing package for you. ‘A bonk normally requires tha first-time bortowers invest from 25 w 3$ percent of their own money before the bank ‘will consider a Joan, For example, ifthe business plan shows a necd for $100,040), the borrower would have 10 hhave 825,000 10 $35,000 of his and her own money in ‘order 10 obtain $65,000 to $75,000 trom the bank. nthe case of a restaurant, the bank may require the borrower to invest 50 pesvent of his or her own money. Banks require that you have a good personal credit record and, in most cases, will quire some form af collateral 10 secure the loan. Collateral can be inthe form of assets used in the business or personal assets, including the unused equity in your home. Creat Unions Many companies, labor unions and government agencies bave credit unions for their employees or members, Credit unions pecform Functions similar fo barks, ‘nclading making personal loans to their members. Ifyou are a member of «credit union, heck it out asa possible source of a business loan. [Loan and Finance Companies “These axe companics that specialize in making personal loans for business purposes. Some of the larger ‘companies make business loans as well as personal loans. Le Insurance Companies: ‘Many life insurance policies have provisions for the accumulation of a “cash value,” against which funds may bbe borrowed. Some policies call it the “loan value.” The interest rate, established in the policy, is usually less than the commercial rate. Chack to see if you, parenis or friends have life insurance with Joan values as they can be an excellent source of financing. ‘Small Business lavestment Companies mat! business investment companies (SBICs) axe privately owned companies licensed by the SBA to provide capital ce small businesses. SBICs look for businesses that have propcctary products with high growth potential. Young. lower-ris, aggressive ‘companies are preferred. Usually, an SBIC wants a share in the business, Community Development Companies ‘Many communities have established community development companics (CDCs) to help attract new bbasiness to their area. Frequently, they are used to develop commercial or industrial parks, Check to see i your community has a CDC, If so, you should talk te them. Suppliers |n order to encourage sale of their products, many suppliers provide retailers with shelving, display cases, xeffigeration units and so on at very favorable terms, Caution should be used when financing assets through a supplier, be sure you understand any commitment you ‘have to make regarding purchasing the supplier's product ‘in the future ‘Also available from many suppliers are extended payiment terms, enabling you to sell the merchandise before having to pay for it, A supplier may offer goods om consigament. Leasing Companies An allemative to purchasing equipment with borrowed ands is 1 lease the equipment. Items conumonly leased are office furniture, automobiles, sucks, computers and production machinery. The leasing company maintains ‘ownership of the item, although sometimes agreements an be made by which you become the owner after a specified time period. Leasing allows you to conserve initial capital and offers: fleniiity in acquising Une use of equipment far oly limited period of time. Private Investors ‘Some investors specialize in making leans to businesses. Tn many cases, the investor(s) will require a panial ‘ownership of the basiness. Care shoold be taken in ‘dealing with private investors to see that your interests are property protected. Investors can sometimes be found in classified advertisements. US, Small Business Administration ‘The SBA’s basic Joan guarantee program is generally Used to Fund the varied long 4erm needs of small business, ‘The program is designed to promote small business formation and growth by guarantecing long-term loans to ‘qualified firms that cannot obtaining financing on reasonable terms through normal lending channels. 0 U.S. Smasi Businass ActministrationLoans are available for many business purposes, such #5 seal esate. expansion, working capital or inventary. Generally, SBA can guarantee up to $500,000 -- usually Tpetween 70 percent and 90 perceat of the Joan value - at an interest ue not to exceed 2.75 percent more than the prime lending cafe, Maturities are up to 10 years for ‘working capital and up to 25 years for fixed assets. Occasionally, SBA will est new loan products or seevices, Different loan programs may include reduced paperwork, shortened approval periods, or smatter Ioan amounts, Customers should contact their local SBA District Office to earn what specialized loan programs available in shels area, Fact