So many clients ask me about leases and the pros and cons of signing a commercial lease.
Of course it applies to pretty much any cost/ expense in the business – what does it take to pay for it?
There’s a lot of talk about “greedy landlords” and maybe it’s true.
Rent certainly is a huge part of the overall expense in a business renting a physical space.
Before signing up to rent a physical space & the ongoing financial commitment involved it’s important to understand how rent will impact your business.
What does this mean?
Let’s say you make cup cakes. You sell them at the Local Food Markets where you pay $150 for a market stall each Saturday.
An extremely important piece of data in your cup cake business is to know how much it costs to make each cup cake. I’m suprised when clients come to me and have never calculated this figure.
Let’s say you calculate that when you make 300 cupcakes it costs about $1.25 to make each cupcake. That’s all the ingredients plus the topping and the sprinkles, packaging etc.
You sell them for $3.50. It’s looking like $2.25 profit on each cup cake. Easy to think “Looking good!”
Let’s say it takes all day to make the cupcakes for the market. Your time for the day – what’s that worth? Let’s say if you were to hire a baker to make the cupcakes. The basic wage for a baker in Australia is about $27.78 per hour* so for a whole 8 hour day to make the cupcakes is about $222.20
Dived this $222.20 by the 300 cupcakes = $0.75 per cupcake. This would eat into the profits. Of course you don’t hire some one else to do it because you love making cup cakes and this is the reason for starting the cupcake business in the first place…
You’ll pay yourself with the money that’s left over on the day. When I work with clients I do encourage them to factor in a payday for themselves as part of the cost as this gives a much more accurate picture of reality.
You pay the market stall fee of $150 and it’s a great day because all the cupcakes have sold.
Let’s do a quick Profit and Loss report here (P&L)
Sales Revenue 300 x $3.50 = $1 050.00
Direct costs for market day:
Cost of ingredients 300 x $1.25 = $375.00
Market fee $150.00
Cost to sell cupcakes $525.00
Gross profit on the day = 1050 – 525 = $525.00
You’re pretty happy because this feels like your pay for the day, and in a way it is. You have 2 or 3 market stalls across your city depending on which week it is and it feels like a good business. You meet people, you take special orders for birthdays, christenings and you get paid to do what you love.
For many people this business model works really well. They have regular clients, customers – cupcakes, breads, tea, and a variety of other specialty items.
They make their wares, take them to the market and at the end of the day there is money left over “pay day”
Then one day some one says “You could have a shop” and then you find yourself thinking how much fun to have your own shop…. your customers say “You could have a shop”
And this is where it gets dangerous…
Let’s say rent is $1500 per week. This may seem like a lot of money for rent there are some paying more and some paying less.
It is super important to get into the numbers to establish whether taking the leap from selling at the markets to having a store front is viable.
The markets are temporary. You pay your $150 when you are there. With rent you’ll pay your $1500 whether you are open or not. What happens during school holidays? summer? winter? Christmas?
Another calculation that is extremely helpful is take that rent x 52 for each week of the whole year and x 3 for the 3 years commitment = $1500 x 52 x 3 = $234 000.00 This is almost quarter of a million dollars. This doesn’t allow for the built in rent increase in almost every lease agreement. And you may end up with a 5 year or even 10 year lease.
That is a lot of cup cakes!
It’s so much more complex than this. We haven’t allowed for general business expenses: paying accountant, marketing, insurance costs and so much more.
Thinking to yourself: “I’m not a numbers person”?
Let’s continue … and do one more basic calculation:
Cost of baking cupcake = $1.25
Cost of baker per cupcake = $0.75
Total cost to make cupcake = $2.00
Sell each cupcake for $3.50
Contribution margin for each cupcake sold = $1.50 Contribution Margin (CM) is the amount each cupcake “contributes” to paying off the expenses. The amount “left over” once the cost of producing the cupcake is paid.
To cover just the rent at $1500.00 = $1 500 divided by $1.50 CM = need to sell 1 000 cupcakes every week – just to pay the rent. Then there are all the other expenses as well as paying yourself and your superannuation.
1000 cupcakes a week and the shop is open 5 days = at least 200 cupcakes per day – just to cover the rent costs! What about wages? electricity? internet? marketing? and so much more?
The calculation is still looking viable and this is precisely why people sign up for lease and then find themselves in trouble. There are numerous reasons that the transition from the market stall to the shop front is challenging.
The shop front is different to the markets. Unless the shop is high foot traffic or a real “destination” there can be long periods of time with no customers.
There are also terrific examples of where a business has made successful transition from market stall to a bigger business model.
Every business is slightly different.
These are the calculations we do as we make informed decisions in business. If you’re wondering about some of the financial decisions in your business, I’m here to help. I do calculations like this with clients every day. Your accountant can help, your bookkeeper.
If you are thinking about getting into a lease it’s time to crunch some numbers. Get out the calculator, pull out all your receipts and bank statements, load up Excel on your computer and start calculating.
Thinking to yourself: “I’m not a numbers person”?
I’m here to help you.