Making A Million Cupcakes Won’t Make A Profitable Small Business, But Understanding Your Costs Might

Cupcakes And Dollars

Have you ever gone to a store to buy something small and said, “I wonder what this costs to make?” I find myself doing that all of the time; it’s an entrepreneur’s curse, so I have heard. I especially do this when I go out to eat and consider a $25 steak, but know that I can do it at home for much less. As business owners, we need to understand the cost of our products in extreme detail to ensure that our pricing is right. In my career, however, the quickest way to get an owner to give excuses is to ask them how much their main product costs to make. ‘Well, it doesn’t matter because this is how much our customers will pay,’ ‘It’s not that easy to quantify because of all the different parts of it,’ ‘We are already making a profit overall, so it doesn’t matter.’ Typically, I just smile a nod when I get these excuses because that means the owner has spent years in denial as to what is important for their small business’s profitability. Here’s the deal, though: most profitable small businesses are not created out of luck; they are forged out of data and understanding of their own costs.

I walked into a bakery that had been open for twelve years and seemed to be doing really well for itself. The owner, unfortunately, worked six days a week, and the seventh was at home working on ‘owner’ stuff. They had a large following and seemed to be busy during their open hours while I was there, but the owner could not turn enough of a profit to hire mid-level leaders to help her run it. One of my first questions was what the main product is that they sell. It was a cupcake! The following question is always the same: What does that cupcake cost us to make? Hundreds, if not thousands, of cupcakes were sold in a day, and the owner just blinked at me after they gave me the list of excuses for why they didn’t know the cost.

This bakery sells multiple different products, just like any other business does. Some of our products sell much more frequently than others, and we typically use that to plan our materials out accordingly. That is a topic for another day, but I think we can all agree up to that point. Now, if our main product that we are selling is making us some profit, great; but if that same product that we are relying on is costing us money each time it goes out the door, how much do we need to overcompensate on our other products? As it turned out for this company, her main product was just breaking even, some of her secondary products were losing money, and the least advertised and pushed items were making the needed profit just for her to get by. How could we know all of this? Because we invested in understanding the costs of her products.

I am not going to fool you and say that it is a simple task that can be completed with a wave of a magic wand, but it is crucially needed for the success of your business. For this example, we needed to understand all of the ingredients that go into each product and the amounts needed for each product. If sugar costs us $9.89 for 23 cups, and our recipe calls for 2 cups, then we are spending .43 per cup and .86 in total for the batch. If the batch makes 24 cupcakes, then we spend .04 on each cupcake for our sugar content alone. I know you are thinking that .04 for each item doesn’t seem worthy of your time, but for this bakery, we found that her total ingredient cost ended up being around $1.10 for her main product. We have yet to understand the labor cost to produce it, the error rate of the product, or the overhead rate of fixed costs that we need to consider in the product as well. Knowing each of these rates is important to get the overall cost of the product. In this case, our product cost, before overhead, was $2.47, which was previously unknown. We were selling these for $2.50. This means that she could literally sell a million cupcakes and only have $30,000 left over for rent, equipment, utilities, and a fancy baker’s hat. The answer is yes, I bought myself a fancy baker’s hat while I was working with this client, and referred to everyone as Chef.

By looking into the details of the cost, we can understand if it is priced right and begin scrutinizing our costs. How often are we pricing out our vendors if we don’t even know how much it costs us? For the price and what would work for the market, we conduct a price elasticity check with our clients by raising the price and seeing if it would have a large effect on our sales. We were able to raise the price of the cupcake to $3.50, which increased our profit from .03 to $1.03 a cupcake. This was huge, especially when considering that we were also selling bulk cupcakes previously for $1.75 each because we ‘thought it was a good price’; turns out, we were losing $0.72 on each one we sold that way. Now that we understood our pricing structure and wouldn’t lose clients, we went after our costs to see which items were bringing the cost up the highest. We found that we could order some ingredients by the pallet, and we would still use them far before they expired. This brought our cost from $2.47 down to $1.96, which saved us $0.51 a cupcake.

Remember when I said making a million cupcakes would only leave us $30,000 left over? After understanding our costs and digging into them, if we sell a million cupcakes now, we would make $1,540,000 to pay our overhead. Investing time into knowing how much it costs to produce an item that you sell is a duty you have to your business, and the only way to make a profitable small business. Without being armed with this information, you could be trying to produce a million widgets, or gizmos, or fill-in-the-blanks, but never coming closer to making a profit. Go out and make your million…