In fact you
cannot realistically evaluate your business concept without examining its
potential profitability in advance of starting.
To determine
what financial return you may achieve you will want to create a projection of
the profit or loss of the business for its first year. And you will want to
estimate the amount of cash that will come into the business and what amount
will go out. This is known as a cash flow projection.
Let's look at
each of these projections.
Making a Sales
Projection
One of the
hardest tasks you face before you open for business is to estimate what your
sales will be by month for the first year in business. This is particularly
difficult because to gain the greatest use from this projection you should do
it 3-6 months before you launch. There is no magic formula for making a sales
projection, but we have some suggestions.
The first step in projecting sales is to do enough research into your business to
determine if there is a seasonal pattern to the sales. Articles about your type
of business, interviews with other business owners and financial statistics
collected by trade associations are helpful in determining what level of sales
is produced during different times of the year. Department stores, for example
do more than 40% of the total years sales in November and December. Use this
information to determine what percentage of sales you are likely to do each
month of your first year.
Second, go back to your
business description and marketing strategy to describe which one or two of
your products will produce the majority of your sales. Determine what the
"unit of transaction" will be for them. For example, if you are a
consultant the unit of transaction is fees/hour or fees/day. A retail store
might have a unit of transaction of so many boxes of a product/transaction.
Using the promotional strategy you created earlier, estimate how many units you
might sell in month one of your business; month two and so on.
The third step is converting you unit sale estimate into
dollars. By now you should have developed your pricing--either a single fee per
hour or a price list of various products or services and their prices. Multiply
each month's unit sales estimate by your fee per unit or use an average of your
different prices. This produces your dollar sales projection per month.
Estimating Your
Expenses
If you have
completed your research on start-up and monthly operating expenses, you should
have a reasonably good idea of your expense categories.
Expenses come in
two varieties:
- Fixed expenses. These
are cost that you have whether you have any sales or not.
- Variable expenses: Money
you spend to get new customers and to make and deliver your product or
service are your variable expenses.
Some expenses
must be paid each month; others are due just once per quarter or possibly twice
per year. In a vertical column next to Month I of your sales projections, write
in "Operating Expenses" and fill in each fixed and variable expense
you feel you will pay your first year.
Calculating Profit
There are three kinds of profit you
deal with in business:
There are three
kinds of profit you deal with in business:
- Gross Profit. This is
the dollars of sales left after paying for the materials or inventory used
to produce the sale. In businesses selling their time, labor or knowledge
their gross profit is usually equal to their sales, since there is no cost
of product involved.
- Operating Profit. This
is what is left of gross profit after you pay your monthly operating
expenses (including your personal compensation). Interest on loans and
taxes are not deducted.
- Net Profit. This is your
sales income left after all expenses, interest costs and taxes to your
state and Uncle Sam. This is the profit left to put back into growing your
business and to possibly pay yourself a bonus!
Sales often materialize more slowly than you estimated and
your expenses often run higher than you estimated.
The Cash Flow Projection
The projection form used for cash flow looks very similar
to that used for the profit and loss projection.
- Starting
Cash.
Unlike the Profit and Loss Projection, where we are only interested in
sales and expenses each month, the Cash Flow Projection also takes into
consideration the amount of cash you initially invest in your business.
This amount is filled in the "Starting Cash" block on the
projection form.
- Cash Sales.
- Credit Sales
Collected. After your first month in business, you will hopefully receive
payment for sales where you granted credit. When you receive the cash you
record it in this row.
- Monthly Cash
Flow. To arrive at the final outcome of the cash that came into your
business in a month's time and the money that was paid out, you take the
total of the "Starting Cash" for the month, cash sales, credit
sales collected, any other cash in, such as interest and subtract the
total of cash paid out during the same month. The result is the
"Monthly Cash Flow."
- Accumulated Cash
Flow - After the first month, you add this months cash flow-positive or
negative--to the previous months cash flow to see how you are progressing
throughout the year.
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