Many students avoid the financial side, thinking it is for accountants. But its basics are simple, and knowing them is what separates a nice idea from a venture that survives. In this chapter we explain the types of costs, revenue and profit, contribution margin and the break-even point, pricing methods, the difference between profit and cash flow, and then the sources and stages of funding.
After studying this chapter, you should be able to:
It is said that money is the language of business: every decision in a venture, from price to the number of employees to expansion, is ultimately translated into numbers. An entrepreneur does not need to be an accountant, but does need a clear grasp of a few basic concepts, because their absence is why many small ventures sell a lot and then close: their owners did not work out properly how much each product costs them, or how much they must sell to cover their costs.
In this chapter we explain the concepts one after another and apply them to a single example, so you can see how they fit together:
The first step is knowing where the money goes. Costs in small ventures fall into three types, and confusing them is one of the most common mistakes:
Paid once when the venture starts, to get it ready to operate. They do not recur every month, but they can be large. They include: equipment and machines, fitting out the premises, designing the brand identity and logo, the first license, initial inventory, and the rent deposit.
In the example: a small roasting machine and equipment (SAR 20,000), fitting out the premises (5,000), designing the identity and online store (4,000), and license and procedure fees (1,000). Total: SAR 30,000.
Recur every month and do not change with sales volume: you pay them whether you sell one bag or a thousand. They include: rent, fixed salaries, subscriptions (internet, software, platforms), average electricity and water, insurance, and loan installments.
In the example: roastery rent (SAR 3,000), an assistant's salary (4,500), and electricity plus store and platform subscriptions (1,500). Total: SAR 9,000 a month.
Linked to each unit sold: they rise as sales rise and fall as sales fall. They include: raw materials, packaging, payment gateway fees, delivery charges per order, and platform commission if any.
In the example: green coffee beans (SAR 18 per bag), the bag and label (3), and shipping and payment fees (4). Total: SAR 25 per bag.
One of the costs most often overlooked by people with new ideas is time. If the service requires the provider to spend time on the road, waiting or setting up, the customer pays nothing for that time, but it reduces the number of customers who can be served in a day, raising the real cost per customer. So always ask: How many customers can the venture actually serve in a day? And look back at the mobile barber example in Chapter 6, where the barber needed more than double the shop price to earn the same income.
Revenue is the money that comes into the venture from sales: unit price × number of units sold. It is not profit, but the money before any cost is deducted.
Costs are then deducted in stages, and the table that shows this is called the income statement (or profit and loss statement). Suppose Hamsa sells a bag for SAR 55 and sold 400 bags this month:
| Item | Calculation | Amount (SAR) |
|---|---|---|
| Revenue | 400 × 55 | 22,000 |
| (−) Variable costs | 400 × 25 | 10,000 |
| = Total contribution margin | 22,000 − 10,000 | 12,000 |
| (−) Fixed costs | Rent + salary + services | 9,000 |
| = Operating profit | 12,000 − 9,000 | 3,000 |
Statutory obligations such as zakat or tax, depending on the business's status, are then deducted from operating profit, leaving net profit. The profit margin is profit as a share of revenue: in the example 3,000 ÷ 22,000 ≈ 14%, meaning the venture keeps about SAR 14 of every SAR 100 it sells, before statutory obligations.
These are the two most important concepts in this chapter, because they answer every entrepreneur's question: How much must I sell so I don't lose money?
The difference between the selling price of a unit and its variable cost:
It is called a "contribution margin" because every bag you sell "contributes" SAR 30: first to covering fixed costs, and once they are all covered, everything beyond is profit.
