Operating Costs and Business Models
Creating a business model with accurate operating costs considered is one part of earning maximum points in the financial plans line of the judging rubric. It can also help with "Future Goals".
In this lesson, you will…
- Figure out how much money it will cost to run your business
- Create your business model
- Estimate how much profit you’ll earn over 5 years
- Continue working on your business model worksheet
The business model that you’ll develop in this lesson will be necessary for the Senior division to complete their 5-10 page business plan.
In this lesson, you’ll create a business model, which is something that explains how you plan to make money and keep your business open. This is a critical part of your business plan, because it is what will convince judges that your business is possible and that it can succeed into the future.
You already started your business model in the last lesson, when you figured out how much revenue your product will earn. In this lesson, you’ll calculate your operating cost which is the amount of money you need to spend to run your business. You’ll need to think about the costs of the different activities, resources, equipment, marketing efforts and materials that are needed to keep your business running.
Here are the main parts of a business model:
- Starting capital (seed money): initial money that helps you start your business
- Revenue: money you earn from selling your goods and/or services
- Operating costs: things you need to pay for to keep your business open
- Profit: the money you have left after paying for your operating costs. This “extra money” is yours to keep or reinvest (i.e. hire people, expand your workspace, etc.) back in your business so that you can make it bigger or better
You already calculated your revenue in the last lesson, now it’s time to focus on the operating costs so that you can calculate your profit using this equation.
[Revenue] - [Operating Costs] = [Profit]
Let’s start by thinking about how much money it is going to cost to run your business. The things you need to pay to keep your business running are called operating costs. Here are some examples of operating costs:
- Office spaces, computers, internet access
- Payment for workers
- App or online store fees
- Marketing and advertising (think back to the marketing strategy you chose in Entrepreneurship 6)
When you calculate your profit, you will write down your estimated operating costs for the entire year. For example, let’s say you have two people working at your company, and you pay them $10/hour. Each week they work for 20 hours, and they work 50 weeks out of the year.
Year 1: 2 people x $10 per hour x 20 hours per week x 50 weeks per year = $20,000 per year
However, after 1 year, you want to hire a new person to help you add new features to your app. For year 2, your calculation will look like this:
Year 2: 3 people x $10 per hour x 20 hours per week x 50 weeks per year = $30,000 per year
For the activity, you’ll fill out the worksheet so that you can add up how much it will cost to run your business each year. Keep in mind that you might not need all the items listed and that you can also try to cut some costs; for example, your office space might be a place that is free for you to use.
The last piece of your business model is calculating profit for each year. Profit is the money you have after paying all of the bills you need to pay. Your profit is what you have after you subtract your operating costs from your revenue. It’s the money you have earned and get to keep. Profit Projection is how much profit you think your business will earn over many years. As a reminder, here’s the equation:
[Revenue] - [Operating Costs] = [Profit]
In the last lesson, you already calculated how much revenue you will earn with your product each year. In these three activities, you’ll calculate your profit by calculating your operating costs and subtracting them from your revenue.
Activity: Identify and Calculate Your Operating Costs
Identify and calculate the operating costs of building your product and running your business.
Here are some categories that most operating costs will fall into. You might need to do research to figure out how much different items cost!
- Equipment - This includes things like computers, desks and chairs.
- Ask yourself: : What items do you need in a space for staff to do work? Do they need computer hardware?
- Software - programs that help you design the product, manage data, or do other things your team can’t do on your own
- Ask yourself: Do you have to pay for use of different databases or other services to run your project?
- Utilities - any rent you need to pay, internet costs, phone bills
- Ask yourself: : How much does internet cost where you live? How much is rent for an office?
- App or online store fees - This will include putting your app in the Google Play or Apple App Store.
- Ask yourself: : How much does it cost to put your app in the Google Play or Apple App Store or selling your invention using an online shop?
- Marketing - Advertising in newspapers, printing fliers, using social media, etc.
- Employee salaries - This includes how many staff you will have and how you plan to pay them
- Ask yourself: : How much do you want to pay staff?
Your operating costs are likely to go up over time. Remember your revenue model from the last entrepreneurship lesson? If you decided to build a new feature or advertise your product more to make more revenue, your operating costs might also go up for doing this! Revisit the explanation for your revenue model and look for things that might also make your operating costs go up.
For instance, if you decided to build more features, you might need to also hire more people to build them. Also, if you decide to advertise your product more, you need to spend more money on marketing.
