More than anything else, the feasibility of a business is determined by its ability to make a profit. As obvious as that sounds, it’s easy to overlook in the fever pitch of startup excitement. A quick and dirty way to figure out if an idea pencils financially is to examine three figures – sales price, gross margin, and overhead.
Gross margin is the sales price less cost of goods sold, or how much it cost you to make the sale. The overhead expense is the sum of monthly fixed costs incurred regardless of sales activity. For example, suppose you sell pocket protectors for $5 each, and that your cost for each is $0.50. Also suppose your monthly overhead—salaries, office space, utilities, and marketing—is $9,000 per month. Your gross margin is $5.00 minus $0.50, or $4.50 per sale. Dividing the monthly overhead by the gross margin gives you the volume required each month to break even. In our example, you would need to sell more than 2,000 pocket protectors each month to make a profit. Time for a quick sanity check – what’s your plan to generate 2,000 sales each month? Is this realistic? Are you so sure that you’re willing to bet your future on it?