You might know already that I run Tapprs, an online photography & travel equipment rental place.

Thought I will share my view of the economics of running such a business, at least at a small scale such as it is now.  Tapprs is still in the validation phase, but the numbers shown here should be relevant even if scaled up. All numbers are actuals, except for revenue.

Disclaimer: I have no accounting background and there could be mistakes on my part. Please do point it out if you find any.

Initial funding:

Assume that the operations began on June 1.

As the sole owner, I put in Rs 1 lakh as equity capital. This is free money (don’t have to pay interest on it). And then I lend Rs 2lakh to the business from my pocket which I charge an interest of 12% annually (realistically, no one would lend to such a business without collateral and interest rates will be much higher).  That means Tapprs would have an interest payout of Rs 24000 every year on it until paid back.

Source of Funds	Amount
Equity capital	100,000
Loan capital @ 12%	200,000
Total	300,000

Use of funds:

Tapprs needs to start. For which, I do these transactions on June 1.

Item	Expense
Purchase of equipment	200,000
Domain	450
Total Initial Expense	200,450

 

So, at the end of the day, my balance sheet looks like

Assets	Equipment*	200,000
	Cash	99,550
			299,550
Liability	Loan from Prem	200,000
			200,000

* – Equipment is considered as Capital expense and is depreciated within 2 years (photography equipment is worth a life time of say 2-3 years, aggressively depreciated) and not considered as revenue expense (and not fully expensed).

Equity has dropped by Rs 450 because the domain expense is virtually worthless at least as of June 1.

Operations:

Fortunately for Tapprs, a website is all is needed to run business and WordPress is free. These steps are taken to make Tapprs operational.

1. Tapprs has only one employee. Prem, the founder agrees to take a salary of just Rs 6000 for everything he does at Tapprs, including janitorial work.
2. A website is designed based on WordPress. Prem does it and does it free of cost. (lets say in exchange for Tapprs letting him use the equipment free of cost whenever he needs them 😉 ).
3. Hosting is done from Prem’s account. Again, Prem offers it free of cost. But for our case, lets expense it. And say, it costs Rs 150 a month (cheapest option with Bigrock).
4. Once the website is done, Facebook and Twitter are used for promotion and Prem’s friends are the victims of his constant broadcasting of Tapprs’ marketing stuff. 🙁
5. Tapprs starts getting a few Likes on Facebook. And a few take notice of the rental options.
6. Equipment is insured at the premium of 3% of equipment cost.
7. A 6% overall loss provision is made to handle other equipment losses. (On inventory size of 2L, it works out to 12,000 a year).

Now the business is fully operational. Let us say Tapprs did reasonably well. But do we know it is enough? How much should Tapprs make to be ‘PROFITABLE’?

I will not get into what Tapprs actually made. But let us see with the above in mind, how much Tapprs has to earn every month to be profitable.

 

Assets	Equipment inventory	200,000
	Cash	88362.5
			288362.5
Liability	Loan from Prem	1,000,000
			1,000,000
Revenue	?	?	?
Expense	Domain +	37.5
	Hosting	150
	Prem’s salary	6000
	Rent allowance	2000
	Misc	1000
	Internet	950
	Insurance +	500
	Loss provision +	1000
			11637.5

* : Rent & logistics allowance. Currently Tapprs runs out of Prem’s home. For which a small allowance of Rs 2000 is paid. Its not high. But it could rise sharply if Tapprs moves to a proper location. Keep this in mind.

+ : Annual expenses apportioned monthly.

So, the operating expenses are around 11637.5. Not bad.. on the face of it.

Hey wait! That is not all!!!

The above figures are before Depreciation, Interest payment and tax (if any).

Assets like camera lenses go down in value quickly. Let us depreciate the assets down to zero within a very aggressive period of 2 years. (Camera equipment is obsolete faster than most other equipments).  Which works out to 200,000 / 24 = 8333 per month (though depreciation is done yearly, I like to provision for it monthly). THIS IS NOT A CASH EXPENSE, but is deducted out of Assets.

Also, Tapprs needs to pay an interest of 12% for the 200,000 taken. This works out to roughly 2000 per month (actually less, but lets keep things simple).

Now, the above statement before tax, but after depreciation and interest becomes:

 

Assets	Equipment inventory	191,667
	Cash	86362.5
			278,029.5
Liability	Loan from Prem	1,000,000
			1,000,000
Revenue	?	?	?
Expense	Domain +	37.5
	Hosting	150
	Prem’s salary	6000
	Rent allowance	2000
	Misc	1000
	Internet	950
	Insurance +	500
	Loss provision +	1000
	Depreciation +	8333
	Interest	2000
			21970.5

* – tax not calculated yet.

Tapprs has to earn ~22,000 net just to stay out of red! And above that… the tax component starts kicking in as well.

That is the cost of running the business (on this inventory size).

Now, what does that mean?