Activity: Calculate your Projections
Now it’s time to put together your revenue model and operating cost to project your profits. For each year on the worksheet, use this equation to calculate profit.
[Revenue] - [Operating Costs] = [Profit]
It’s okay if you have a negative profit in the first 2 to 3 years that you are in business. However, over time you want to make sure your profit goes up. If you are still in the negative by year 3, you need to revisit your revenue model or your operating costs. Maybe you are not quickly getting enough people to use your product, or maybe your operating costs are too high.
Tip: If you want to include starting capital in your business model, please read the additional resources first before calculating your profit projection.
Your business model is a very important part of your business. It is how you will convince judges and investors that your product is a good idea and is worth investing in. If you are in the senior division you can explain your business model in your 5-10 page business plan and in other elements of your work to ensure a strong submission. Think about what will you highlight in your submission.
When it comes to entrepreneurship, there are a lot of complicated things to think about, and sometimes you don't even know the answer. Sometimes it takes educated guessing to get it right. Here are a few questions to consider after you’ve accomplished your business model:
- What needs to happen so your business is successful?
- How much money is required to get your business started and generating revenue?
- Did you think about more features to add to your product for your profit projection?
- Why did you choose the revenue model you did?
- How do you expect your business to grow?
Tip: Be sure to include this information in your submission - it’ll help judges understand your plan for success! In the next lesson, you’ll develop your business plan, where the business model will be a key part.
Additional Resources: Starting Capital and Business Models for Nonprofits
When you’re first starting out your business, you might need some money to get started. This is known as starting capital. You might need to buy computers, hire people to help build your product, or rent an office space. All of this costs money, and you aren’t making money from your business yet. So how do you get this money?
Many businesses get this money by asking people to loan it to them. These people are known as investors. Once you get your business started, investors expect to either get their money back plus more, or receive something else in exchange. Here are a couple of different ways to get people to invest in, or put their money into your business.
- Crowdfunding - a large group (crowd) of people each give small amounts of money that add up to a larger amount. This allows regular people to directly invest in your business, but it’s not recommended for long term funding. These people usually get something in exchange, like 10 free downloads of your app. This can be especially effective if you have a large social media base to tap into.
- Investors - wealthy individuals who invest their own money early on in the business, but expect equity in exchange. Equity is like partial ownership, based on how much money they put into the company.
- Venture capital - a group of professional investors (also known as a firm) who understand investing opportunities and risks in startup businesses. They do a lot of research to try to invest in startups that they think will become successful in the marketplace. The money they invest comes from a variety of sources.
All types of investors accept a certain amount of risk with the hope of some reward over a certain period of time. This is the reason for their investment in the first place. They want to put in some money so that their money can grow through your business, but there is a possible outcome that they won’t get that money back. When you are developing your business plan, think about how you might use investors to build your plan, or if you'd want to use any crowdfunding resources to get your business off the ground.
Starting Capital Example
Let’s think about a street food vendor business as an example. If you wanted to start your own street food vendor business, you would need funding to get started. You could ask your parents to be investors in your business. When you ask your parents for the money, your parents will want to know:
- How much money do you need?
- What you are buying with the money they are giving you?
- How much will they get back and when (return on investment/ROI)?
When you talk to investors, you will need to be prepared to answer some important questions. At the very least, they will want to know how much money you would need, understand how you will put that money to use, and what they will get back. This is where your business model will be important. Your business model should be able to answer their questions and more.
Let’s get started on your revenue model to start answering some of these questions!
Including Starting Capital in your business model
Typically if you receive starting capita, it will be a large sum of money, all received during year one. You will then use this equation during that year to calculate your profit.
[Starting Capital] + [Revenue] - [Operating Costs] = [Profit]
Business Model for Nonprofits
If nonprofits shouldn’t make any profit, how do you design your business model? This is a very good question. Nonprofits still need to have a business model, but it will be a little different.
Nonprofits can still have revenue streams, and they may get a lot of their money from grants. But they can’t keep any of the left over money. Typically they will need to use this money to make their business better or to do more social good. They can pay their own workers more, or try to provide more of their services to the community, but their owners should not be pocketing the money for their own purposes.
Technovation is a nonprofit! If we have left over money from grants or from our revenue streams, we reinvest that money back in the community. We might put money into opening a new Technovation chapter, or hiring a new curriculum writer to improve the curriculum for our students.
If your business has the potential to make a lot of money, but you still want to have a social mission, try making your business a social enterprise instead.