On Wed, 17 Sep 2003 13:38:05 -0400 (EDT),
(Jack-of-all-trades - JOAT) scribbled

Not, not trolling. This has been nagging me for awhile. As many
of you know, I'm on a fixed income, and I don't do this for a living. I
do sell something once in awhile tho, and I know how I figure profit.

Because I'm not doing this for a living, I don't figure in tool
wear and tear, depreciation, electric, etc,, simply because I'm going to
be using the tools and electricty anyway. I also don't figure in any
R&D time, or R&D materials. Again, because I'm not doing it for a
living. I do count in price of materials - wood, finish, any hinges,
etc. And, try to figure a reasonable price for whatever, based partly
on materials cost, but mostly labor. The labor is based on actual time
spend working on something, and doesn't include glue or finish drying
time.

OK, so based on that, what I would call profit, is anything over
materials cost.

That's your net cash flow, not profit in the economic or accounting
sense (well, maybe it is, see below). For profit, you need to subtract
your other real costs. Profit is always gross revenues (or sales)
minus costs. The issue is how do you calculate costs.

There is a useful distinction between accounting profit and economic
profit. Accounting profit is what your taxation authority and bank are
interested in. To calculate accounting profit, you take off your other
costs (power, depreciation on machinery, wages paid to others, etc.),
but not the cost of your own labour.

For economic profit, which is what you should be interested in, you
also need to take into account your "opportunity costs". E.g. what is
your time worth and what could you earn in interest if you left your
money in the bank instead of buying equipment. Note that these are not
theoretical costs, they represent actual money out of your pocket. It
is important to consider those as costs if you're trying to set up a
business. You might have a large accounting profit, but if you end up
only earning a dollar or two an hour, it might not be worth doing.
Even if you end up making a decent hourly wage, you want some amount
over that so that you're making more than if you had left your money
in the bank and gone to work for someone else. (Of course, you might
also put a value on the flexibility and satisfaction working for
yourself gives you, but that's another issue.)

In your case, accounting profit is irrelevant (except for your tax
return). You are saying that there is no opportunity cost other than
the cost of materials, since you would be spending that money anyway.
So the opportunity cost of power, machinery, etc. is zero in your
case. You don't want to or can't work for anyone else, and presumably
enjoy making the pine cone turkeys and would be indifferent between
making them for sale or doing other stuff for yourself. So your time
has no opportunity cost. So, for you, the economic profit is as you
would calculate it - Sales minus material costs.

I'm curious, because quite awhile back, I read an article about a
guy who makes wood stuff, for a living, and specializes in stuff like
chopsticks. No prob with that, if people want to pay the $25 for a pair
of chopsticks, up to them. The article covered all the guy's expenses,
and how he figured all this. There was the usual overhead, elec, etc.,
tool depreciation, etc. Then there was materials cost. Even with
expensive exotic wood, the actual wood cost was low,very low. Maybe a
dollar or so, for even the realy expensive woods, but probably an
average of about 25 cents a pair, and apparently he didn't use anything
like poplar, maple, etc., you know, the cheap stuff. Then the guy
figures in the cost of the sawyer, who cuts the pieces, at $75.00 per
hour. He is the sawyer. Then, there was labor, at $35.00 per hour, to
shape the chopsticks. Only took something like a minute or so for a
pair. Again, he did the work. If I recall right, he figured in labor
for finishing them too, and again, his labor. So, after all is said and
don't, this guy only figured something like about $5 or $10 profit on
each pair. He didn't count in the sawyer fees as profit, even tho he
was the sawyer, and pocked the money.

So, am I missing anything on how I figure profit? Or, is this guy
just trying to find every tax loophole he can?

This guy is looking at it from an economic profit perspective. He is
counting his labour as an opportunity cost, he assumes he is worth
$75 per hour as a sawyer and $35.00 per hour for shaping (?) &
finishing, etc. Another way of looking at opportunity cost is that if
he wanted to hire someone, this is what it would cost. So, if you're
looking at whether it's worth setting up a chopstick-making business,
he is looking at it properly. And it is a profitable business, I
should get into making $25 chopsticks.

He cannot deduct the value of his labour as a cost for accounting
purposes, so there is no tax loophole: he has to pay tax on his
labour. It does not matter whether he pays himself a wage or declares
it as profit (net income). So, his sawyer fees are not part of his
economic profit, but they are certainly part of his accounting profit.
I'm not familiar with the US tax system, but in Canada, an individual
would end up paying the same amount of taxes and Canada Pension Plan
contributions whether he paid himself a salary or not.

All this is my professional opinion, and worth exactly what you're
paying for it.
Luigi
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