Factoring in the costs to launch your business

April 24, 2013

If you’ve come up with an idea and performed some preliminary market research and have now decided to start a business, it’s important to consider how much money you’ll have to spend up front to get the business going.  These expenses are generally called “startup costs”.   It’s impossible to list all of these expenses for every type of company, but consider items like:

  • Legal/Accounting fees to set up a business

  • Lease or other real estate expenses

  • Build-out costs necessary to transform your empty space into usable workspace

  • Initial inventory, product, or raw material purchases

  • Recruiting or other employee related costs

  • Marketing or public relations costs

  • A period of expected losses while you’re getting your business up to speed

Once you have a list of your potential startup costs, it’s important to understand how quickly you’ll recapture this initial investment.  By way of example, if you have a business idea which will generate $1,000 in profit (after all expenses and taxes) each month, then you would be able to recoup your $12,000 in startup costs in 12 months.  Having a lot of startup costs isn’t necessarily a bad thing, in some industries, it is not uncommon to need several or even many years to make back all of your startup costs.  However, it is important to know how much money you’ll have to spend up front before your business can really begin operations.  This is money which needs to be raised either in the form of equity (contributions from owners), debt (loans from individuals, banks, or companies), or some other method and, without it, your business can’t really get off the ground.

Did you know that we provide custom financial models?  Ask us about them at forecast@whatisforecasting.com.

Questions to Ask When Analyzing an Industry (Market Research)

April 21, 2013

You’ve got a great idea for a product, but you’re not sure how many people might be interested in buying it.  How would you go about determining your potential market?  By doing a bit of research and building a model showing your total addressable market.  This market model would likely provide the drivers for your revenue model which was discussed here.

There are many articles online about different approaches to market research including primary (speaking to potential customers yourself), secondary (finding an analysis that has already been performed on a group of individuals or a particular market opportunity),  to looking at competitors (sometimes called competitive intelligence) of related products or looking at demographic information in a particular area.  Any, all, or none of these may be appropriate to your potential opportunity.  When conducting market research, I start by asking a few questions:

  1. How is the product or service being used?

  2. How often is that product or service being used?

  3. How “durable” is the product or service (or, how often will it have to be re-purchased by a user)?

  4. Who is using the product or service and what are some common characteristics of these users?

  5. How is it being sold?

It may be easiest to think about this in terms of some basic examples: an industrial garage door, a very high end pen , and a tax accountant.

An industrial garage door is a product which is used by businesses (typically a manufacturing company or distribution company which would have the need for a loading dock).  It is installed once and may require some basic maintenance, but should last for a long time (say 10 years).  It’s likely sold to in a building supply store or specialty store to a business customer or construction company.  Performing market research to identify the potential market for industrial garage doors might include obtaining a list of companies with loading docks within a particular region, factoring some level of growth or decline depending on whether companies are moving to or leaving the area, and dividing that figure by 10 as only about 10% of the industrial garage doors would be expected to need replacement each year, since the average life is 10 years.  The answer we’re targeting here is the total number of industrial garage door installations taking place in a particular area each year.  We wouldn’t expect to capture 100% of these sales, but by making an estimate of our market share, we should be able to have some idea of how many sales we might expect.

A high-end pen is typically used by an executive or other office professional.  It lasts a very long time, but requires frequent replacement of ink cartridges.  It’s likely sold at a stationary or gift store to either the end customer or someone who will later give it as a gift.  Here we may decide to split our market research into two pieces: one for actual pen sales and another for replacement ink sales.  Speaking to a local stationary store about their pen sales volumes might be a great place to start, and may uncover some sales trends, such as that most pen sales happen around college graduation.  It might also uncover several key competitors which may be targeting specific areas of this market.  In the replacement ink market, it would be helpful to know how frequently ink must be replaced as this would be a recurring market.

