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Accounting Solver

ENTREPRENEURS! LAUNCHING FROM A HOME BUSINESS TO A SELF-OWNED OUTSIDE BUSINESS

by ren on December 6th, 2007

Our apprentice-like challenge is into its 5th week and the b5media ACES have completed their response to the fifth, latest challenge. The advice should serve any entrepreneur thinking of upgrading a Home Business to a Self-Owned Outside Business. Let us know what you think.

Kay’s business is doing great. However, her family is growing weary of pushing aside aprons and hats from the dining room table in order to eat. It is clear that Kay needs more room for her business.

A small building has become available down the street from her home for sale. It is a reasonable price and would allow her to have some room for growth. However, she’s concerned about the best way to finance a purchase and whether it’s a good investment. Is now too soon to buy?

Additional space is available in a warehouse further down the street to rent. It is more expensive on a per month basis than a purchase but the lease would only last 3 years. This means fewer payments but also less permanency.

Kay needs to get out of her house. Should she buy or rent? What are the advantages and drawbacks of each? What are the most important considerations?

The holiday season is not the right time to stop production and move premises so dramatically. Considering the current real estate market, that building down the street should still be available after the holidays. Before buying or renting a new place you need to consult your family. This is a decision to make as a family, since it affects everyone. And it is a decision that should be made after the holiday rush – after you have developed a solid business plan that includes expansion.

If you are truly concerned that you will lose an opportunity, it is possible to hold open on escrow for 60 – or even 75 – days until you decide for sure. But be wary: You may have to put up earnest money and are likely to lose it if you don’t move forward on the purchase.

It is unlikely that your family can’t handle the in-house production for three and half more weeks, if they really can’t then it’s unlikely that you’ll have the support necessary to create a going business and may need to consider keeping it as a lucrative hobby. It would be best to concentrate on filling orders now, and worry about the rest later, after you’ve talked to your family (especially your husband) and made a business plan.

After the holidays, and before you decide on expansion, move your “workshop” to your garage. You can buy plastic tables at a low cost to do work at and bring in a space heater.

Instant expansion is not only unnecessary, it can be a business-killer without a comprehensive business plan outlining when expansion, through buying or renting outside premises, would make sense. And if you decide not to expand right now, but the building down the street is a good investment you can buy it as a family, and rent it out to someone else.

But before you commit to buying, there are some things to take into consideration:

  1. Is moving premises so soon a good idea to begin with? Check into zoning regulations to find out if you can stay put for now. The garage, or even a backyard shed, would be good choices. You need to see how your business does after the holidays, and after you’ve made your business plan. If you plan to expand, you will likely need new premises in the future, but now might not be the time.
  2. Is the building down the street a good investment? Another thing to look at is whether the building down the street is a good investment, without the business being in the picture. Investment and building equity are two different things. If the building is a good investment, it might be worth buying, regardless of your business concerns.
  3. Can your personal financial situation support a purchase? This is a very important question. A bank is not going to give a loan to a business that is so new, and that has not been bringing in regular profits for an extended period of time. Therefore, any “buy” decision is going to have to be based upon your family finances. If it is a good investment, and you can buy, you can rent the building for your business from the family. If things go well enough, it is possible down the road to buy the building for your business from the family.


Moving premises: Should you even change location?

Here’s where it gets especially time consuming and sticky — and why you should tackle this question after the holidays, when things slow down a bit. The BUY decision is an investment, an infusion of additional capital into family finances/the business. The RENT decision is an additional expense, but would also require additional capital since you are currently producing your aprons and hats rent free.

The rent v. buy decision involves a lot of careful thought, including a possible expansion of the products you offer. If you are going to move out of your home, you have to be prepared to take this from a home business to a self-owned outside business.

The underlying decision and the basic question with regard to both options (RENT or BUY) confronting you is this: Do you want to grow the business and put up the additional capital (whether borrowed or from your own or your household’s finances, whether to RENT or BUY)?

  • Determine whether there is enough of a potential (in terms of aprons, hats and other products catering to the same market) to justify an expansion.
  • Determine whether you have the creative and productive capacity to generate additional products (expansion would mean going beyond aprons and hats).

A negative answer on either of the above points means a NO to expansion of the business. You should move your business to a convenient available space where it will not interfere with your family.

