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The Economics of Small, Farm Products - Farm Flows

I haven't written one of those boring Farm Flows posts in a while, so I thought I better get back on it.

Actually, we've received a bunch of questions about the economics of soapmaking and whether it can sustain a small farm, such as ours. We love that so many people email us questions about leaving the rat-race and starting a small business. It's inspring, and I hope that some of what we share on our site will help them achieve their dreams. 

However, we don't know whether what we're doing will work. We're not yet paying the bills with farm income. What we do know is what it would take for items such as soap, lip salves, etc to provide a meaningful income for us. And that's what I think people really want to know. Can I move to the middle of nowhere and make soap (or other small, farm products) and live a happy life? The answer is my least favorite of all answers: it depends.

Our soaps and lip salves on display at OMG in Nashville

I am not going to give you all of our numbers because I want you to figure it out for yourself. Don't rely on other people's numbers. They aren't your own.

My goal in this article is to help walk you through the process that I use when I'm trying to answer this question for ourselves. At Little Seed our goal is NOT to create a giant business. We want to make an income sufficient to cover our bills and save a little for the future. We DO NOT want to sit in an office and manage employees. We want to be farmers. You should read this article with that standpoint in mind. 

Step One: Create a Monthly Budget

Understand your underlying living expenses. If you want to support yourself this is the critical question. How much do you need to make? I've said this before, but I really think this is the most important step. How much does it cost you to live the life you want to live? Seriously. Is it $30k per year, $80k per year, more, less? I've found that most people don't know the answer. If you want to find out whether you can live off the sales of your small products you'll need to figure this out.

So where to start? The best way is to pull out a pen and paper and start writing down all of your monthly expenses. ALL of them. Mortgage/rent, cell phone bill, internet bill, cable bill, groceries, beer/wine/liquor, eating out, gas expense, insurance, home repair and maintenance, car repair and maintenance, and so on. Create a simple monthly budget. I like monthly budgets because most of my bills are monthly so it makes it easy. If you don't know what you're spending start tracking it (or look at old bank statements or credit card bills).

Don't be conservative, you need to account for EVERYTHING. Clothes, medicine, toys for the kids, whatever it is. If you can't think of a monthly number for everything then take a guess at a full year and divide by twelve. A good example of this is vacations. You don't take vacations every month, but you probably take one or two per year (unless you're a farmer, of course). How much does one of your vacations cost? Take that and divide it by 12, that will give you the monthly number to put in your budget. Do that for clothes, holiday presents, birthday presents, etc. It adds up, don't forget stuff.

Also, be sure to add a lump sum of how much you'd like to save each year.

Step Two: Understand the Economics of the Product You're Selling

What does it cost you to make the product you're selling? This appears to be an obvious step, but based on the price of many small-scale products I see around here I don't think many people know the answer. 

Start with the raw materials. For soapmaking you'd need to know how much your oils cost, how much milk/water/beer/etc costs, are you adding fragrances or essential oils, and so on. Break it down by batch. I know our batch size when we started was 80 oz. I knew what each component of that 80 oz was (coconut oil, olive oil, goat's milk, sodium hydroxide, plus anything we added). How much do each of your inputs cost per ounce (including shipping, or the gas it takes you to go get it from the store)? How many ounces go into a bar of soap? That's how I figured out our raw material cost per bar. It's pretty simple once you sit down and do it. If you don't know the price of something get online and search for it, that'll help you price your raw materials before you make anything.

Next figure out your cost of packaging. Are you wrapping the soap in cellophane? Printing your own labels? Buying labels? How much does it cost to package one bar of soap? Again, look online at your options and make a ballpark estimate.

Distribution is another huge expense. Are you selling online? How much does an online store cost/month? How much do boxes, packing paper, tape, etc cost? Or are you driving your soaps to stores? How much does gas cost to get there?

What are the other operating costs of your proposed business? Electricity, fuel, feed for the animals, water, etc.  

Labor is a big one too. Will you need to hire someone to help? If not, how much of your time does it take to create, package, sell, and distribute one bar of soap? How much do you want to get paid per hour? Add that in there too. 

Step Three: What Type of Infrastructure Do You Need?

Do you need land, buildings, vehicles, etc? How about storage facilities, computer software and manufacturing equipment? What will all that cost? Can you pay cash or do you need a loan?

The cost of your capital equipment needs will need to be estimated each year and spread over the amount of products you're selling. This is called depreciation expense. The good thing about depreciation expense is that most capital equipment lasts for many years. The upfront costs suck, but after that you're set for a few years.

Step Four: Price Your Product

Now you should have a pretty good idea for how much it costs you to create and sell your product. My approach to pricing is to add the profit margin that I think our products should make and see where it comes out.

If you come to a price that is lower than your competition go back and look at all your numbers and estimates and make sure you didn't miss anything. Be certain that you're not being too conservative.

If you come to a higher number than your competition consider ways to lower your costs, or find a way to justify a higher price point (organic? local? special properties?).

Step Five: Determine How Many Units You Must Sell to Pay the Bills

By this step you know how much it costs you to make your product (hopefully on a per unit basis, i.e. one bar of soap, one pound of cheese, one dozen eggs, etc). And from that you've determined the price of your product. The difference is your profit per unit. The profit per unit is the number that you need to determine whether you can pay your bills. (One note: If you're including your own personal labor in your cost estimate you will need to back that number out since it will be contributing to your bills as well.)

All that's left to do is divide your total cost of living by the profit per unit. Say it costs you $50k per year to live the life you want and that you make $3 in profit per bar of soap you sell. Well... you'll need to find a way to sell 16,700 bars of soap! That may seem like a lot, and it is, but don't get discouraged.

Look at it this way: Could you sell 2,000 bars of soap and make $6,000? Seems a little more achievable. What if you added on other small products? Could each of those contribute a similar amount? Can you find one higher priced, higher margin product that could fill the gap for you?

Go through that process with each idea that you have and pretty soon you'll understand which products might make sense for you to produce and which don't. Admittedly, this is a simplistic approach and your actual results won't be linear (i.e. profitability on sales of 16k bars of soap will be very different than on 2k), but it's a great starting place. Once you get a sense for the numbers you'll have a lot more confidence when you start production. Go do it!