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When you decide to start your own business you should consider the viability of this business, keeping in mind that under certain conditions it may be viable, but when the conditions are different, it may no longer be financially viable.
The following financial areas should be considered as part of your evaluation:
Establishment expenses
You should have sufficient capital funding to cover the initial costs, including initial operational costs that take place at the beginning of the operational phase, before any revenue comes into your cash flow.
Capital investment Capital investment may be required for items such as furniture and equipment, renovation of the business place, initial inventory and some working capital to cover the initial operating expenses for the first months, while establishing the business, prior to creating any revenue.
Once the amount of the required capital investment is calculated, the financing options of the investment amount should be evaluated, considering financing through equity, loans or a combination of the two. As a rule of thumb, it is recommended that at least 20% of the investment amount should be made through equity and the rest by means of loans. It's advised not to invest all your personal savings in the business and to keep a contingency budget aside to cover unexpected costs.
Operational expenses Operating expenses are fixed expenses that are not directly related to revenues. The operating expenses in the business could include: municipal rates, electricity, water, rent, expenses for specialised services such as accountant / bookkeeping, salaries to employees, maintenance of vehicles, depreciation, advertising, etc.
Gross profit margin
The gross profit margin is used to assess the company's financial health, presenting the proportion of money left over from revenues after accounting for the cost of goods sold.
The gross profit margin, also known as gross margin, is calculated by dividing gross profit by revenues:
Remember that without an adequate gross margin, your business cannot pay for its operating expenses. In general, a company's gross profit margin should be stable, unless there have been changes to the company's business model. For example, when companies automate certain supply chain functions, the initial investment may be high; however, the cost of goods sold is much lower due to lower labour costs.
Industry changes in regulation or even changes in a company's pricing strategy may also drive gross margin. If a company sells its products at a premium in the market, all other things equal, it has a higher gross margin. The challenge is to keep in mind that if the price is too high, customers may not buy the product.
Break-even point
To be profitable in business, it is important to know what your break-even point is. Your break-even point is the point at which total revenue equals total costs or expenses. At this point there is no profit or loss - in other words, you 'break even'.
A business could be turning over a lot of money, but still be making a loss. Knowing the break-even point is helpful in setting up the prices, setting sales budgets and preparing a business plan.
By understanding where your break-even point is, you are able to work out:
how profitable your present product line is
how far sales can decline before you start to incur losses
how many units you need to sell before you make a profit
how reducing price or volume of sales will impact on your profits
how much of an increase in price or volume of sales you will need to make up for an increase in fixed costs.
So, before you start investing into the business, do the maths, verify that your business is viable, and then go for it!
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