It means

• inventory has to earn at least 10% on its worth (at the non-depreciated cost of Rs 2L). Else you are losing money. (However, as inventory keeps increasing, the % needed keeps dropping.. call it the economics of scale. You could take more debt, buy more equipment and try to rent it out.. but beyond a level… a poor month can wipe you out because of the heavy interest portion).
• to make the entire business worth the effort, lets say you want Rs 15,000 at least every month as net profit on investment of this size (also, the nature of the business is such that it may not take more than 1-2 hours/day once things settle down). Let us not think of scaling up, making more money, etc for now. Just minimal viable case for Tapprs to function. In that case, Tapprs has to earn Rs 37,000 every month on its current inventory to keep you minimally happy.  That is almost 18.5% of initial inventory (37k/200k) value. IN ONE SINGLE MONTH! If you charge 1% of cost per day for rent, it means all your items have to go out for atleast 18.5 days EVERY MONTH!!! That is a utilization rate of almost 60% (18.5/30days). Whew! Tough ask!!!
• Tapprs has a cash of around 86000 which could be used to purchase more items. BUT… will it make sense to wait for 2-3 months to see if the current inventory is making any money at all? And more importantly, is the inventory earning money at a profit? What is the cost of the sale? We have decent understanding of it now.. but it really has to be seen over at least a few months.
• With scale comes benefits (and pains too). If we raise the inventory to say 2.5L, you need only 15 equipment rental days to make 37500 as you now have more items to make money from. That’s a relatively slightly easier 50% utilization rate. Maybe Tapprs should scale up a bit. BUT, remember, your depreciation will be higher too (roughly 10400 now, ie) 250,000/24months ) and that has an implication on net profit. Now, this can be handled by 1 more day of equipment rental roughly.. ie) 16 day utilization in a month.
• the trick lies in quickly scaling up… on profitable items… and making sure the items are rented out on a decent no of days. And not simply scaling up on every item.. they could lie on the shelf indefinitely… adding dead weight.
• if you think you cannot meet your utilization day ratio… scaling up is a foolish thing to do and your debt burden will force you out soon.

Let us 5x the business.

• Take 8,00,000 loan (again from Prem at 12%). Now total loan is Rs 10Lakhs.
• Purchase equipment for 8L.
• Employ 1 person @ 8000 per month for handling things like delivery, pickup, etc.
• And of course, you need to raise Prem’s salary for 5x’ing! (Now, things start sounding murky).
• Still run from home. Running from a rented premise is still unviable.

Now, that part looked easy-peasy! Lets see what happens to our numbers.

Assets	Equipment inventory	958,333
	Cash	58363
			1,016,696
Liability	Loan from Prem	1,000,000
			1,000,000
Revenue	?	?	?
Expense	Domain +	37.5
	Hosting	150
	Prem’s salary	10000
	2nd employee’s salary	8000
	Rent allowance	2000
	Misc	3000
	Internet	950
	Insurance +	2500
	Loss provision +	5000
	Depreciation +	41667
	Interest	10000
			83304.5

* – tax not calculated yet.

Now, you have 10Lakhs worth of equipment (depreciated in a month to 958333) to make money from.

• you have to make at least 84,000 to be profitable. Which is roughly 28% utilization rate (8.4days @ 1% rates/30days).
• let’s say you need at least 40,000 to be happy for taking this risk. Then, you really need to make 125,000 every month. That is 12.5 rental days at 1% rates. Or a utilization rate of ~40% (12.5/30days). This is for ALL equipment. Of course, realistically, a few may perform very well and a few badly. The average at any cost has to be around 40%.  And you have tax to pay as well.

How to raise profits:

• increase utilization. Looks difficult, given that photography rental is mainly a weekend activity.
• reduce expenses. Hmm.. I can cut Prem’s already low salary. He won’t be happy. The best way is to pay off Prem’s loan soon.
• depreciate equipment slower. No way! I want to depreciate it within 2 years. After that, if you manage to still keep the item.. its good as free.
• reduce internet, misc, insurance expenses.
• procure items at a much better price. Comes with scale.
• RAISE RATES!!! I am experimenting with rates now. But I might raise it a bit and also lower it and try different combinations. Raising rates should not affect utilization rates.. which to me is more important.
• You suggest to me!

Working capital:

An issue in the above 5’xing could be ignoring working capital.

You notice that cash left is around 58363. And though our expenses are 83304.5, the actual cash expense is 41,637.5 because the depreciation isn’t a cash expense.

That means, you really have only one month’s worth of cash in the bank. A bad idea!

Ideally, I would prefer 2-3 months worth of working capital. And also our model is such that revenue will also significantly pay for working capital and we do not really work on receivables as money is immediately charged from customer. But I could pay Prem at the end of the year though. However, realistically, if you had a loan from outside and if the payment is monthly.. you better watch your cash to meet monthly expenses.

That is because, even profitable businesses run out of working capital.

My thoughts:

• will try to keep it running as a part-time, but serious venture.
• will try to scale slowly from internal revenues. But will not plonk down any more capital from my pocket.
• loving the exposure I am getting on marketing, customer service, pricing & strategy, risk management, financial management of a small biz, etc. But is it worth the effort? Am weighing the benefits.
• might even shut it down in 2012, I have other profitable things to do.

Is your venture making a  profit?

Now, you could be a library owner, a toy rental store or even my competitor renting out photography equipment! Have you given a thought if your business is running profitably or not? Considering net profits and not just operational profit.

As a reader, what do you feel? Anything that I am wrong on? Anything that you think that should help Tapprs?

Will await your comments. Will try to answer them as best as I can. Well, except about the revenue Tapprs made ;-).

Thanks for reading!