Only the foolhardy and reckless forge ahead with a business idea before estimating if it will really be profitable. Once you have looked at all the details involved in implementing your business idea, you need to do an estimate of your breakeven point and return on investment (ROI). The breakeven point tells you how much income you need to cover your expenses, while the ROI can give you an estimate of the actual profits you can expect to make for all the money and time you are investing.
Step 1: Estimate your costs
Start by estimating all the costs that will be involved in your business. These can be broken down into both fixed and variable costs. Some costs may be spread across more than one project, in which case you can either divide the total cost by the number of projects you have or ignore them, since you’d have those costs in your business whether you implement your idea or not.
Fixed costs are those expenses that you have on a regular basis, whether weekly, monthly, or yearly.
Variable costs are any expenses that are one-off or only occur periodically.
Step 2: Estimate your revenue
There are different types of revenue or cash that you can estimate will come into your bank accounts. This includes any income you have been getting in the past and expect to continue receiving, as well as how much that income might increase. Obviously, any increases in income will depend on additional marketing you are doing or changes you expect in the market. For example, if you are planning some new joint ventures for one of your existing products, you’ll have to estimate how much income you expect to receive from those partnerships.
The other revenue to estimate is the amount you’ll earn from new business ideas. This is the most difficult and will be a very rough guess if you don’t have any historical examples to base it on. You can gather information from people who have done these types of ventures before as a starting point. You can also look at the estimated size of your market and the average conversion rate for your business model.
Step 3: Estimate your own time investment
How many hours a day or week do you think you will have to spend on your business? For past projects, you can look at how much time you’ve put in compared to the profit you made. This shows you exactly what your return was for your time. For future projects, look at how much time you think you’ll have to spend each month.
You can calculate your time as an actual expense if you want to put a specific number value on your time. For example, do you value your time at £40 per hour? Is that how much you have earned per hour from your past projects? If so, then multiply that number times the number of hours you expect to put into your new project and add that to your total expenses.
Step 4: Calculate your break-even point and ROI
The final step in figuring out whether your business will be profitable is to compare your estimated revenue and expenses. This is just the simple sum of subtracting expenses from income.
Look at your expenses each month compared to what you expect the income to be each month. How many weeks or months will it take for your revenue to cover your expenses? That’s your breakeven point.
When will you start earning a profit on your business idea? What will your total profit be at the end of the year (total year’s revenue minus expenses)? Divide your total profit by total expenses and you’ll have your return on investment. For example, if you earned a total of £20,000 in sales in one year for one project and spent £5,000 (including your time), then your profit was £15,000. Your ROI was £15,000 divided by £5,000, which equals 3. Multiply that number by 100 to get the percentage. That’s a 300% ROI! Pretty good.
Even a rough estimate of how profitable a business idea will be can help you avoid a major investment mistake. Many get so excited about their great idea that they rush in and can lose a huge amount of money. By estimating your breakeven point and ROI, you can determine whether your business goals and plans are worth the effort and expense you will invest, and whether you should even move ahead with them.