An affirmative answer to both points means a YES to expansion of the business.

IF you plan to expand, and IF you are in a position to put up capital for new business space, you need to make your decision on whether to buy or to rent.

Buy v. rent: An accounting decision

The effect of either a RENT or BUY decision is to increase your Cost of Goods Sold. Presently, your Cost of Goods Sold does not include the Occupancy Costs of the business. You probably do not include the cost of your time spent (although you are paying a part-time employee to help). Right now, Cost of Goods Sold includes the following:

  • $7 for hats (sell for $15 for a profit of $8)
  • $10 for aprons (sell for $17 for a profit of $7)
  • If you sell all four of the hats and apron sets you can make in hour, the total is $112 (but you have to deduct cost of materials and labor)
  • Global profit is affected by paying $8 an hour for a part-time employee and selling in sets for $28 (reducing basic profit to $11)
  • Calculation: If you make four hats and four aprons an hour (assuming all are sold in sets), you make $44 an hour on materials. When you pay the employee, your global profit (what you have left after paying for materials and employees) drops to $36 an hour.
  • Calculation: Your cost per hour right now is $28 (cost of four hats) + $40 (four aprons) + $8 (one employee) + $76

At this point, what you need to find out is this: If the costs attendant to a RENT or BUY decision are added to your Cost of Goods Sold, will you still be making enough of a spread to make the business worth your while?

In addition to the RENT, there would be one-time costs of moving expenses, some furniture and fixtures, some improvement of the premises. There would be recurring costs of light and water, telephone service, repairs/maintenance and insurance. There are interest costs if the additional capital is borrowed. If you use your own funds, you should plug in (as an Opportunity Cost) what you are currently earning on your funds.

For the BUY option, the attendant costs (one-time and recurring) would be the same as for the RENT option. Depreciation would be added to these costs since you would (eventually) own the building.

Before you make a final decision on whether to grow the business (RENT or BUY), undertake the following analysis:

  1. Above we noted that you spend $76 per hour for materials and one employee. You need to add other costs that you may not have thought about to this number. Your own labor should be counted in an hourly wage at least equal to your employee (”pay” yourself $8 an hour). Also, value needs to be given to family members that are helping for “free” right now. Consider the amount of rent it would be to use the garage from now on (% space of the total house area used in the business multiplied by the depreciation if you own the house, or by the rent if you don’t own the house). Realize that if all of the aprons and hats are sold as sets, that amounts to “making” $112 per hour. You will need to subtract the final cost from that number.
  2. Determine the warehouse RENT and all related costs to setting up the business in the warehouse except for the cost items that would also apply to setting up in a building you would buy.
  3. Determine the amortization payments for the building you would BUY and all related costs to setting up the business in the building except for the cost items that would also apply to setting up in the warehouse that you would rent.
  4. Determine how many additional aprons/hats you have to produce/sell to pay for each option (RENT or BUY).
  5. Decide which option delivers more money (i.e., net per unit) for less production effort (your time, your family’s/employees’ time, additional burden on finances for the additional raw materials, etc).
  6. Decide whether the additional burden is worth the expansion of the business (it is an expansion whether you RENT or BUY).Consider the result of your analysis from item 4 above (how many additional hats & aprons to cover RENT or BUY) in the light of your initial gut feeling for the potential of the business. If the number of additional hats and aprons is a small percentage of your gauge of the potential for the business, then you have a solid indicator for expansion. If the number is a huge percentage, it would be foolhardy to expand, and you should neither buy nor rent.

This accounting decision is based on your answer to this question: Do you want to expand your business? If the answer is yes, you need to be prepared to make the production changes necessary, and even consider raising the price of your product (perhaps start charging $18 for hats and $22 for aprons — $35 for a set) and/or expanding your product offerings.

Thanks to the b5 Media Business Channel bloggers behind this post: Accounting Solver, Biz Chicks Rule, Brandcurve, Common Sense PR, Copyblogger, Doing Biz Abroad, Greener Assets, Interview Chatter, Leadership Turn, Linked Intelligence, Project Management 411, Second Life Pros, Small Business Boomers, Successful Blog, The Golden Pencil, Yielding Wealth

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POSTED IN: Accounting for NonAccountants, Best Business Practices, Cost of Goods Sold, Personal / Household Finance, Small Business Finance

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