How Much Money Do I Need? - Part 1
Excerpted from Chapter 7 of Profitable Woodworking: Turning Your Hobby into a Profession
By Martin Edic
"It takes money to make money."
We've all heard the saying, and in our capitalist society it is often true that you need capital to get a business up and running. In the woodworking world you have two choices. You can invest money in your business with the intention of getting a return in the form of profits. The money may come from savings, loans from family, bank loans or a number of sources. If you plan well, your start-up capital will be adequate to set up your business and keep it running until you begin receiving the cash flow that is the lifeblood of any business.
The other option is to start from scratch and use what resources you have to get things flowing. This approach, called bootstrapping because it involves pulling yourself up by you own bootstraps, is best for the part-time business. You can start a woodworking business in a corner of a basement or garage, with a few tools and your skills.
Money is a sensitive issue with new businesses. Many woodworkers I know are uncomfortable admitting that it is an important part of being a professional. The approach you take to the money that flows through your business will, to a great extent, determine how much enjoyment you get out of the business. Learn about it now, and you'll seldom have to worry about it later.
Investing in Your Future
Money never disappears unless it is stolen, and event hen, a savvy money manager has anticipated the possibility and used some form of insurance to protect the business. Money management and planning are essential for helping you increase the value of your money (your time and skill) and invest it wisely to receive a good return.
When you start your business you often have to make many investments that take time to show you a return. Tools, rent, insurance, office equipment and marketing are some of the possibilities. No matter how painful the investment may seem, if you work hard, it will pay you back many times over. You don't spend money to start a business, you invest money in your future. This attitude and approach is vital if you are going to succeed. Try to consider the long-term return on your investment when you put money into your woodworking company.
Capital expenditures are investments in the long-term success of your business. These include tools, real estate, product development, start-up marketing efforts and and other initial investment in a tangible lasting aspect of your business.
Overhead is the ongoing cost of doing business, including rent, utilities, supplies, insurance, regular marketing expenses like Yellow Pages ads, labor and professional services. Materials and inventory are the raw materials and finished products that you have on hand.
Each of these areas requires an investment, especially when you're starting a new business or making the leap from part-timer to full time. We're going to look at those investments that are considered start-up investments and those that are ongoing investments or overhead. Before we can get into that, we have to take a look at accounting.
Accounting and bookkeeping are skills you must learn to succeed. It is not necessary to become a numbers whiz or spend hours struggling through accounting classes (although taking classes can be an illuminating experience). There are several bookkeeping software programs available that will handle nearly any need you may have. Most of them are as simple as a checkbook and have the added advantage of producing professional-looking invoices and tracking them. If you don't have a computer you can get a simple one-write system at an office supply store and have your accountant show you how to set it up. An hour or two of simple bookkeeping per week will keep most woodworking businesses running.
In case you are wondering, there are several compelling reasons for getting your act together moneywise from the beginning. It helps you keep Uncle Sam happy while making sure that you are taking full advantage of the many tax benefits that owning a business can offer. You definitely need an accountant for this, particularly one who is experienced in working with small businesses. The equipment, supplies, utility bills and labor charges you pay are deductible at different rates and over various lengths of time. You'll want to be able to take full advantage of this.
Another important feature of accounting is its role as an information system. This is especially true when you use a software product to track the flow of money through your business. Your computer can instantly generate profit-and-loss statements, expense statements for specific projects or products and many other useful reports. This capability becomes handy when bidding a job that is similar to one you've done in the past or when pricing a new product. Your profit-and-loss statement also tells you whether you made money on a project and may help you spot areas where you can do better.
Learn enough about accounting to get a system working for you. Small-Time Operator by Bernard Kamaroff (see Resources on p. 150) is an excellent start-up guide for those of you who can't handle the numbers.
A Start-Up Budget Worksheet
If you live lavishly or are heavily in debt, it may not be advisable to leave an income-producing job and start a business. Start paring down your bills and paying off your debts. It's good practice for running a business to eliminate unnecessary luxuries and expenses at home before you are dependent on the sometimes uneven income experienced by an entrepreneur. Paying off your credit cards also gives you a fallback source of revolving credit for your business in the future.
Deposits - You'll be putting up money for security deposits on your rent, utilities and phone. This, unfortunately, is money you probably won't see again for the life of your business, unless you can negotiate its return in the future, after you have proven your trustworthiness. Since this initial outlay can amount to several thousand dollars, I recommend negotiating the best possible deal to reduce these deposits before you sign any agreements.
Capital investments and improvements - Any building, renovating, rewiring, painting, etc., that you must do to get your doors open is considered a capital improvement. Remember when budgeting for these things that commercial requirements are different from residential ones. You will likely be required by law to have licensed contractors do the work or at least inspect it, particularly when it comes to electrical, pluming and HVAC (heating, ventilation and air conditioning). You may also be looking at installing dust removal and air ventilation systems for finishing, explosion-proof fans, safe storage areas for chemicals and many other required expenses. Plan ahead and budget for them after you talk to local building-code officials about what is needed.