sheets explaining the various loan programs that the SBA administers, including fixed lines of credit, are available from the SBA. Also available from the SBA or SCORE are brochures eotitled "Business Loans From The SBA” The Loan Proposal ‘When you approach Tender or investor for the purpose of obtiining funds for your business, you must have the means of telling your story in astraghforward and. convincing manner. The best way 1 do this is with a ‘writen foam proposal, presenting all the pertinent {information ina logical farmat. Although a well-done proposal requires a considerable uncont of work, the effort is usually worthwhile. It indicates to a prospective lender or investor that You thoroughly understand your business and its financial ‘demands. The proposal must be thorough, concise 270 neat It may be submited in longhand, but iis worth the money to have it typed. Cash flow charts may be submstted in writing, ‘The proposal should answer most of the questions that will be asked by a prospective lender and should present a convincing picture. Tel it like itis, being totally honest. Overstatements of facts and figures will not serve you well in the feng run and wll be challenged by an astute leader. If you cannot prepare this yourself, get help. It will pay off! Exhibit 3 provides an outline of a typical loan proposal. Exhibit 3 - Outline for a Loan Proposal m Cover Page A. Name, adress and telephone aursbet B. Nanse and file of principals} Amount oF loan investment) requested D. Purpase of the loan (investrent) E. Repayment terms ofthe loan Description and Surnmaary af the Business ‘Length of time the business has been operating ‘The business's historical trend “The naruce of the business Wha: does it do? ‘What is unique about your product line or service? ‘What or who is your marker? ‘The basinese’s competition, ‘The business's long-leea growth plan Trends in your induamry ‘Management ‘A. Your management experience B. Your menagement oun 1, Table of organization 2. Brief révor of key individuals and their espornibibues ‘Current staff or work force lve! and Fume needs 4. Bristing backop C, Your accountant and storey ‘The Loan (Investment) Request A. Justification ofthe loan B. Details ofthe loan request 1, Amoustnecded 2. How the finds will bo used 3, Collsteral available for a loan and it value 4. Repayment teams ofthe loan 5. Ability pay aloan Financial Data AL Financia! statements 1, For anexisling ousines, three years of Iestorical and any interim statements 2, Balance sheets 3. Profitand lors or income statement B, Projected cath How analysis fr a least the next 12 mouth, inluding loan (ewestimest) ©. Sources and amounts of any other loans or investments (0 Be pu into the business D, Personal financial statement Credit Information A. Buuks at which you mintain accounts BL Banks at which you have borrowed money CC. Trade suppliers D. Other creditors Miscellaneous incorporated, copy of atcles of necrporetion renting, copy of lease ‘Type end arrount of business insurance coverage ‘Aging of accounts receivable Copies of business and personal ax returns Rormpne> moORP US. Small Business Administration "GEE Saal ‘The importance of business planning cannot be ‘overemphasized. A business plan is an opecating ool, that forces you to take an objective view of your business, and provides the means 10 identify areas of strengths and ‘weaknesses. It pinpoints needs you might otherwise ‘overlook, spots problems before they arise acd points out ‘what must be done to make a profit and increase your ‘business. A business plan can help you avoid entering {nto a venture that may fail. Ifthe plan shows the business tobe marginal, the hours spent writing a plan will save ‘you the nigh cost of a business failuce, ‘A business plan + Clearly tales both the short- and long-zange objectives of te business *+ Provides the direction or pln for achieving these objectives. + Provides financial forecasts based on yout ‘estimates ofthe future and your business. experince, * Provides budget guidetines, including projected cash flow analysis and income statements © Gives a break-even analysis af your business. ++ Helps determine the acnount and kirds of financing best for your business. » Gives banks, investors and suppliers useful information they need to make fast and accurate decisions about your business. + Farces you to think thcough every aspect of your business and recognize opportunities for growth and profit. + Provides financial information so that ve pas: cen be compared tothe present al fone Is not possibic in this Handbook to present an example ‘of 3 complezed business plan. Exhibit 4 contains an outline listing the contents ofthe plan, Remember, a business planis a dynamic, not z suai tool After itis prepared t must be used eiten. tts Meni, nocrigid, and should te altered as conditions change. Most inponant is thatthe ownes(s}/manager(s) prepare the report. 