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To be able to estimate whether 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 the product costs you to purchase, produce, or import.
The difference between the two amounts you come up with shows how much money you have got left to pay your rent, telephone, internet access, marketing and your own pay.
Example of a Estimate of Costs
If you sell CDs at Dkr. 140.- on the internet and promote it like this: “no postage & packaging”, your calculation could look like this:
| Sales price, excl. VAT:: | 112,00 Dkr. (incl. VAT 140) | | - Purchase price at record label: | - 88.00 Dkr. | | - Packaging and padded envelope: | 1.25 Dkr. | | - Postage: | -9.75 Dkr. | | = Contribution margin: | 13.00 Dkr. (11,6%) |
This calculation shows you that each time you sell a CD at 140 Dkr. you have 13 Dkr. left 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.
Contribution ratio
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:
13 Dkr. x 100 / 112 Dkr. = 11.6
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 management and development presentation which pays you 6,000 Dkr. per presentation – here you may only have 100 Dkr. of direct expenses for the cab taking you to the hotel where the presentation is held. This generates a 5,900 Dkr. contribution margin. (98%).
But then you probably have considerable fixed costs and cannot expect to sell presentations 37 hours a week.
The same thing apply to e.g. accountants, lawyers, and psychologists.
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