Financial Feasibility analysis

Financial feasibility analysis is the final component of a comprehensive fea- sibility analysis. For feasibility analysis, a preliminary financial assessment is usually sufficient; indeed, additional rigor at this point is typically not required because the specifics of the business will inevitably evolve, making it impractical to spend a lot of time early on preparing detailed financial forecasts.

The most important issues to consider at this stage are total start-up cash needed, financial performance of similar businesses, and the overall financial attractiveness of the proposed venture.

If a proposed new venture moves beyond the feasibility analysis stage, it will need to complete pro forma (or projected) financial statements that demon- strate the firm’s financial viability for the first one to three years of its existence. In Chapter 8, we’ll provide you with specific instructions for preparing these statements.

1. Total Start-up cash needed

This first issue refers to the total cash needed to prepare the business to make its first sale. An actual budget should be prepared that lists all the anticipated capital purchases and operating expenses needed to get the business up and running. After determining a total figure, an explanation of where the money will come from should be provided. Avoid cursory explanations such as “I plan to bring investors on board” or “I’ll borrow the money.” Although you may ulti- mately involve investors or lenders in your business, a more thoughtful account is required of how you’ll provide for your initial cash needs. We’ll cover funding and financing in Chapter 10.

If the money will come from friends and family or is raised through other means, such as credit cards or a home equity line of credit, a reasonable plan should be stipulated to repay the money. Showing how a new venture’s start-up costs will be covered and repaid is an important issue. Many new ventures look promising as ongoing concerns but have no way of raising the money to get started or are never able to recover from the initial costs involved. When projecting start-up expenses, it is better to overestimate rather than underestimate the costs involved. Murphy’s Law is prevalent in the start-up world—things will go wrong. It is a rare start-up that doesn’t experience some unexpected expenses during the start-up phase.

There are worksheets posted online that help entrepreneurs determine the start-up costs to launch their respective businesses. Start-up cost work- sheets are available via SCORE (www.score.org) and the Small Business Administration (www.sba.gov).

2. Financial performance of Similar businesses

The second component of financial feasibility analysis is estimating a proposed start-up’s potential financial performance by comparing it to similar, already established businesses. Obviously, this effort will result in approximate rather than exact numbers. There are several ways of doing this, all of which involve a little gumshoe labor.

First, substantial archival data, which offers detailed financial reports on thousands of individual firms, is available online. The easiest data to obtain is on publicly traded firms through Hoovers or a similar source. These firms are typically too large, however, for meaningful comparisons to proposed new ven- tures. The challenge is to find the financial performance of small, more compa- rable firms. Samples of websites that are helpful in this regard are provided in the Internet Resource table in Appendix 3.2. IBISWorld, BizMiner, and Mintel provide data on the average sales and profitability for the firms in the industries they track. Reference USA provides revenue estimates for many private firms, but fewer libraries subscribe to its service. (This resource is more commonly available at large city libraries.) On the expense side, a very useful website is BizStats.com, where an entrepreneur can type in the projected revenue of his or her firm, by industry classification (not all industries are covered), and receive a mock income statement in return that shows the average profitability and expense percentages of U.S. businesses in the same category. IBISWorld also normally provides a chart of the average expenses (as a percentage of sales) for major items such as wages, rent, office and administrative expenses, and utili- ties for firms in the industries they follow. Another source to help estimate a firm’s sales and net profit is BizMiner (www.bizminer.com). BizMiner provides a printout of the average sales and profitability for firms in the industries it fol- lows and provides more detail than similar reports. It is a fee-based site but is

free if accessed through a university library that subscribes to the service.11

There are additional ways to obtain financial data on smaller firms. If a start-up entrepreneur identifies a business that is similar to the one he or she wants to start, and the business isn’t likely to be a direct competitor, it’s per- fectly acceptable to ask the owner or manager of the business to share sales and income data. Even if the owner or manager is only willing to talk in general terms (e.g., our annual sales are in the $3 million range, and we’re netting around 9 percent of sales), that information is certainly better than nothing. Simple Internet, ProQuest, and LexisNexis Academic searches are also help- ful. If you’re interested in the sports apparel industry, simply typing “sports apparel industry sales” and “sports apparel industry profitability” will invari- ably result in links to stories about sports apparel companies that will mention their sales and profitability.

Simple observation and legwork is a final way to obtain sales data for similar businesses. This approach is suitable in some cases and in others it isn’t. For example, if you were proposing to open a new smoothie shop, you could gauge the type of sales to expect by estimating the number of people who patronize similar smoothie shops in your area, along with the average purchase per visit. A very basic way to do this is to frequent these stores and count the number of customers who come in and out of the stores during various times of the day.

3. Overall Financial Attractiveness of the proposed venture

A number of other factors are associated with evaluating the financial at- tractiveness of a proposed venture. These evaluations are based primarily on a new venture’s projected sales and rate of return (or profitability), as just discussed. At the feasibility analysis stage, the projected return is a judg- ment call. A more precise estimation can be computed by preparing pro forma (or projected) financial statements, including one- to three-year pro forma statements of cash flow, income statements, and balance sheets (along with accompanying financial ratios). This work can be done if time and circum- stances allow, but is typically done at the business plan stage rather than the feasibility analysis stage of a new venture’s development.

To gain perspective, a start-up’s projected rate of return should be weighed against the following factors to assess whether the venture is financially feasible:

■ The amount of capital invested

■ The risks assumed in launching the business

■ The existing alternatives for the money being invested

■ The existing alternatives for the entrepreneur’s time and efforts

As promising as they seem on the surface, some opportunities simply may not be worth it financially. For example, it makes no economic sense for a group of entrepreneurs to invest $10 million in a capital-intense, risky start-up that offers a relatively low return (say around 3 percent) on the capital the entrepre- neurs are investing. The adequacy of returns also depends on the alternatives the individuals involved have. For example, an individual who is thinking about leaving a $150,000-per-year job to start a new firm requires a higher rate of re- turn than the person thinking about leaving a $50,000-per-year job.12

Other factors used to weigh the overall financial attractiveness of a new business are listed in Table 3.6.

Source: Barringer Bruce R, Ireland R Duane (2015), Entrepreneurship: successfully launching new ventures, Pearson; 5th edition.

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