Some people have a bigger problem than others when opening a new business. These are folks who are completely enamored with their business concept and eager to begin. They are so smitten and eager to start, they have no patience with the economic realities involved in their business. If you recognize this tendency in yourself, it's extra important that you prepare a financial forecast carefully and pay attention to what it tells you. This step tells you whether your idea is a sure winner, a sure loser, or, like most ideas, whether it needs work and polishing to make it presentable.
How can you tell if your business idea will be profitable before you implement it? The honest answer is, you can't. This fact makes business scary. It also makes it adventurous. After all, if it were a sure thing, everyone would go into business.
Just because you can't be sure you will make money doesn't mean you should throw up your hands and ignore the whole problem. You can and should make some educated guesses. Think of them as SWAGs (scientific wild-ass guesses). The challenging part is to make your profit estimate SWAGs as realistic as possible and then make them come true.
The best way to make a SWAG about your business profitability is to do a break-even forecast. Although a break-even analysis or forecast can never take the place of a complete business plan, it can help you decide if your idea is worth pursuing.
Most financial backers expect you to know how to apply break-even analysis to your business. Your backer may ask what your profits will be if sales are slightly higher or lower than your forecast.
Many experienced entrepreneurs use a break-even forecast as a primary screening tool for new business ventures. They won't write a complete business plan unless their break-even forecast shows that the sales revenue they expect to obtain far exceeds what they need to pay all the bills. Otherwise, they know their business will not last very long.
In essence, a break-even analysis involves making the following estimates and calculations:
- Sales revenue. This consists of the total dollars from sales activity that you bring into your business each month, week, or year.
- Fixed costs. These are sometimes called " overhead," and you must pay them regardless of how well you do. Fixed costs don't vary much from month to month. They include rent, insurance, and other set expenses.
- Gross profit for each sale. This is defined as how much is left from each sales dollar after paying for the direct costs of that sale. For example, if Antoinette pays $100 for a dress that she sells for $300, her gross profit for that sale is $200.
- Break-even sales revenue. This will be the dollar amount your business needs each week or month to pay for both direct product costs and fixed costs. It will not include any profit.
You owe it to yourself do this analysis as one of the first steps in your business planning process.
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