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The Business Plan as Research



Is there any point to doing a business plan for your business or should you be driven by your gut instinct and intuition when managing your business?
Somewhere in the region of 50% of small businesses fail in the first couple of years. Why? There are a variety of reasons but most entrepreneurs will tell you that it is not the result of a lack of passion, commitment and hard work on their behalf. One obvious cause of failure is that businesses run out of cash. Most entrepreneurs start their business with a limited amount of funding which, even when carefully managed, will only provide for a certain amount of runway before the business needs to be self-sufficient. Doing the proper research before starting the business can be a way of getting a head start on understanding the challenges you will face and may even allow you to change direction before starting. After all, most people wouldn’t take an exam without revising or make an expensive purchase without thoroughly researching the options so why start a business without doing the same.

Can the business plan format provide a useful framework for doing this research and what are the questions to ask?
Whats the big idea?
Most people start a business because they have a vision about creating a business that is very different than the ones that currently exist. Or different from the business they are aware of. Starting a copy cat business in a competitive market can be a recipe for disaster. But believing you have a great idea is not in itself enough. Doing some quick research to understand whether there is a market for the type of business being considered is a good start.

It is also now relatively easy to do a quick internet search to see how many companies are already offering and advertising similar services. That way you can get a feel for the size of the market and the competitive landscape. Ideally what every entrepreneur wants to find is a large market for their product or service with very low competition. At the opposite end of this competitive spectrum is launching a business selling a commodity (undifferentiated) product into a highly competitive market that is dominated by large companies.

What are the questions to ask:
  • What is the purpose of my business, what specifically is the product/service I am going to sell?
  • How is my product/service different from what the competition is providing? Is this level of differentiation really enough to give me a competitive advantage?
  • What is the size of the market I am going to be entering?
  • What is the level of competition in the market in terms of numbers of competitors, the size and similarity to my business?
The aim here is for you to be able to state the overall size of the market, the size of the specific niche that you are going to target and the level of competition in that niche (number and size of firms). You will also need to be able to state the reasons why your offering is different in a way that is important to its customer and the extent of that differentiation.
What is it going to sell and for how much?
You will need to understand the products and services you are going to sell in some detail and understand what pricing strategy you are going to employ. This, together with an understanding of the costs involved in producing your product/service, will give you an idea about the gross profit margin your product will make. You will need to understand the competition in the market and how they are pricing their offerings.
To generate some form of financial plan for your business you will need to be able to estimate the volume of unit sales you will make for at least the first 18 months of your business. This is not easy and will depend on the level of detail you have behind your marketing plans and the amount you plan to spend on marketing. It will also depend on the level of competition in your market and the extent to which your product/service provide something that is different from the competition. What are the questions to ask:
  • For each product/service I am going to sell how much am I going to be able to sell it for and how much is it going to cost me to buy or produce it?
  • From the above, what is my gross profit margin for each product?
  • What is the volume of units sales for the next 18 months to 3 years?
  • From the above what gross profit will you business be making each month for the next 18 months to 3 years?
The level of gross profit that is required to generate a successful business will depend on the nature of the business and the level of its overheads, which we will come on to shortly.
How will you market it and what will it cost?
Do you have a clear understanding of who your customer is and how they will find out about your business? Do you have a clear view on how, once they have found out about your business, they will move down the ‘buying funnel’ and become customers? The more information you can have at the outset about how you are going to market your business and, particularly, the cost involved in acquiring your customers, the better prepared you will be to turn your business into a success.

Digital marketing is becoming an increasingly popular means of marketing the startup business as more and more people use the internet as their first port-of-call to find answers and services. It’s possible to use tools such as Google Adwords to get a sense of the level competition, and cost, associated with advertising particular product/services.

For any given keyword Adwords will give you an estimate of the cost per click (CPC) of someone clicking on your ad and being directed to your website. You can use this to get a sense of the cost of involved in using paid advertising to attract visitors to your website and, ultimately, acquiring them as customers.

