Startup Profit Potential

What is the Startup Profit Potential of Your Business Model?

One key element of your business model to evaluate is the startup profit potential. Can your business model earn you the profit you require or will it end up being a money pit?

Break Even Analysis

The most common method of evaluating the profit potential of a new business is to undertake a break even analysis. Break even analysis will tell you how many units of your product or service you would need to sell to break even. The break even point is where your costs match your sales volume and you have made neither a profit or a loss.

The formula for calculating your break even point is:

Sales -([Variable Cost per Unit x Sales Volume]- Fixed Costs) = EBIT = 0

Where:

• Variable Cost = cost of goods and selling expenses, which vary with changes in production volume
• Fixed Cost = administrative expenses that do not vary with changes in production volumes
• EBIT = Earnings before income tax

You may have noticed from the equation, that you will need to develop cost estimates for your fixed and variable costs, and determine prices before you can calculate your break even point.

Identifying Your Operating Costs

Before you can even begin your break-even analysis you will need to identify your operating costs and classify them into fixed and variable costs.

Fixed costs are costs that do not vary in total as sales or production volumes changes over a relevant output range. These costs include administration costs such as rent, salaries, utilities, and depreciation.

Variable costs are the costs that you incur as you produce or sell your products or services. These cost vary with any changes in production or sales volumes, and include costs such as material costs, sales commissions or shipping costs.

Setting Your Prices

Getting your small business pricing right is a critical factor determining the success of your new small business. Some of the factors that will influence the development of your pricing strategy include, customer value, your competitors, and your market position.

The method you use for setting your prices will depend on your competitive strategy you choose for your business, and the competitive conditions that exist within your industry. The two main methods of determining your price are cost-plus or a variant of market value.

Using Your Cost Data to Calculate the Break-even Point

When you have identified and classified your operating costs, you can move on to calculating your break-even point. Then you will be able to investigate the startup profit potential of your business idea!

Calculating your Total Operating Costs

Once you have determined your break even point, you will be able to work out your target sales volumes. With a sales volume, you will also be able to calculate an estimate of your operating costs and begin to develop your operating budget.

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