One of the most challenging assessments for many entrepreneurs to make about a business idea is confidently assessing the financial viability of their idea. In our article Start-Up Series: 7 Step Guide to Assessing Start-Up Success we promised a series of articles to help assess which of your great ideas have the potential to go all the way.
By step 5 you would have defined the problem clearly in step 1, determined in step 2 that there is value in the solution, identified the market size for that solution in step 3, and in step 4 assessed the competition to identify an achievable market share.
The next step is to analyse the finances to determine whether the business will be financially viable. This is done by building a financial model of the business. By building a functional model with calculations based on the variables and drivers of the business, analysis of the financial outcomes of different scenarios can be performed by tweaking the different variables and drivers.
Building a model can be quite complex and it will evolve during the planning and analysis of the business and subsequently over the life of the business. The model is usually put together on a yearly basis. A good starting point is to follow these steps:
- Determine a price that you can charge for the solution and the frequency of the charge. For example, is it a one off or recurring charge and if recurring, how often? If there are different levels to the solution, then you will need to determine the price for each level.
- Apply the market size and market share determined earlier to the price above to calculate an annual revenue figure.
- Determine the costs to sell the solution. These can include:
- Employment costs for sales people and administration support
- Commissions – either employee bonuses or payments to non-employees
- Travel costs to attend sales calls and marketing events
- Advertising and promotion expenses
- Transaction costs – for example merchant and transaction fees on sales
- Determine the costs to deliver the solution. These can include:
- Where the solution is a physical product:
- Manufacturing costs
- Shipping costs
- Warehousing expenses
- Warranty claims
- Where the solution is a service or non-physical product:
- Software development and maintenance costs
- IT infrastructure costs
- Employment costs for people delivering the solution
- Employment costs for providing after sales service
- Where the solution is a physical product:
- Determine the costs to administer the business. These can include:
- Employment costs for administration including management, finance, internal support services
- Premises costs including rent, electricity, communication, IT infrastructure
- Outsourced professional costs including Accounting, Legal, Employment relations
- Insurance costs
Once you have the revenue from sales and added up the total expenses you can determine the anticipated profit to ascertain feasibility.
Further analysis can be done with the model by playing with the variables to stress test the strength of the financials. For example, what would happen if you had to discount the sales price by 10% or employment costs were 20% higher than anticipated?
If the model does not result in a financially viable business use the model to determine what changes would need to happen to the business to make it viable. For example, increase the sales price, or reduce the employment costs by reducing the head count. Once you get to a point that the business is viable you need to determine if the changes made to make it viable are realistically achievable.
Further analysis can be done by extending this financial model into a 3 way forecast that will estimate the cash flow of the business and project a Balance Sheet showing the Assets, Liabilities and Equity.
Once you have given considerable thought to the inputs into your financial model, you may require some assistance to build the model so it is robust enough to do sensitivity analysis on and convert into a 3 way forecast. Please contact Robert Pitt on 3218 3900 for assistance with the model build. We encourage you to follow our Start-Up Series of articles to work through this 7 step guide to assess if one of your ideas could be a start-up success. If you want to delve into all 7 steps in one sitting, please download our Guide here.
Please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice.