What I'd like to see more of is articles about how to evaluate our businesses, to look upon our activity as authors and publishers just as if we were a small factory.
What that means is being able to ask questions like these:
- Is our business model sound?
- Is it improving over time?
- Is it covering all of our costs, including those not specific to individual titles?
- Are we actually making a profit, and how long should we expect that to take, after starting the business?
It's not just a matter of counting our sales at the end of the year.
What's the point of financial analysis?
An Income Statement isn't just a tedious document that old-style businesses put together — when done right, it's vital and important information to help you direct your spending and efforts.
I've been a Chief Operating Officer and a Chief Financial Officer for several small-medium businesses, both public and private — all of them young (1-10 years old). I'll use accounting terminology from the USA business world, but all countries do similar things though the terms may vary.
I'll focus on three ways to look at our businesses, and the data we need to support that.
1. Gross income — your business model
When we start as indie authors, we generally focus on the creation of work to publish (I'll call that “books” or “titles”, whatever you may be writing), and the delivery of that work to distribution and retail publishing channels.
Over time, many of us develop additional ways to earn income. As an example, I have the following channels today, in various stages of maturity:
- Creation and sale of 24 titles (my own books)
- Publication of titles for others (publishing work, several imprints)
- Consulting work for colleagues
- Speaking engagements
Each of these is a “line of business”, with its own costs and income. Some are relatively predictable while others are not, but all can be grown by marketing, if that seems like a worthwhile investment.
For each of these lines of business, I have income and direct cost. The direct cost is specific to each business line and an element in that business line (e.g., paying for a cover for a particular title, or hours spent on a particular consulting gig), not a general or indirect cost like office supplies or internet access. The typical term for that direct cost in the US is “Cost of Goods Sold”, or “COGS”.
The reason you consider each of these channels separately is that they behave differently. You could lump them all together and call it “income” and “COGS”, but you wouldn't learn anything by that. For example, I could lump together the first two bullets — it's all publishing — but my own works have a different cost structure since they include the significant investment of my labor hours to produce the manuscript. If I were doing subscriptions for podcasts, that would look very different from simple “speaking engagements” as a business line.
Keep your lines of business separate and unique whenever they have structural differences in the way they make money or require money.
What about labor?
In a larger business, we would pay salaries and that includes paying for our own labor. Until we reach that size (if ever), we should track our labor for the direct costs of our business lines, just as any factory would have a time clock for the people who produce the goods.
Our time has value. In principle, we could be earning a salary somewhere else. It's an illusion to think that our time doesn't count when we look at the costs and income of our titles, since the time we spend writing is by far the largest cost associated with our books. It takes quite a bit of investment in, say, audiobooks or translations, before you exceed your labor cost (your hours times a realistic rate).
For our small informal businesses, there's no way to show our labor cost (we don't have salaries), but when we analyze Return on Investment (ROI) below, that will come into play.
Gross Income = Income (for each line of business) minus COGS (for each line of business).
This is your Business Model. This is the engine of your business, how you make money. It might not be profitable from the start (it takes a little while to earn enough to offset the direct costs), but it should be profitable in principle as soon as enough time passes (the initial costs stabilize, and new income arrives). When you look at these numbers, you should be able to see your way to profitability over time, even if you're uncertain about how long that time will take.
If you can't see how it can ever be profitable, then you have a problem. Either your costs are too high (spending too much on editors, covers, etc.) or your sales are too low (need marketing, better appeal, etc.), or both. At the beginning, you should wait until you have several products before despairing, but this is still important to keep an eye on. It's a cliché that a typical startup (in any industry) takes 5 years or more to achieve profitability. We're lucky that in our industry the start-up costs are so small we don't normally require outside investment (other than our labor) to carry us over this period until we are profitable.
If your business model doesn't look like it can be profitable in principle eventually, then you haven't got a business.
Companies experiment with new lines of business all the time — it may well be that you have mature business lines that are profitable while others are immature and uncertain. That's another reason you want to set things up to track each line of business independently, so that you can make judgments at the line of business level about investing more effort or cutting the experiment off if it doesn't look like it can ever be profitable.