1f you have trouble understanding how to write a pan, be ‘quick (o get help. SCORE caa be of great assistance. ‘Also, an accountant car. help im preparing the financial reports. However, only you can set the objectives of the dusiness—only you can decide where you want the. Dusiness to po and what you want it zo be. Do it! | RECORD KEEPING | ss Experience has cleasly demonstrated that fora person about to start a business, an adequate record keeping system will increase the chance of survival and reduce the ‘rebability of failure, Similarly, forthe established business, experience bas shown that 2 good record-kecping system increases the chances of remaining in business and of earning larger profits, How’ Because ‘accounting records can furnish the following ely information: Amount of business done ia cash and credit ‘Amount of business tied up in eceivables. + Asmount of collections ard losses from eredit sales. + Aging of accounts recebvable and amount of credit given to delinquent accounts. ‘Amount ef cash on hand and in the bank, ‘¢ Whether business records agree with hank, statements, + Amount awed to creditors and suppliers. + Gross margin. 4 Tolal expenses. + Amountof weekly payal + Adequacy of payroll recor for withholding, ct + Payment of taxes and deposis of withholding. + Net profit eamred and axes owed + Which proctor service makes profit. * Which produc or service loses money. Amount of money invested in inventory. 2 US. Small Business AdministrationExhibit 4 - Outline of the Business Plan Cover Shect—Contains name of te business, ramet oF (@. Application wnd effect of fosn or personal funds principals, adévess and phone sustber of business, name and ‘iless of person who wrote the plan ‘Statement of Purpost—Aa operating and poliey guide for your Dusiness funds ae needed, stele how Uiey willbe used and wnt effec hese funds wil have on the business. ‘Table of Contents A, Deveripion of de business 1, Product sold, services offered 2. Capital equipment and value 1. How much is needed 2, What for —nventory, equipment, renovations, te 3, How funds will help business 4. What aypens if fads are not available in fl) HL Objectives of business and plans w abhieve cher 1. Listobjctives for each par of your business 2. Describe your plan ip achieve euch objective TL. Summary—Summarize all thoyghte wed dens shout the business 50 at Chey make sense to you and readers Port —Financtat Date A. Sources and application of fading —A resttement of B. arkee | er say your potcter ic Pare l-G, Shows up csh flow projections 2. Who needs ic B. Capital equipment jist—but list depreciable assew on 3 Siusof te muket income saucent 4. Growth potential Balance sheet—Shows ates, Linbilites net worth ©. Location of business slagiven tine 1 Physiol features of site 2. Whether itis leased on ovned D. Break-evenanalysis—The sale or inoame poit at 3. Renovations needed “whieh the company breaks even 4. Desctipon of neightericod 5. toning reactions, any E. Tnenme projections (Profit an loss saements) & Other businesses in the tea 1 Thre yer nny 1. Acvantages an disadvantages ofthe loenton 2. Fn yoo detiled by months 8. Whether location snecessry and, 40, 4. Second and tind years detail by quarters ect on opesting cose 4. Noves of explanation D. Competition Fo Cash flow projections: 1. Names and uddesses of competiors 1 Fiat yer detailed by months 2. Theishare of marker 42. Second and third year cetailed by guaters 3. Wha you have thas your competitors do mot 4. Notes of explanation 4. cae effets ofeomptitor 5. Cempirison of your site nsde and ou to G.Deviaion analysi—Compaes neal income eed competion expense projevted income and expenses ob a ‘rort-ig-month bats, SpoW srengle and weaknesses. ‘E. Mamagement {Your background aad experience Historia! fnancia repo for exiting business 2. Experience of management employees 1, Balance sheets for past three years 3. Analysis of sbength and weaknesses of management 2. Team statement for past he yes isslading your om 3. Taxeetims 4. Neds or he futce and pha ore 5. Job descriptions and sining program Pure Supporting Documents Trades personal risumés, radi report, job deseo, F,esaael ceonae, gal documens, eters of irtest and anything 1. Number of employees an experience 2. Swrengths and weakresses 3. Skillset for Eanie 4. Plans ro hite ang trining programs nas todo with the plan US. Small Business Administration