Tools - When you're starting out, go slowly with tool purchases until you know what you'll need, especially when it comes to major expenditures on big power tools. Get the basics, and buy the exotic tools as you need them or when they will obviously make a worthwhile contribution to your operation. Don't underestimate the cost of hand tools and hand power tools. When my brother and I did an inventory of his shop prior to a move, we were surprised to find that his hand tools added up to a greater investment than his large stationary power tools.
Your accountant will be writing off your tools, over time. You may not, in many cases, write off a big tool all at once. The tax law says that such a tool has a useable life span of three to five years, and you may only write off a percentage of its value each year. Check with your accountant if you are planning on tax write-offs to help pay your tool expenses (as you should be).
Starting inventory - Materials such as wood, finishes, glue and sandpaper; equipment such as saw blades, drill and router bits; office supplies and any other purchases that you consume are significant start-up expenses because you may be financing your starting inventories of these items. It is amazing what a seemingly insignificant item such as sandpaper can cost over a year of full-time woodworking. Once you get rolling these things become part of your overhead and production costs. Now, at the start, you must take them into consideration when budgeting.
Marketing costs - Start-up is the time to plan your marketing and provide an adequate budget for it. It is easy to become involved in shop remodeling and tool purchases and not leave any cash for promoting yourself. In my opinion, it is far more important to put aside more money and time for marketing than for tool purchases. Once customers start giving you deposits for projects or start ordering bookcases, you can buy the tools you need. There is nothing more depressing than sitting in a beautiful, well-equipped shop with nothing to do while the bills keep piling up.
To budget your marketing costs you need a simple plan for your first year's marketing. That plan probably calls for some kind of informational brochure or sell sheet and methods for getting it out to likely customers. Putting together such a marketing piece is one of the significant investments you must make when starting your business. By getting it done in the beginning, you'll have a valuable tool you can use to generate business for your shop. Other necessary marketing tools are business cards, letterhead and envelopes with your company name and logo on them. In Chapters 8 and 9 we'll go into your marketing plan and budget in detail.
Insurance - There are several kinds of insurance you'll need from the beginning. Theft, fire and disaster insurance protects your investment in your business, health insurance protects you from medical bills and disability insurance covers the loss of income-earning ability should you get injured. Some clients may expect some kind of bond or project-completion insurance. You'll also need liability insurance to protect yourself from injury lawsuits arising from accidents involving your work or shop. Proof of adequate liability insurance may be required when submitting competitive bids. Having liability insurance may help you win a bid over one from an uninsured competitor. An insurance broker with small-business experience can guide you through the options. Use a well-known company.
One final tip about insurance. Get a high deductible to save on premiums. It may be cheaper to pay out-of-pocket for small (under $1,000) losses than to pay the higher rates that low deductibles mean. If you can't afford the cost of full health insurance, there is a tactic that can protect you from major medical bills that could mean the loss of your business: There are health-insurance policies with very large deductibles ($5,000 for instance). They are much cheaper and, in essence, mean you pay all your noncatastrophic medical expenses out-of-pocket while keeping protection for major medical bills. Having this minimum insurance is far better than going without health insurance.
Education - Both woodworking and running a small business are highly skilled activities. You may want to invest in training through taking college courses or seminars, reading and going to conferences and trade shows. This start-up investment can mean long-term savings of thousands of dollars. Try to budget money for subscriptions to trade magazines, new books and other educational materials that can increase your business and craft skills. Join local business and trade associations and be an active member. The small dues payments can mean a lot of work over the years as you make connections and build a reputation.
The amount of money required for starting up can be daunting; however, you are investing in your future and the American dream of succeeding on your own. This investment may determine your earning ability and quality of life for many years. Doing it right at the beginning can mean being profitable early in your business life and remaining so. Undercapitalization is a primary reason for the many failures of new small businesses.
An Operating Budget Worksheet (Overhead)
If you understand what your overhead is, you can derive a figure for your "shop rate," which is an hourly figure you can use when doing estimates and bids. Your shop rate is your hourly overhead plus a percentage for profit. It's useful for quoting your minimum rate when people ask you to do small jobs. It also helps when you are pricing product lines or things you are making in quantity. And if you get really busy and the market justifies it, you can raise your shop rate, increasing your profits.
Shop rate is important because many inexperienced woodworkers undercharge because they don't understand the relationship between overhead and profit. It is very likely that the woodworker who charges $15 an hour for a project is losing money or at best breaking even. This is because when you are in business for yourself you can't think in terms of what you would settle for as a salary. Your actual take-home pay is only a part of what you must charge if you want to succeed.
The following example will walk you through the process of establishing a shop rate. I've kept it as simple as possible but you'll have to adapt it to your situation. Different skill levels, geographic areas and other considerations will have a significant impact on your shop rate. For these reasons, you should work out your own shop rate rather than relying on some kind of average figure. Start with monthly bills (see the chart below).
Establishing a Shop Rate
This shop rate is the basis for estimating your work. You'll notice that materials are not included. They must be estimated separately because they vary greatly from project to project or are based on the quantity of a product you are making. Always remember to add on a markup or profit to any materials you sell a buyer, including hardware and outsourced components. This markup covers your time and effort in procuring the materials.
Excerpted with permission from Profitable Woodworking Copyright 1996 By the Taunton Press Inc. - All rights reserved. For information on ordering a copy of this book, call 1-800-888-8286.
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