2. Net income — do you actually make money?
Your business has other costs, of course, such as marketing, office supplies, rent, utilities, and so forth. These costs are indirect — they're not associated with a particular line of business, or they're not required to produce the product being sold, which would make them part of COGS (Cost of Goods Sold).
Typically these indirect costs are relatively stable. They don't grow very quickly as the lines of business grow, and they're quite predictable. In American terminology, this is often referred to as the “nut”, the cost you have to cover with your Gross Profits (above) in order to be profitable overall.
Net Income = Gross Income minus all indirect costs.
Net Income is what you pay taxes on.
In a larger business, the indirect costs would include salaries for anyone not actually making or managing the products that are sold, and the related healthcare, pensions, and other costs.
Obviously your Gross Income has to be profitable before your Net Income can be, and you must pay particular attention to trying to minimize your indirect costs.
Marketing is usually applied to a particular business line, and often to one element in the line, such as an ad for a particular book. Why is that considered an indirect cost instead of a direct cost?
Part of the reason is that it can be difficult to associate a particular marketing cost with a particular sales income, but the main reason is that marketing is an optional cost. You can produce the titles, or consulting work, or whatever line of business without marketing. You may make more money if you also market it, but you don't have to incur that cost necessarily.
3. Return on investment (ROI)
The above two sections address the Income Statement for businesses like ours, but there's another way of looking at your business model.
Practically speaking, most of us are investing our (unpaid) labor into starting and running our indie author business, and a certain amount of unavoidable cash. Are we doing well? Should we have a job, instead? That depends…
I'm indebted to Dean Wesley Smith for his recommendation of treating our investment like a Variable Annuity. What this means is, you take the cost associated with a product (such as a book), both in money and in labor (your hours times a realistic rate), and each year you analyze what you earn from that investment.
For example, let's look at the first book of my first series (ANNWN-N1, published 2012), the first book of my second series (CHAIN-N1, published 2016), and a bundle of 2 books from my first series (ANNWN-B2, published 2017).
By the end of 2017, they had cumulatively cost me, in out-of-pocket cost and in labor:
ANNWN-N1: $3992 (includes an audiobook) plus $9552 (317 hours @ $25/hr) = $13544.
CHAIN-N1: $1501 (includes work from a conlanger) plus $5442 (199 hrs @ $25/hr) = $6943.
ANNWN-B2: $2 (no cost to create the bundle) plus $225 (9 hrs @ $25/hr) = $227.
In 2017 alone, they had also earned me:
ANNWN-N1: $1058, or 7.8% of the investment cost.
CHAIN-N1: $1453, or 21% of the investment cost.
ANNWN-B2: $531, or 234% of the investment cost.
For my titles overall, my goal is to reach 10% return each year, or better. That's another way of saying we are investing our labor hours at an attributed rate plus whatever out-of-pocket costs are required into annuities that pay off at a certain percentage every year.
Each year I may also need to invest more in existing products — new covers, new formats, etc. — but that's done with an eye to recouping that cumulative investment over time.
This is why you want to track your labor hours for your business lines. It underscores how efficiency in writing or other time spent on a book improves your return. And the tracking of the cumulative costs helps you evaluate if additional investment in a title is warranted, in terms of its potential return. In my case, I knew that bundles were worth doing, but it wasn't until I started tracking the results of making bundles and what they earned that I realized just how well bundles performed, despite their relatively lower sales volume.
The indie author business is a great way to turn unpaid labor into earnings.
4. What should you be tracking?
There are 3 types of data that we must track, to get an accurate view of our business.
A. Out-of-pocket costs
This is every payment that you make to anyone. Each expenditure is either part of the Business Model (attributed to a business line and a product in that business line) or part of your indirect costs (office supplies, marketing, etc.).
This implies that you can tag everything at this level: “direct cost for Title X”, “direct cost for consulting gig Y”, “direct cost for speaking engagement Z”. You need to organize your business lines and the way you think about them to support this.
Many people use an accounting system for this (e.g., QuickBooks) or an outside accountant — in the latter case, you will need to give enough information (and oversight) to your accountant to make sure he sets your business up like this. Special care needs to be taken to make sure that everything appropriate is included in the COGS (“Cost of Goods Sold”) bucket for your business lines, since an undirected accountant who doesn't understand your particular business model is likely to throw direct costs like these into some miscellaneous indirect cost bucket.