A tax accountant generally charges by the project or the hour.  Those services may be utilized by either individuals or corporations on a relatively periodic basis – perhaps annually, perhaps more frequently.  Sales are most likely local, with customers either walking into a retail establishment or via a referral from an existing customer.   Market research might start with a look at the number of individuals and corporations seeking tax assistance and the number of providers offering these services.  An estimate would also have to be made for the number of hours which must be spent on each customer each year.  Then, consider any constraints, such as the number of working hours in a year, per tax provider and considering that many of these hours might have to be spent around a couple of key dates (April 15 and October 15, as examples).

The goal at this stage is just to obtain some preliminary information about the market, and evaluate whether it is a market in which you wish to participate.  It’s possible that the market is small, very competitive, or that you are not located in an area which would be a significant enough market for your product or service, in which case it might be best to reevaluate.

Did you know that we also provide custom financial models?  Ask us about them at forecast@whatisforecasting.com.

Financial Model – Apps (iPhone App or other mobile device application)

April 24, 2012

Every couple of years, a particular type of startup business becomes really trendy.  About a decade ago, everyone wanted a “dot com” business.  After that, everyone wanted a blog.  Now, with the sale of OMGPOP and the huge valuations being put on companies like Zynga, lots of people are pursuing “iPhone apps” or “iPad apps” as a new business idea.

And, lots of people should.  There’s a lot of money to be made creating applications for the masses or even for specific niches of users.  But, that doesn’t mean that everyone should be in the app business. If you want to build an iPhone app or an app for any smart phone, be sure to think it through as a business, not just as a “get rich quick” idea.  This means:

  1. Define your goals for the project
  2. Develop a good estimate of up-front development costs and ongoing operating costs
  3. Construct a revenue model which makes sense, given points 1-2 above
  4. Set specific criteria which define your customer
  5. Craft a marketing program to go after your target customer

Define the goals of your iPhone app project

Think about what is it that you want your iPhone app to do, (note: “make me a millionaire” isn’t a complete answer!).  Think of project goals such as:

  • Customer goals: Why does your customer want your application?  Does is fill a need or address a particular pain point?  Why is this particular product “better” than alternatives?
  • Producer goals: What do you want your app to accomplish for you?  Are you looking to build a mailing list/referral list?  Do you want your app to drive views on your website?  Are you selling the app and trying to drive revenue through sales of the app?  Are you trying to increase viewership of advertisements?  Do you have “in-app” products to sell?

What are the costs of developing an application?

The next step is in understanding the costs which go into developing an iPhone app.  If you have technical skills and design skills, your major investment here might be time.  For those who wish to outsource parts or all of the development and design work, then there are real cash costs which will be incurred, in addition to time, including:

  • Identifying a developer / designer
  • Defining the project scope
  • Initial development
  • Initial design
  • Testing
  • Refinement
  • Final testing
  • Deployment

Basic applications might take several thousand dollars of investment and several weeks of work.  More complex applications can easily run into the tens of thousands of dollars and months of work.  These aren’t sums to be taken lightly.

There are also ongoing costs in the delivery of your app to the market, most notably that most “app stores” like the Apple App Store charge a percentage of sales to host and deliver an iPhone or iPad app to the customer.

How much can I make?

Here’s the big payoff… if your iPhone app costs $10,000 to develop and you sell 25,000 units your first week on the market at $1 per copy, then even if Apple charges you 30% of your revenue, you’d still make $7,500 ($25,000 * 70%) – $10,000.  Plus, you’d have opportunities to continue making money in future weeks.  So, how can you make money with an iPhone app?  Well, there are several methods, many of which may be combined.

  • Sell the application – this is an up-front fee paid by customers to download your app.  In Apple’s App Store, this is typically referred to as a premium application.
  • Sell advertising on a “pay per click” basis – this requires your customers to click on an advertisement for you to be paid a commission.  Commission rates will vary.
  • Sell advertising on a “pay per impression” basis – this requires that your customers use a your application in such a way that they see advertising.  Typically, you’re paid on a “per 1000 impressions” basis, which means that your application has shown the advertisement 1000 times.
  • Sell products, services, or upgrades “in app” – this type of revenue typically requires that some percentage of your users upgrade to a premium version (from a free version), purchase add-on products or services, or otherwise spend money on options that you provide.
  • Sell products or services “outside the app” – this requires you sell some other type of product to your app customers, such as a new app or some other product or service which isn’t directly linked to the application currently in use.  An example might be that Rovio sells “Angry Birds” books on their website.

