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What does feasibility budgeting mean?
At its most basic, it’s working out if you can make money from your business idea. Depending on how much detail you go into, you can also start to work out what your return on investment would be.
Should this be done in isolation?
This is an essential process every single business should go through prior to committing to starting a business. Even going through the process of doing some ‘back of an envelope’ calculations are better than nothing, but the more detail you go into the better off you will be. As well as doing a feasibility budget, you should also do a cash flow forecast which will give a wider understanding about the flow of money in and out of your business.
This should also be done alongside a ‘practical feasibility’ which checks to see if there are any ‘deal-breakers’ that would mean your business will not be able to start or succeed.
Process of a feasibility
There are lots of ways to undertake a feasibility study, but this guide purposefully starts with a relatively basic method. If you are starting a business with low costs or low-risk this might be enough. If you are spending a lot of money and/or pursuing something that is high-risk, then you might want to consider getting professional assistance.
How to use this business guide
This guide is purposefully broken down into stages so you can just do one or two of the steps at a time. You may want to use a feasibility template to help you but it’s not essential, and you could use word or excel depending on what you are most comfortable with.
Before you can forecast any figures, you need to have an understanding – as far as possible on:
Working out these figures is a whole task in itself, but essential to preparing figures so it’s worth spending the time to get this right.
See also: Forecasting sales for new businesses
Stage two – gross margin
What is a gross margin?
This is the difference between the sale price of a good or service and the direct costs associated with producing that product or service. Gross margin does not take into account overhead or fixed costs that don’t change with the number you produce. A simplified example is making and selling a jar of chutney (costs illustrative):
Sale price / income per unit £3.75
Labour cost per unit £0.55
Ingredients cost per unit £0.95
Jar and labelling per unit £0.25
Total direct costs £1.75
Gross margin £2.00 per unit / per jar
To calculate the gross margin for an enterprise, you will need to multiply the unit gross margin (£2.00 in this example) by the proposed unit of sales.
Using the above example:
£2.00 x 10,000 units = An enterprise gross margin of £20,000
See also: Writing a business plan
What can we assess from a gross margin?
It is a useful starting point to see if, before you take fixed costs or overheads into account, whether there is a good enough gross margin to start with.
If you are happy that the gross margin gives you some ‘room’ to play with, then continue with the next stage of the feasibility.
If the gross margin is too small to be feasible at this stage either:
In stage one you will have assessed and estimated all of your costs, both the variable costs you used in your gross margin calculation and the fixed costs and overheads.
To forecast the profitability of a business you need to add your fixed or overhead costs to your gross margin. In brief, this includes all the costs that cannot be attributed to a unit and that will cost the same whether you sell one unit or 1,000.
Example fixed costs for a chutney business might include insurance, marketing, delivery costs, phone, electric.
Sales/income (£3.75/unit x 10,000) £37,500
Less variable costs (£1.75/unit x 10,000) £17,500
Gross profit £20,000
Total fixed costs £9,000
HINT – set this up on a spreadsheet if you can – then you can play around with the figures more easily.
The good news about this stage is that it’s easier to estimate these costs as you should be able to get quotes for most elements of the set-up costs. Hint – the bigger the cost the more time you should spend on getting quotes and accuracy.
Some example costs to consider:
Site preparation and infrastructure costs
So having done the various figures, what are you looking for?
Fairly straightforwardly, your forecast profit calculation needs to be based on realistic figures and include all likely and possible costs. Full accounting profit and loss figures can include some complicated calculations like depreciation for example. If this is likely to be part of your business model (i.e. if you are spending a lot on depreciable items such as machinery) then it’s recommended you get an accountant or financial consultant to help you with these more complicated figures as they can have an impact on your business planning.
Once you have arrived at your best estimate profit figure, you need to ask yourself:
It’s also recommended you do a ‘sensitivity test’ to your forecast profit figures. What would happen to the bottom line if:
For example, if you are planning on letting out a Shepherd’s Hut for glamping accommodation and you have done your figures on £80/night at an average of 70% occupancy.
Do the figures again and work out what your profit/loss would be if:
Sometimes you will get the situation where, once you do the sensitivity there is no profit or maybe even a loss, which can lower your confidence and maybe put you off the idea. It’s recommended you do these sensitivity figures so you are realistic and have a financial representation of what could happen. The most difficult task of all is taking a view on estimating, and trying to get it to the most realistic financial forecast.
Profit divided by turnover x 100.
For example, £50,000 profit / £200,000 turnover = 25% profit from turnover.
Use benchmarking to compare this percentage figure with other businesses.
Final stage checks:
If, after research and using realistic figures ….
Then at this point you can move forwards with confidence and start researching the practical business considerations.
Farm diversification, diversification ideas, rural business, rural business ideas