An undirected accountant will still be able to tell you about your Net Income, but if he puts costs in the wrong place, you will get no benefit from the detailed information about your business lines that you need to properly analyze your Business Model.
How your books sell, in detail, is a fundamental part of your analysis for marketing and other needs. (There are similar issues for other business lines, but I'll just focus on tracking books here since it's a high-volume activity.)
Unfortunately, this means that you really have to step up to tracking your sales, for real, in detail. If you've gone wide (not just Amazon), then this typically means a monthly process where you track the units sold by channel by title by format by month by country, with estimated receipts (currency conversions, etc.). Then, when you receive payments for those sales, you can finalize the receipts.
This tracking is typically done in a spreadsheet. It's a straightforward process to turn those finalized amounts into paid invoices in your accounting system or with your accountant. (“Amazon USA paid $X for Y units of title Z in format MOBI in January 2018”). At year-end, you estimate the unpaid amounts based on the unit sales reports from the vendors and make estimated invoices. The invoices are how the income makes its way into your accounting system.
As an example, each month I pull sales units from my 9 distributors/retailers into a spreadsheet. That just takes a few minutes. I also look at the actual payments I've received and match them up to prior month rows in that spreadsheet, create a matching invoice for my accounting system which I mark as paid, and mark the rows in my spreadsheet as paid, also. That just takes a few minutes, too. While I invested a lot of time setting my spreadsheet up and tuning it to do what I want, it only takes me an hour or so to do the monthly work of keeping it updated.
From my master spreadsheet I can generate dozens of pivot tables which give me a wealth of analytical data to see how my sales track by, say, country or format or date, to see the effect of advertising, to track sales over time or sales by series entry. That spreadsheet is the heart of my business and I use it every day. (Contact me for more information.)
C: Labor hours
This is simple to track, but you need to do it for your lines of business.
For the purposes of business analysis for indie authors, I don't think you need to track your hours for indirect costs (e.g., figuring out how to do Amazon Ads, continuing education, accounting, etc.). That's not because it's not important to do those things, but because the costs are indirect — you aren't going to make business decisions based on how much time you spend “keeping up with the industry”, for example, but you will make decisions based on “how much time do I spend editing someone's books when I publish them — maybe I need to charge more” or “how much time do I spend preparing for a speaking engagement — maybe I need to raise my rates”).
I keep a trivial spreadsheet when I'm writing a manuscript that tracks hours (and word count) for each writing session. When the manuscript is done, I add the hours I spend editing, formatting, distributing, etc., and I include the word count to help track my words/hour rate. I add this information to the spreadsheet where I track Variable Annuity information (see above) and use it to calculate effective labor cost.
For my own books, this just helps me make decisions about the overall investment I'm making and predict how long things typically take. But when I wear my publisher hat and work on someone else's book for publication by one of my imprints, then it's very important for me to know how many hours I spend (which has an imputed cost) versus what I'm charging (royalty rate) to publish that book. If my royalty rate is too low to recover my labor (and out-of-pocket) investment in a reasonable period of time, then I need to see what I can tweak to fix that (my time spent or my royalty rate). Remember, I want to average at least a 10% earnings per year from my investment as a publisher for others, too.
Because our businesses are mostly too small to have actual salary issues (yet), our labor “costs” do not appear in our financial statements, only in our Variable Annuity and other analyses. Once that changes and you acquire employees, then you still have to track the hours in this way, since for any employee (including yourself), the fully loaded labor cost is divided between those same “direct cost” buckets (“Cost of Goods Sold by business line detail”) and appropriate “indirect cost” buckets, such as SG&A (Selling, General, & Administrative) costs, so that the Business Model as a whole still correctly reflects your actual costs within each business line.
If you don't come from a business or corporate background, all this may seem like a lot of work and a big learning curve, but I assure you it's worthwhile. Even if you just have one title in development, it's never too soon to begin tracking the data at the detail level you will need to do this when your volume increases.
You can only analyze data at the level that you track it — you can't make up detail that you didn't keep.
It's good to know, at the end of the day, that you're making a profit, or getting closer to doing so. But if that's all you know, you're operating the levers of your business blindly, and that can leave you vulnerable to unwelcome surprises.