Once you have some better ideas about your goals for the project, the costs you might incur, and the payoff you might achieve, it’s critical to make sure that you understand the customer and have crafted an appropriate marketing strategy to acquire those customers and achieve your goals.

If you’re considering developing an app, be sure to download our “Application Model

which you can use as a template in developing your specific business model.  We’ve included estimates of common costs to give you an idea of some of the expenses which you may have in developing your application, various methods to collect revenue (app sales, in-app purchases, CPC and CPM type models), and other great financial and operating metrics.

Remember to follow us on Twitter!

Financial Forecasting – Inventory (part 1)

April 19, 2012

Forecasting inventory is critical for understanding a company’s balance sheets and cash flow.  There are books written about inventory, so this topic will have to be split across several posts.  For this first post, let’s get a general understanding of what inventory is and several common methods to value inventory.

Inventory is all of the “stuff” that plan to sell and generally consists of one or more of the following: (i) raw materials, (ii) work in progress, and (iii) finished goods.

  • Raw materials are inputs which, when combined or worked, can be turned into something that will eventually be sold to a customer.  If you think about a car manufacturer, an example of a raw material might be sheets of steel, which are later turned into door panels or a hood.
  • Work in progress is basically everything that isn’t a raw material or finished good.  In the care example, this might be the chassis of a car.  It’s no longer just metal, but has been turned into something else, but isn’t yet a car.
  • Finished goods are products which are ready to sell in their current form to a customer.

Sometimes, it isn’t always clear when a piece of inventory is a “work-in-progress” or a “finished good”.  Again, thinking of the car example, a completed engine might be sold to some customers as a finished good but would also be considered a work in progress for car.  Typically, companies have a method to move various pieces between these stages to properly and consistently account for each stage of inventory.

In valuing inventory, there are a few methods which are most typical: FIFO, LIFO, and Weighted Average Cost.

  • FIFO is defined as “first in first out”, which means that when a company sells a piece of inventory, they will effectively “sell” the first piece which was placed in inventory.
  • LIFO is defined as “last in first out”, which means that when a company sells a piece of inventory, they will effectively “sell” the last piece which was placed in inventory.
  • Weighted Average means that when a company sells a piece of inventory, they will sell that piece at the average cost of all pieces in inventory.

This might be much clearer with an example.

In this example, inventory costs are going up slightly ($1 each time our company is buying the inventory).  You can see that when the first piece of inventory is purchased, it is valued the same under the FIFO, LIFO, and Weighted Average methods.  Similarly, when that first piece of inventory is sold, the inventory balance decreases by the same $20.

The differences between the methods come about when the company has more than one part in inventory, and then makes a sale.  As you can see, from January 4 to January 10, the inventory balance is the same.  On January 11, however, under FIFO, the company is effectively selling the piece of inventory which was purchased for $21 on Jan 4.  Under LIFO, the company sells the piece of inventory purchased most recently or the $24 piece of inventory purchased on January 10.  Under the weighted average method, inventory declines by $22.5 (the average of 21, 22, 23, and 24).

There can be good reasons to pick one inventory valuation method over another, but these basics will at least help you understand the common inventory valuation methods.

 

Starting a business? Consider a Booth at a Trade Show or Fair.

