Step 3 for Starting a Small Business

Step 3 for Starting a Small Business: Verify Your Profits

Customers and competitive knowledge aren't enough for small business success, unfortunately. You also need to verify through some careful calculations that your business really, truly works on a dollars-and-sense level.

The bottom-line, in other words, is the bottom-line number on a profit and loss statement: You need to make sure the business produces enough profit to pay the business owner a fair wage and a return on the money he or she invests.

This profit verification step typically requires two substeps:

At a transaction-level, you need to verify you sell the items for an amount that generates a healthy margin. For example--and it really is just this simple--you need to verify that a cup of coffee that you sell for $3 costs you way less than $3 to brew. Or, if you're providing some personal service (tax return preparation, catering, house-painting, or anything else) you need to verify that the thing you sell for $20 costs you way less than $20 to provide, that the thing you sell for $200 or $1000 costs way less than $200 or $1000 to provide.

As a general rule--and curiously the rule applies to all sorts of businesses--you want to have at least a 50% margin on the items you sell. In other words, if something costs you $1, you need to sell it for at least $2. If something costs you $100, you need to sell it for at least $200.

Even after you verify your basic transactions are profitable, you need to verify that you'll be able to "do enough volume" to make the venture work.

Again, perhaps surprisingly, this is very straight-forward. Let's say, to keep things simple, that you're selling $2 cups of coffee that cost you $1 to brew. You therefore make $1 in profit for each cup you sell.

What you need, therefore, is to sell enough cups of coffee over the month to pay yourself a fair wage and to pay any fixed costs of operating your business. Suppose that based on the hours you'll work, you deserve $2000 a month. Further suppose that your fixed costs (perhaps lease payments on a coffee cart) cost $2000 a month.

Remember in this example that you make $1 a cup of coffee. This means that on a monthly basis you need to sell 2000 cups of coffee to pay your salary and you need to sell another 2000 cups to pay the coffee cart lease payment.

To be in this business, therefore, you want to feel pretty darn confident that you'll sell 4000 cups of coffee a month. If you can't sell that many cups, your business won't work. Sorry.