The real world definition of net profit is the amount of money left in your hand after paying:

1. Direct costs: Those directly attributed to the specific product, including labor, materials, costs of sale etc.
2. Indirect costs: Those shared with other products if you are making and selling more than one product in the same facility.  Administrative, overhead costs and certain marketing costs are examples of expenses that are frequently shared in this situation.
3. Capital costs: Interest and equity payments, equipment
4. Misc. costs: Taxes, licenses, reserves.

Profit can be expressed in dollars or as a percentage of sales.  Either way it must provide a worthwhile return on total investment.  The ideal product will be one that will cover all costs, and provide enough profit to be considered an attractive “rate of return”.

Defining “attractive rate of return” is like trying to define the word “fast”.  I have found from years of motorcycle and ski racing that one man’s idea of “fast” is another man’s idea of “slow”.  An amount which is “attractive” to one investor may well be below minimums for another investor.  As a very general and broad rule of thumb, the new product developer could use 15% annual return as a minimum acceptable annual rate of return.  For sake of comparison, in 2003, the average annual corporate net profits were running about 6%.

If you have not done so already, make up a “cost-of-goods-sold” form.  List each part and how much the part will cost to fabricate, mold or otherwise produce in quantities of 100, 500, 1000, 5000, 10,000, 25,000, 50,000 and 100,000 pieces.  If you will be importing parts be sure to include freight to your facility, import fees and duty fees for each part or assembly.  List the labor cost to assemble each completed unit.  List the cost of packaging and the labor to package it. If the product will be sold in cases or “master packs” be sure to take the cost of the master pack and the labor to put the individual boxes into the master pack, divide that cost by the number of units per master pack and add that to your final packaging costs per unit.  Add up the total cost to produce, assemble and package one complete unit based on each quantity breakdown.  Note: if you are an individual product developer or inventor, Always use the lowest quantity you will produce as your base cost per unit.  Don’t ever use your cost-per-unit at high quantities as your base price for cost-of-goods-sold, since you will only be fooling yourself.  Depending on the product and your ability to build awareness and demand, it may be months or years before you will have enough orders in hand to justify a large volume purchase.

Add in your own profit markup (anywhere from 30% to 100% of your cost of goods sold).  Add another 20% to 30% to cover rep’s and distribution then double that figure to arrive at an approximate retail price to the end user.  When all is said and done, a general rule of thumb is that the ideal product will be one that sells to the end user for five times the cost of goods sold.  If this final figure is the same or below the perceived value to the consumer, the product has good potential for profitability

It is often easy to determine manufacturing costs and project anticipated profit margins but it is very hard to predict, with accuracy, what a product’s perceived value will be in the eyes of the target audience.  If the customer perceives the value to be greater than the price it is easy to raise the price.  However, if the customer perceives the value to be less than the price you are asking, it can mean instant death for the product.  The evaluator and the developer need to constantly monitor the perceived value from the different perspectives of the end-user and each of the middlemen in the channels of distribution, to be sure the perceived value of the product is always great enough to keep the product profitable for all parties.

If, in your search for competition, you have detected even a hint that someone may already be working on a similar product, you must think about what would happen if you were suddenly forced to pay licensing fees or royalties to someone who comes knocking on your door with a patent in hand before yours issues.  Could you still be profitable?  Once you have arrived at a net profit figure, refigure your net profit as if you were forced to pay a “licensing fee” of 5% or 10% of net sales. You need to know NOW whether you could pay a royalty fee to another party and still remain profitable or whether you would be wiser to “cease and desist” upon notification that another party was granted a prior patent.