April 9, 2012

If you think you have a great idea for a product that you want to introduce to a large group of people or are looking to “get the word out” about your new business, sometimes participating in a trade show or fair is a great method to achieve a quick level of recognition in the marketplace.  Selling at a trade show is great for someone looking to start many different types of businesses, including:

  • Bakery startup
  • Restaurant or food concepts
  • Clothing, leather goods, or t-shirt startups
  • Crafts startup
  • Artists, including painters, sculptors, wood or metal workers, glass makers, and pottery makers
  • Jewelry makers
  • Other small manufactured products for homes or businesses

To successfully start a business through trade shows or fairs, consider these 5 steps:

  • RESEARCH – Find a trade show which is appropriate given your product and understand your competition at that trade show.  It might be very hard to sell chicken sandwiches at a vegan festival, but entering a bar-b-que chicken in a BBQ fair could be great publicity, in addition to being a great way to sell product.  Make sure you understand how your competition might be selling products and try to develop a unique method for selling your products at an attractive price point.
  • MINIMIZE  – There are fees involved in selling at a trade show or fair, and anything you can do to manage your expenses will greatly improve your bottom line.  Additionally, setup at trade shows or fairs can be very time and labor intensive.  Your back will thank you for each pound of extraneous equipment that you can leave behind.  This isn’t to say that you should go with a bare-bones booth; on the contrary, an attractive booth with well-displayed products will generally attract more attention than a comparable booth with folding tables.  Just consider the trade off between the extra “stuff” and the benefits you might get from having that stuff at your booth.
  • BE FLEXIBLE – Cash or credit is a great way to sell products, particularly at a higher price point.  Customers may not carry $500 in cash to buy your painting, but they probably will have their credit card.
  • BUILD YOUR NETWORK – Even if you don’t sell each customer a product, get them interested in your business and get their information.  Building a mailing list, distributing business cards, and getting publicity from trade shows is critical to building a bigger business.
  • GROW AND PROSPER – Keep track of your sales and expenses at each trade show.  Analyze what worked and didn’t work, so that your next show can be even more successful.  Also, make sure that each trade show or fair that you participate in generates revenues which more than cover your costs.  If they don’t, it will be very hard to continue to build your business.

If you’re considering starting a business via a trade show or fair, check out our trade show financial model.

Trade Show or Fair Model (General Merchandise)

Remember to follow us on Twitter!

Financial Model – Starting and Building a Business at Trade Shows or Fairs

April 9, 2012

This model highlights some of the costs incurred in starting a business at a Trade Show or Fair, as well as a model for revenue and expenses which you might be able to generate at each trade show.  Includes a break-even figure for units sold and other operating metrics including units sold, gross profit, gross margin, net margin.

[paidownloads id ="3'"]

Consider all of our other models here.  Did you know that we also provide custom financial models?  Ask us about them at forecast@whatisforecasting.com.

 

 

 

Financial Forecasts: What is an Accrual?

March 28, 2012

Although it’s possible to have an accrual which would be treated as an asset, almost always an accrual refers to a liability of the company for which the company has not yet received an invoice.  Common accruals are related to payroll, vacation, material purchases, utilities expenses, or similar.

Each type of accrual may be calculated a bit differently by each company; however, there are some relatively common methods.

  • Based on prior periods – Assume a company is billed for utilities on a monthly basis and receives the bill approximately 15 days after the end of the month.  If the company is trying to close the August books within a couple of days of month end, they will not have received the utility bill until September 15th.  They may therefore record an accrual for utilities expenses equal to the utility bill from July, as the July bill would have a similar number of days, similar rates, and presumably a similar level of utilities usage as August.
  • Based on time – A company may only pay a property tax bill once a year, but, for accounting purposes, will want to spread this expense throughout the year.  If a property tax bill for $1200 is expected to be received in January for the year, a company might choose to accrue $100 per month for property taxes.  The accrual would then increase $100 per month until year end when the balance would be $1200.  Then, when the company receives the bill, it will pay the bill and reverse the accrual.
  • Based on an estimate – Vacation accruals typically updated on a monthly basis based on the number of employees, the amount of vacation days that each employee earns per month, the number of days of vacation taken, and the prior balance of vacation days outstanding.  The company then takes this estimate of vacation days outstanding and multiplies it times the average salary per day to calculate the balance of a vacation accrual.