iRecords provice a wemendeus amount of information, ‘Most importants thai Une system be + Simple w use. + Easy io undersand. Reliabie. + Accurne, + Consistent, + Able to give information ona timely bass ‘The following information must be rocorded: + Cash eceips + Cash disbursements (expenditure) * Sales. + Purchases. + Equipment + Toventory + Aecoums receivable (amount customers ove). “+ Accounts payable (what business ome5). From the record keeping system, the owner/manager must dbotermine the following information: ay + Cash sales and cash receipis. + Cash on hand, + Bank balance of business. + Monies paid ou:—both cash and check + Accounis receivable, + Accounts payable, + Payroll in derail + Taxes—sales, social security, withholding, et. * All journal entries posted as like elements to general ledger. * Cash flow statement, «Profit and loss statement. ' Balance sheet. ‘© Reconciliation of bank statement with awn books. Peity cash balance, All federal wxes deposited and withhoiding and sales taxes paid, * Accounts receivable aged to 30, 60 and 90 days. ‘+ Inventory worked to remove dead stock and order Every business needs controls. Ifyou do not control the ‘business, it will control you. Adequate record keeping provides infomation for preparation of the suaements that provide the control. ‘Thore are five control statements thal give a chear picture of your business: ‘+ Cash flow sheet—Shows the cash in compared to the cash out by subtracting disbursements from receipts. © Income statement—Shows total sales and receipts, cast of sales, gross margin, expenses and ‘et profi, all expressed in percentage of sales. Balance sheet—Shows assets, liabilities anu net ‘worth of the business. ** Break-even anaiysis~-Shows at what level of sales the business breaks even, Break even analysis is based on gross margin, * Deviation anafysis—Compares actual pecfocmance to projected performance. These are ibe early warning systems, the problem inicarors and the solution indicators I there isto be only 4 single statement available monthly, it should be the cash flow ststoment, because this will show haw well cash is ‘managed. Obviously, cash in must be greater than cash out Before you open the Geor of a new business, be certain a _good record-keeping sysiem is in place. If you do not understand the need fer this, it indicates you da net have ‘coough managerial know-how a run a business, If possible, do the record keeping yourself. I not, hire a part-time bookkecper, use # business service or public accountant. SCORE car help you set upa system, In any case, be sure—absolutely sure—that you understand what records are requived for your business, If system is designed by someone else, understand the system, TRS Publication 583 is he?pful forthe beginner. 4 US. Smal! Business AdministrationSuccessful business owners know that the greatest ‘opportunity for success and growth comes through quality of service and customer satisfaction, However, the service must be priced properly or there will be n0 profi. ‘Many small businesses do what they consider a good ‘volume of business, bat do not make any money, Why? ‘Because of improperly priced services or products. Some ‘make a profit on certain services, Jose money an athers ‘and do not know which is which. Remember, the right to establish price is yours—-100 percent yours. Types of Costs For the purposes of this section, costs are defined as 4 Fixed coste-—Costs that remain the same in any line period despite changes in business activity. ‘These incl et, irsurance, utilities, office supplies, salaries, dopeeciation, legal services, ‘accounting and propery taxes. Those expenses ace usually callod overhead. + Variable costr—Costs that usually vary in ‘proportion with business activity. These include ‘materials used in manufacturing, goods purchased for resale, labor and commissions. In service ‘business, labor may not be variable Calculating the Cost of a Service ‘A simpte, casy-toamderstand method of calculating the cost of a service is by basing the cost on billable hours. Because services must be provided by people, begin by determining the number of hours available for billang in a year, Then calculate the break-even point by dividing the ‘overhead and labor charges by the billable hours and adding the cost of any materials used. Your desired profit is then added to the break-even point. Two examples are shown below, Example t ‘Two people experienced at bookkeeping open a business together. They estimate their overicad expenses as shown in Table 2. ‘The 1wo entrepreneurs decide they cach want a salary of $25,000. In this case, the salary is actually an overhead ‘expense, but we will iret it separarsly because the principals decide they want :o make a profit of 20 percent ‘on their salaries but only a 10 percent profit on their ‘overhead. These expenses ate sel oul below in Table 3, — GER nacaieciaa SERVICES PROFITAB! ‘Table 2 - Estimated overhead expenses Expense Amount per year 59.600 Utilities 1.800 ‘Telephone 1,200 Office supplies 1.200 Insurance 500, Depreciation 2.500 Advertsing 2.000 Miscellaneous 4,500 Total 520400 Table 3— Estimated total revenues required Expense Amount per year ‘Owners salaries $350,000 Profit on salaries (20%) 10,000 Overhead . 