Feasibility budgeting for new businesses

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.

See also: What’s the importance of a cash flow forecast?

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.

Stage one – research

Before you can forecast any figures, you need to have an understanding – as far as possible on:

1. What your costs are likely to be
2. What your income is likely to be

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:

1. Research your costs again and/or selling price point
2. Review the principle of your product or service

Stage three – forecasting profit

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

Fixed costs

Insurance

Marketing

Delivery costs

Phone

Electric

Total fixed costs £9,000

Profit £11,000

HINT – set this up on a spreadsheet if you can – then you can play around with the figures more easily.

Stage four – calculate start-up ‘capital costs’ (one-off set-up costs)

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.

See also: Business startup advice – Should I go to the bank first?

Some example costs to consider:

Planning costs

• Ecological survey
• Asbestos survey
• Professional fees
• Planning fees

Site preparation and infrastructure costs

• Demolition
• Groundworks
• Services – electric, water, gas, internet, drainage – clean and sewage
• Access roads and car parking
• Security

Mobile items

• Cost of purchase

Build/conversion costs

• Structural components, roofs, walls, windows, doors
• Flooring
• Lighting
• Internal fittings
• Interiors
• Labour

Equipment

• Fixed equipment
• Specialised equipment
• Fridges / freezers / ovens

Marketing

• Setting up a website
• Getting branding or a logo done
• Signage
• Setting up an office

Stage five – analyse

So having done the various figures, what are you looking for?

Profitability

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:

• Is the profit figure more or less than I was expecting?
• If it is much higher than what you were expecting, do you need to re-check for accuracy or be more conservative with the figures?
• Is the forecast profit enough to live on or achieve what you need or want to from the business?

It’s also recommended you do a ‘sensitivity test’ to your forecast profit figures. What would happen to the bottom line if:

• The unit sale price decreased?
• You sold less than you forecast?
• The costs are more than you forecast?

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:

• You had to reduce your price per night to £65/70/75/night
• You only achieved occupancy of 50/55/60%
• Your costs increased by 10/20%

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.

Other tests:

• Return from capital
• Profit from turnover

Calculated by:

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 ….

• There is a positive gross margin
• There is forecast profit
• The capital start-up costs are not prohibitively expensive and you can finance the purchase
• The return from capital is sound
• You have an acceptable profit from turnover

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

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