Lets take a simple example. Suppose that your business is to sell furniture and that Adwords tells you that it will cost £2 per click to advertise on their platform. That means that each visitor to your website, from Pay Per Click (PPC) advertising , will cost £2. Lets assume that in your business you can expect to convert 2 in every 100 website visitors into paying customers. That means the advertising customer acquisition cost is £100 for each customer. Now, whether this is a good or bad figure will depend on the nature of your business and particularly on the lifetime value that each customer will bring to your business. If you think that each customer is only ever going to make a single one-off purchase of £90 then spending £100 on advertising to acquire that customer is going to generate a large loss for your business. However, if you believe that the customers you attract will be making repeat purchases over several years and generating thousands of pounds in profits, then spending £100 to acquire that customer is likely to be good value.

Perhaps the important point to note is that even if you don’t intend to use paid internet advertising it can give you an indication of the general level of competition and cost of marketing in your particular market. As the level of competition goes up so does the cost of acquiring a customer relative to their lifetime value of their purchases, and the volume of business available to any one business goes down. If your plan is to use inbound or content based marketing to market your business it will be worth looking at the number of your competitors who are already actively engaged in marketing through the main social media channels. This will give you a sense of the challenge and likely response to your own efforts.

What are the questions to ask:
  • Who is my target customer?
  • What form of marketing am I going to use to make my target customer aware of my business?
  • What process am I going to use to convert the potential customer into an actual paying customer?
  • What is the cost I will incur in acquiring customers either in terms of paid advertising or content creation time or both?
  • What is the lifetime value that the customer will provide to my business?
  • Does the customer acquisition cost, when compared to the customers lifetime value, suggest a viable business model?
How will you operate it?
Once you are clear on the details of your business, the products/services it will sell and the level of competition it is worth considering how you will operate the business to deliver those customer orders. Will you need a physical presence, an e-commerce platform, and staff to manage your business and if so at what point over the next couple of years will you need them? This is the point when it is worth thinking about what you will need to do to start delivering a service and all of the overhead costs you are likely to incur when you are operating.

The key questions
  • Go through a list of the typical business overheads and put an estimate in for the cost you will incur for each category. Start by thinking about how you will operate the business and what costs will be incurred in delivering as your business grows. Use the overhead list as a checklist to ensure you don’t miss any areas
  • Use the sales volume profile you have produced to provide a guide as to how the cost of your business will grow and pay particular attention to the major cost items - staff costs and property are two of the biggest and IT costs can be significant if you are planning to create any web based applications
  • Don’t forget to include the cost of any assets you will need to buy to manage your business such as computers, furniture or specialist equipment
The aim is to generate a overhead cost profile for your business over the next 18 months to 3 years. People generally under estimate costs and over estimate revenues and so it is always a good idea to include a level of contingency (10-20% as a minimum) to cover the unforeseen
What profits will it deliver and is that enough?
This is the point where you can now pull all of the financial information together to produce a 18 month to 3 year cash-flow forecast. For each month you will have the gross profit figures and the overhead figures. Make sure as you review them that they are consistent - steadily growing sales volumes are likely to increase overheads at some point. Also, don’t forget about providing for business taxes if your business is generating profits.

Key Questions to ask:
  • At what point does your business start generating a profit and what is the total cash outflow until it become profitable?
  • The start-up costs (pre-trading) and the losses generated until business is profitable constitutes the amount of funding your business will need - do you have access to that level of funding or a plan for getting access to it?
  • Don’t forget that you will also need to fund your own lifestyle until the point when your business can afford to pay you a salary - how long is that time period and have you got the personal funding in place to cover what you need?
What if you got it wrong?
In all probability your plan will not be an accurate representation of the way your business will pan out. Most plans aren’t. It can be helpful to try and anticipate the key risks to your plan and do some scenario analysis to understand the impact of certain of your key assumptions being wrong.

Key Questions to ask:
  • What happens if my volume forecast is over-estimated by, say, 20%? What level of monthly sales volumes do I need to break-even and generate the level of profit I require from the business? Is this realistic?
  • What happens if I have over-estimated the price by, say 20%, (or underestimated the cost by 20%)? What gross profit margin do I need to sell my products/services at to cover my overheads and then make a reasonable profit? Is this realistic or too ambitious?
  • What is the financial impact of the major risks I anticipate and what is the impact of having significantly underestimated the customer acquisition costs?
  • How long can I afford to fund myself and the business for?
  • What are my 1 month, 2 month & 3 month targets that will tell me that my business performance is on track or tell me that the business is not working and that I need to re-think my plan?
Next Steps
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Written by Accquant Chartered Accountants
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