20400 Profit on overhead (105%) 2.010 Total 582.440 ‘The number of working days per year is 260 (5? weeks x S days), Subtracting holidays, vacations and sick days, the actual number of work days tou 230, Two people ‘working 8 hours per day results in 3,680 heurs (230 x 2x 8 = 3,680). However, the bookkeepers estimate ‘20 percent of these hous (736) will not be spent working for clients, Therefore, the billable hours fe this company total 2.944. ‘To deiermine what rate to charge, the bookkeepers divide the desired revenue {$82,440} by the number of billable fhours (2,944), resulting in an hourly rate of $28.00, Profit isthen celcvlated by subtracting total overhead and salaries from the proposed revenue {$82,440 — $70,400 = $12,040). This isthe profit \o be realized, assuming the billable hours figure is realistic foe the first year of operation, Example 2 WA Repair Service employs ten repair technicians, who are paid $18,000 each, Social Security lax, unemployment tax, workers’ compensation insurance, health insurance and retirement benefits cost an additional 85.400 cach, for 2 total cost of $23,400. Because there are ten technicians, the yearly labor change is $234,000. US, Small Business Administraton 7DWA Repair Service's overhead expenses are listed in Table 4, Table 4 -DWA repair service's overhead expenses Expense Amount per year Sclaries (including owner) "$60,000 Payroll uxes and costs 3,700 Insurance 13,000 Uiilies 2,600 Reat 10,000 ‘Telephone 1,200 Depreciation 5.000 Miscellaneous 2,500) Total 358,000 ‘To break even, DWA Repair must have tal revenue of $234,000 (labor) plus $98,000 (overhead) = $332,000. ‘Alt of itmast come from te income ofthe repate sereice based onthe bout rate charged. ‘The owner of the business bas calculated the billable hours as fotiows: Work days per year = 52 weeks x 5 days = 260 days, Subtracting 15 vacation days, T sick days and 8 holidays leaves 230 work days. Work hours = 250 work days x 8 hours = 1,840 per year for cach repair technician. However, from experience, the owner knows thet he ‘cannot keep his erew working eight hours per day as there 4s Jost time between jobs. He deducts 10 percent of the hours as nonbillabte, leaving 1,840 - 184 = 1,656 billable hours per technician. Because there art 10 technicians, the toxal billable hours = 1,656 x 10 = 16,560 por year. ‘To determine the hourly labor cost, the owner divides the Tabor cost per year ($234,000) by the billable hours (16,560). The result is $14.13 per ous. To find wtal cost, overtiead must be added, Toul ‘overhead per year is $98,000, When divided by billable labor hours of 16,560, overhead equals $5.92 per ou, Thus, the total hourly cost of labor plus overhead is S14.13 + $5.92 = $2065, ‘The owner knows hat ifhe charges only the hourly rete based on actual cost, he will merely break even, Tn order tw make a profit so that e ean reduce debts, buy new ‘equipment, provide working capital and provide a return ‘on investment, dhe owner decides 10 a68 25 percent on his labor, and 30 percent on his overhead, as shorn in Table 5. Table 5 - Calculation of final hourly rate Labor cost per hour + S413 Profit on tabor (25%) 353 (Overtead onst per hour Overhead profit 30%} Toiat ‘The awner decides to charge $25.50 per hour, This hourly rate, muliiplied by the billable hours of 16,560, resulis in «an income of $422,280 00 per year. Thus, the income. ($422,280) minus the expenses ($332,000) equals profit of $90,289. Each year this calculation must be repeated to include any changes in labor of overhead, any materials are used in the repairs, they must be figured imto the cost per job. A profit percentage is also ‘added to the materials charge. ‘Remember, the charge for a service equals materials plus labor plus overhcac, with a profit built imto each component. aaa Ue Ear eg Ae {In setting prices, the objective is ta maximize profit, Profit has just three ingredients: cost, selling price and sales volume. In this section we are concerned with selling price, which has about the same elements for all