When building a budget model or other “large scale” set of projections, typically, all but the largest accruals can be ignored; however, specific accruals may be large enough to consider in your financial model and understanding how each may build through the year can be very important in understanding cash flow.

 

Favorite Functions: =if( and =roundup(

March 26, 2012

One of the most powerful functions in Excel is the “if function”.  The if function is tremendously helpful with constructing a financial forecast, particularly for scaling certain expenses subject to certain criteria.

The function “=if(” is used to provide one result under one set of circumstances and a different result under a different set of circumstances.  The form of the function is =if(test, value if true, value if false).  It’s easier to see in an example:

+if(A>B, A, B)

In this function, we test whether A is larger than B.  If A is larger, then the cell will equal “A”.  If A is not larger, the cell will equal B.

What makes the “if function” so powerful, is that it can be used in conjunction with virtually every other excel function, including additional “if functions”.

Let’s assume the following:

  • Revenue is $1000 per unit
  • Cost per sales person is $1000 per sales person, per month
  • A sales person can only sell 10 units per month
  • You must have at least 1 sales person
  • There are no “fractional” sales people, in other words, we’ll have to hire another sales person if we have more than 10 units sold in a given month.

How would you create a spreadsheet which would do this, assuming that you project units sold of 4, 8, 12, 16, 20, and 40 units?  There are several ways to do so; however, here’s an example using the “if function” in combination with the “roundup function”.

Note that the form of the roundup function is =roundup(value, digits) so that if you were rounding up the number 3.2 to the “0″ digits place, it would look like =roundup(3.2,0) and would give you a result of 4.

After calculating the functions, these formulas would provide the following result:

Many models will be straightforward enough that they do not require the use of the “if function”; however, if you find yourself wanting to build a complex model, the “if function” can sometimes be a life saver.

Financial Forecasts – Days Sales Outstanding in Cash Flow Projections

March 22, 2012

As mentioned in the earlier analysis of accounts receivable here, days sales outstanding is a metric which quantifies the time between the time a company makes a sale and the time that the company collects cash.

The specific calculation for days sales outstanding is: (Accounts Receivable Balance /Average Day of Sales) is equal to days sales outstanding.  Unless you’re an accountant or frequently look at financial statements, knowing the definition isn’t particularly helpful, so let’s look at an example:

In this simplified income statement and balance sheet, showing one month of results, the company has sold $1 million worth of products or services  and collected $1 million of cash.  Now, imagine if it took a company 30 days to collect money.  In this scenario, after the first month, the company’s financial statements would look like this:

In this scenario, the company would have $0 in cash, but $1 million of accounts receivable.  All other accounts would be the same.

You can probably imagine that if the company had days sales outstanding of 15, then the company would have $500k of cash and $500k of accounts receivable as sales which took place in the first half of the month were able to be collected; however, sales in the second half of the month wouldn’t be collected until the following month.

Now, imagine that the company has 45 days of sales outstanding.  What would the financial statements look like at the end of months 1 and 2?

You can see that at the end of month 1, the company only has accounts receivable, but by the end of month 2, $500k had been collected and $500k remains outstanding as accounts receivable.  Said another way, the company’s cash flow in month 1 is $0.  In month 2, the company would have $500k of positive cash flow.

When building a financial forecast, it’s easiest to follow these steps to ensure that you’re appropriately capturing accounts receivable in your cash flow.

  1. Forecast revenue by month, using a revenue model
  2. Determine an appropriate “days sales outstanding” figure.  If you’re starting a new business and don’t know a good DSO figure, you might check publicly traded companies in the same industry as a starting point.
  3. Calculate accounts receivable, by dividing each month’s revenue by the number of days in the month, times the DSO figure from step 2.
  4. Calculate cash flow which is (in this simplified example), equal to monthly income + accounts receivable in the prior month – accounts receivable in the current month.
  5. Your ending cash balance is equal to the cash balance at the end of the prior month, plus the cash flow which you calculated in step 4.

In other words, your 3 financial statements will look like this:

This completed model is posted in our models section here.