The sales volume at which revenue equals total costs, so the venture neither profits nor loses:
Let us check: at 300 bags, revenue = 300 × 55 = SAR 16,500, and costs = (300 × 25) + 9,000 = 7,500 + 9,000 = SAR 16,500. Profit is zero.
| Monthly sales | Total contribution margin | Fixed costs | Result |
|---|---|---|---|
| 200 bags | 6,000 | 9,000 | Loss of 3,000 |
| 300 bags | 9,000 | 9,000 | Break-even (zero) |
| 400 bags | 12,000 | 9,000 | Profit of 3,000 |
| 600 bags | 18,000 | 9,000 | Profit of 9,000 |
What do you do with the break-even point? Ask: Is selling 10 bags a day realistic? How many orders do we actually expect, based on our experiments? If the number is far from reality, you have three options: raise the price (if the value allows it), lower the variable cost (a cheaper supplier, simpler packaging, consolidated shipping), or lower the fixed costs (smaller premises, or renting time on an existing roastery at first instead of buying a machine). Try these scenarios in the break-even calculator in the toolbox.
Notice that we did not include the SAR 30,000 in start-up costs in the monthly break-even calculation. The reason is that it is not a monthly cost but an amount paid once, recovered from profits after passing the break-even point. The time needed to recover it is called the payback period:
Many people confuse three closely related terms: contribution margin, net profit and profit margin. To make the differences clear, let us take the simplest venture possible: a small café that sells only one product, a single type of coffee at a single price, so the calculation is easy and every concept stands out.
Contribution margin per cup = 15 − 6 = SAR 9. This is not profit yet; it is what remains of the cup after its variable cost, and it goes first to covering the rent and salaries. The break-even point = 15,000 ÷ 9 ≈ 1,667 cups a month, about 56 cups a day.
Suppose the café sold 2,000 cups this month:
| Item | Calculation | Amount (SAR) |
|---|---|---|
| Revenue | 2,000 × 15 | 30,000 |
| (−) Variable costs | 2,000 × 6 | 12,000 |
| = Total contribution margin | 2,000 × 9 | 18,000 |
| (−) Fixed costs | Rent + salaries + services | 15,000 |
| = Operating profit | 18,000 − 15,000 | 3,000 |
| (−) Statutory obligations (such as zakat), assumed | 300 | |
| = Net profit | 3,000 − 300 | 2,700 |
Notice the large difference: every cup "contributes" SAR 9, but the net amount left from each cup this month is 2,700 ÷ 2,000 = only SAR 1.35. If we break down the price of a cup (SAR 15), it divides like this: SAR 6 variable cost, SAR 7.5 its share of fixed costs (15,000 ÷ 2,000), SAR 0.15 statutory obligations, and SAR 1.35 net profit. That is why it is wrong to say "I make SAR 9 on every cup."
Net profit margin = net profit ÷ revenue. In the example: 2,700 ÷ 30,000 = 9%, meaning the café keeps SAR 9 of every SAR 100 it sells. This ratio is useful because it allows comparison between two ventures of different sizes, or between two months of the same venture.
If the number of cups sold changes, while the price and costs stay the same:
| Cups per month | Revenue | Operating profit | Average profit per cup | Profit margin | What each extra cup adds |
|---|---|---|---|---|---|
| 1,000 | 15,000 | −6,000 | −6 | −40% | 9 |
| 2,000 | 30,000 | 3,000 | 1.5 | 10% | 9 |
| 3,000 | 45,000 | 12,000 | 4 | about 27% | 9 |
| 4,000 | 60,000 | 21,000 | 5.25 | 35% | 9 |
The last column is constant: every extra cup adds SAR 9, before the break-even point and after it; before it, the 9 goes to covering fixed costs, and after it, it becomes profit. But the average profit per cup and the profit margin rise with sales, because the same fixed costs are spread over more cups. However much sales grow, the profit margin before obligations will never exceed 60% (9 ÷ 15), because that is the most a cup leaves after its variable cost. The same happens at Hamsa: every extra bag adds SAR 30, and the average profit per bag rises from SAR 7.5 at 400 bags to SAR 15 at 600 bags.
