Once you are sure that there is demand for your new business and that you can compete with companies that are already established it is time to assess the profitability. This step requires a considerable amount of research, but it is really not something you can afford to skip over.
The more it is going to cost you to set up your firm the more important it is that you do this research properly. Potentially, you could waste thousands on buying equipment, securing licences and undergoing training, only to discover you cannot make enough to cover that initial outlay.
So, how do you get an accurate picture of profitability? So you can work out if it is a viable business proposition.
Identify your business start up costs
The first step is to list the minimum equipment, licences and training you need to start a business. Then you need to add how much it will cost you to obtain it all. If you want to be through include the cost of buying new, second-hand and leasing what you need.
This will give you the basic start-up costs. If you need a loan to be able to afford to buy all of that add the interest you will pay to the list.
Now you need to list out your monthly overheads. This can be tricky to do. You just need to start with the obvious things and the rest will follow. For example start with:
Business premises rent
Power bills – just the element that keeps you connected to the grid and the lights on
Self-employment fees (e.g. in some countries you have to pay social insurance fees regardless of whether you make any money)
The best way to make sure you do not miss anything is to take yourself mentally through each of the tasks you are likely to be doing the most. As you go, note down things that cost money.
Don´t forget your annual overheads
It is really important not to forget to factor in costs that only occur periodically. Examples of this include the cost of servicing equipment, renewing licences or training new recruits. Usually the best approach with these costs is to divide them by 12 or 13 and add them to your monthly overheads list.
Work out material and labour costs
The monthly and yearly are overheads that you cannot avoid paying. They are effectively background costs that you have to cover regardless of how much work you do. Now you need to look at things like materials and labour costs that fluctuate depending on how much work you do.
This can get a little complicated, for a firm that is planning to offer a range of services. In that situation it is best to choose the tasks you are planning to do the most.
You need to sit down and work out the cost of the materials you will need and how long it will take to complete the job. It is important to factor in things like fuel and the spare parts you are likely to need on a very regular basis. You then have to subtract that amount from how much you can charge. This gives you a rough idea of how much profit you can expect to make each time you do a job.
Working out your turnover and potential annual profit
Now you need to estimate how many times a customer is likely to order something from you (aka turnover). Multiply the profit by that amount. Now subtract your yearly and monthly overheads from that figure. If you have money left over you have a potentially viable business idea.
This is a very rough way to work things out. As you can see there are a lot of variables, so you really cannot predict how much money you will make. What you will do is to get a pretty good feel for whether it will be easy to make a success of your new business or it will be practically impossible.
Remember to be realistic when calculating profitability
When you go through this process it is really important to be realistic. A common error entrepreneurs make is over-estimating the level of potential demand for their services. Or, worse they can see it is profitable if they do say 100 jobs a year, but forget to factor in the fact that each job takes a week. In other words they greatly overestimate their capacity. If you do this you can easily end up thinking a business model is viable when it is not because to be able to complete those 100 jobs you would need to hire another person. Potentially, their wages could eat up all of the profit.