5 Steps to Validating your Business Idea
The financial forecast “proves” your concept and is the cornerstone of the “new” business plan. There is no room for guesswork here or some generalized statement of revenues and expenses. Instead, your forecast is essentially your first year’s profit and loss statement generated before you have a spent a dollar on your business. Your forecast needs to have revenue projections, and a detailed summary of cost of goods sold, labor costs and all other expenses.
You build your revenue figures by estimating day-over-day, week-over-week, and month-over-month how many customers are coming into the business. Sounds like guesswork. Wrong! You have to estimate by checking out the competition and discovering how many customers you see yourself having on any given day. With the proper due diligence, you can accurately determine your customer flow.
- Break down your days by into good, average and bad days and extend this practice to the months. This gives you a fair sense of your customer flow and you need to know how many people will be buying your goods and services.
Pricing is next. You set your prices so that you can multiply your customer flow by the “average” spend of a customer and that gives you your revenue. 100 people a day spending $10 on average results in $1,000 in revenue.
If after you have projected customer counts and average spend by your customers results in revenue that is too low in your estimation; then you can increase revenues by either:
- Increasing customer flow
- Increasing your prices
Both of these options have to be thoroughly explored. People will only pay so much and there may be a limit on how many potential customers you have in your area.
You then have to deal with cost of goods sold. Cost of goods sold is an expense that is triggered by a sale. If you are in the hardware business, every time you sell a screw, hammer or drill, your inventory is depleted and that triggers a cost of goods sold. Make a decision what you want to “mark-up” the products you are selling to be.
You could mark up your product 3 times or even 4 times. So, if you buy something for a dollar, you have to decide whether you sell it for $3 or $4. If you price it at $3 – your cost of goods sold will be 33% and if you price $4 – your cost of goods sold will be 25%.
If you are in the renovation business; then your cost of goods sold is the cost of the lumber etc. that you require completing a job.
You have to clearly break down the cost of all your products or services to ensure that you have included all possible costs – don’t cut corners. Having a handle on your cost of goods sold ahead of time means that you will be able to price properly and then be able to figure out what your real revenue is going to be. A lot of entrepreneurs price their products and services based on the competition. What if the competition is out to lunch; then your pricing will be wrong too.
Labor is next. If you plan to have employees you should make up schedules for the year – in advance. Match your revenues with employees to deliver the revenue. That will ensure that you have an accurate take on labor cost. Again, as with revenue, make up schedules for busy, average and slow days. Is it work? For sure; but don’t you want to know ahead of time what your biggest expense is going to be?
Lastly, pin down all other expenses. Here is a good starter list of accounts that you should explore:
- Advertising and Promotion
- Bank Charges
- Legal & Accounting
- Motor Vehicle
- Office Expenses
- Professional Fees
- General Supplies
- Web Design and Maintenance
If you put the time into building your financial forecast, you will be in a position to decide whether your concept is viable. That is why we call it “proving” your concept. At the end of this stage, you will know before you have signed a lease or borrowed any money whether you should sign the lease or go into debt – you would have “proved” your concept.
Having an accurate financial forecast will put you on the path to profitability. Not having an accurate financial forecast will send you into battle unarmed.
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