Pricing is one of the hardest and most consequential decisions in a venture, because changing the price by a few riyals can change profit substantially. If Hamsa raised its price from SAR 55 to 60, the contribution margin would rise from 30 to 35, and the break-even point would fall from 300 to about 258 bags. There are four main pricing methods:
You calculate the unit cost, then add a profit percentage. Example: a variable cost of SAR 25 + 60% = SAR 40, which is far less than the specialty coffee market accepts. Its advantage is simplicity and assured coverage of variable cost. Its drawback is that it ignores what the customer is willing to pay and what competitors charge, so you may sell below your real value, or above what the market accepts.
You look at the prices of alternatives, then set yours close to them, higher if you offer more value, or lower if your positioning is economical. Its advantage is realism; its drawback is that it may make you copy others without knowing whether their prices are profitable at all.
You base the price on the value the customer feels, not on your cost. A gift box with three types of coffee, a brewing tool and a card explaining each origin may sell for SAR 150 even though it costs SAR 60, because what the customer buys is "a special gift worthy of the person receiving it," not just coffee. This method needs a deep understanding of the customer, which interviews reveal.
You start with a temporarily low price to win customers quickly, then raise it gradually. It is risky if not calculated well: customers who came for the cheap price may leave when it rises, and you may lose money on every sale until then.
A venture can be profitable on its income statement and still be unable to pay the rent. The reason is that accounting profit differs from cash flow, the actual movement of money into and out of the account at a given time.
Example: Hamsa received a large order from a company for 300 gift bags for its employees, worth SAR 16,500, with the company paying two months after delivery. On paper this is excellent profit. But the venture needs to buy the beans and bags now (SAR 7,500) and pay this month's rent and salary (SAR 9,000). If there is not enough in the account, the venture may stumble while being "profitable."
To avoid this:
Every venture needs money to start or to grow. Funding sources differ in their terms and cost, and in what they ask of you in return. The first question before looking for funding: Do I really need it now? Many ventures can start small with their own resources, prove their model, and then seek funding on better terms.
| Source | How it works | Advantages | What to watch for |
|---|---|---|---|
| Bootstrapping | The founder's savings, then reinvesting the venture's revenue | You keep full ownership and control, and learn discipline | Slower growth, and risk to your personal money |
| Family and friends | A loan or contribution from people close to you | Fast, flexible, with easy terms | It can affect relationships; put the agreement in writing |
| Grants and competitions | Non-repayable support from government bodies, competitions or incubators | Not repaid and takes no stake | Competitive, and the amounts are usually small |
| Loans and financing | From banks or financing bodies such as the Social Development Bank, with guarantees from programs like Kafalah | You give up no ownership | Repaid whatever the venture's outcome, and needs regular cash flow |
| Angel investor | An individual who invests their own money in an early venture in exchange for a stake | Often brings experience and connections along with money | You give up part of the ownership |
| Venture capital | Funds that invest in fast-growing companies in exchange for a stake | Large amounts to accelerate growth | Suits only highly scalable ventures, and expects high returns |
| Crowdfunding | Small amounts from many people through licensed platforms | Also tests demand, and builds a customer base | Needs a good marketing campaign |
When a startup relies on investors, funding usually comes in successive rounds, each tied to a stage of the venture's maturity:
When someone invests in your venture in exchange for a stake, they implicitly set a value on the venture. If you offer an investor 10% of your venture for SAR 100,000, you are saying the venture is worth SAR 1 million after the investment (100,000 ÷ 10%), and 900,000 before it. You must justify this value with numbers and evidence.
With each new round new investors come in, and the founders' share of ownership falls; this is called dilution. Dilution is not necessarily bad: owning 40% of a company worth ten million is better than owning 100% of a company worth a hundred thousand. But you must understand it before you sign.
The answers are on the Answers to Self-Assessment Questions page. On the interactive course page you can answer and check these questions directly, with practical tools linked to the chapter.
Choose a small venture in your city, estimate its fixed and variable costs and its price, then calculate how much it must sell each day.