By Rajiv Varma
Make financial projections and prepare a business plan
This will help you finance your business. Your investors and bankers will ask for this when you go to them for financing. Understand the importance of keeping low fixed costs. Also, pay attention to the concepts of economic profit and opportunity costs.
Be realistic and conservative in your financial projections. On the cost side, pay attention to three major costs:
Firstly, the startup costs: these are one-time costs, e.g. purchase of property or cost of specialized training in a field. Although substantial, these costs are harder to control because they are fixed.
You may be able to negotiate these down slightly, but often you will have to put up the money. Having said that, it is always prudent to keep the costs lower and get the best deal possible.
Keep fixed costs under control
Secondly, pay extreme attention to fixed operating costs (this is important!). This is money you will be spending, regardless of how your business is doing, e.g. monthly or annual rent, employee salaries etc. It is very important to keep these costs under control, because they serve as ticking time bombs. Lets say you have 100K in capital and your monthly fixed costs are 10K. In absence of any revenue, which is often the case when you start a new business, you will have 10 months before all of your cash reserves are totally depleted. At that time, either you will have to borrow from a bank or sell some equity to investors willing to invest in your money-loosing business.
We cannot understate the importance of controlling your fixed costs: the higher your fixed costs are, the more business you will have to earn to make your business profitable.
There are several ways you can control your fixed costs. You should first minimize the costs that do not considerably affect the quality of services you offer, e.g. choosing first floor or second floor retail space, which can be cheaper than prime retail space at ground floor. You could also choose cheaper software to manage your operations, rather than spending a lot of money on software that offers tons of features you will never use.
You should not compromise on fixed costs which have a considerable impact on the quality or on your revenue stream, e.g. try to hire the best yoga teachers that have the charisma and ability to develop a following clientele, even if they are a bit more expensive.
Understand your profit-margin
The third major cost is the variable cost: this is the money that you spend when there is revenue. For example: if you pay your instructors on a per-student basis, the cost will be considered a variable cost. The profitability will be determined by the difference between your revenue and your variable cost, plus your fixed costs.
Revenue and Cash-Flow
Now, let us pay attention to the revenue that you generate by selling your products and/or services. In the beginning you will not have much revenue, so you will be depleting your cash reserves; but, hopefully, you will ramp up sales and a healthy revenue stream will build up.
You must understand the difference between cash-flow and revenue. Products can be sold on credit, but they may not generate enough cash-flow, which a growing business might require quite desperately. Therefore, a prudent policy of terms of sales with your customers should be established so that enough cash reserves can be maintained.
We hope that all goes well and that, eventually, your revenue becomes greater than your costs. At this point, pat yourself on the back as you are the proud owner of a profitable business. This is no small feat: about 96% of businesses fail within 10 years.
To be successful, a business must become profitable, but unfortunately, a profitable business does not guarantee a "successful" business. This is because of a very important concept called "economic profit."
Running a business full-time means giving up the salary which you would be making as a full-time employee. This is called "opportunity cost." Economic profit is the profit made after deducting the opportunity cost from the accounting profit.
Pay attention to this number when doing financial projections. If you have a family to support, then estimate the number of years on which you can survive with negative economic profit. You will dipping into your savings for your living expenses. This also has a huge impact on the success of your business. No business is born profitable; it requires time and patience.
A money-loosing business will eventually run out of capital. A profitable business, on the other hand, has no such time limit. Therefore, the chances of a massive success in a marginally profitable or even a break-even business are much higher, because you have more time to figure out creative ways to attract customers and drive up sales.