lypes of businesses. For example, it manufacturing, the clements of the selling price are direct costs, ‘manufacturing overhead, nonmanufaccuring overhead and planned profit, In.a service business, the elements ere ‘matetials and supplies, labor and operating expenses, planned profit end corapettion, (See “Pricing Services Profiiably,” page 15.) In a retail business, the elements of rice are costs of goods sold, overhead, sales volume, planned profit and, often, competition 6 U.S, Small Business AdministstionTypes of Costs Jn the retail business, there are two types of costs: the cast of acquising the goods, called cost of goods, and the cost ‘of operating the business, called operating expenses, Cost of Goods (Vartable Cost) Cost of goods is known as a variable cost or expense ‘because it varies depending upon the amount of goods purchased for resale and the price of the goods. Cost of goods includes the price paid for goods, freight charges, impor dies, handling charges and any commissions. Operating Expenses (Fixed Cost} Operating expenses are a fixed cost because they usually do not vary with the volume of business, Operating expenses include wages, management salaries, rent, uiives, office supplies, insurance and any other costs ausibuted to the operation of the business, Planned Profit Planned profit is whatever the owner/manager calculates lhe business will generate, Usuaily, relum on ommer's investment, frits of labor, plans for expansion or selocation, retam to stockholders, demand for the product and competition are considered when calculating the amousi of planned profi. Competition 1 seting prices, small businesses stould consider prices ‘harged by competitors fer similar ar comparable items, A srcall business should not iry to compete pricewise ~ith lage stores, discount houses of supermarkets. type of competitor can charge less hecause of buying power, Pricing should be based on the quality oF type oF service offered, as customers will ey higher prices for ‘merchandise o obtain the services they want, Pricing Below Competition Beating the competitor's price is effective only if really increases sales, This strategy reduces the profit margin, Consequently, cast of goods and/or operating expenses must be reduced and inventory must be closely ccontrolicd; the product line must be limited to fast moving items, and services must be timited or eliminated, Pricing below competitors often backfires because every ‘cost component must be constantly monitored and «adjusted, Competitors can retaliate by matching the lower ‘prices, at which point both businesses lose. Pricing Above Competitors ‘This sirategy depends on whether non-price ‘considerations are imponant enough to customers 19 ustify higher prices. These considerations include specialized services (such as delivery, product knowledge, exclusive location, brand or designer names}, satisfaction in handling complains, in-home. demonstrations and 30 on, Markdowns A markdown isa reduction in the price of any item brought about by overbuying, overstoeking seasonal merchandise, misjudging customer response, poor personal selling or competition. This technique is used to avoid being left with dated merchandise shat will be dificult to sel. Tn setting a markdown price, the original cost of the merchandise should be recovered if tall possible. [fde selling price originally was high enough, a simall profit is possible Price Lining ‘This is a marketing strategy based strictly on price, A. specific portion of the Buying public is targeted by ‘carrying products in a specific price range. For example, ‘etal sxre carries an exclusive line of women’s ‘ndesgarments or an expensive designer perfume line, Price lining is only seccessful if there i litle or no competition. [1 works 0 the benefit ef the reaifer because it limits the merchandise line and makes inventory and baying casier, Its also easier for the customer to select ‘merchandise, 50 that fewer salespeople may he needed. Markup One technique of establishing price is to mark up goods sold by adding a percentage to the total cost of the goods, For example, a retailer purchases shoes at $25 per pair ‘and marks them up 60 percent for resale. Cast of shoes per pair = $25 Marup percentage Oe Markup amount per pair = $15 Selling price per pair = S40. ‘The 60 percem markup must caver all operating expenses, including the owner's salary and profit, ‘A given markup is satisfactory depending on the sales volume, When beginning a business, itis difficult to determine how much goods must be marked up because he new business has no history of sales on which ta base US. Small Business Administration ”