Psychology homework help. Background
One of the major reasons for failures of small business is inadequate capital. For some reason, many of us are convinced we can operate on a shoestring and build. That’s actually a very difficult way to go–and by difficult we don’t simply mean hard or challenging, we mean in most cases it is not possible. There is a basic rule in small business that applies to the business generally and any particular project. From experience we can tell you the rule is a good one and you should use it. Here is the rule:
Once you have your best estimate for how much something will cost and how much money you’ll make, double your costs and cut your anticipated earnings by half. If the costs are still less than the earnings, you’ll probably make it. If the costs are more than earnings, you will probably not succeed in the project.
Chances are as you read that you either think it is too harsh or that you can beat it. So, does everyone else. They are just as incorrect. You need a certain amount of arrogance and can-do attitude to succeed in building your own business, but you should also be wise with the finances.
So, let’s talk more about financing.
Opportunity Cost – Opportunity cost is what you can’t do because of what you did do. Often there is a chain of consequences. For example, in the morning when your alarm goes off, you can turn it off and go back to bed. If you do, you will get more sleep, but you will be late for work. If you’re late for work, you could be disciplined or lose your job. If you get up and go to work, you don’t get the extra sleep. The idea of opportunity cost is that there is always a cost to every choice. How does this play into financing? Let’s say I have some money available. I’m either a friend, a bank, or whatever. You want me to give you my money so you can start your business. I could use that money for another business. I could use it to invest in my retirement plan, buy stocks, go gambling, buy a lot of hamburgers, or whatever. Each of those choices has some kind of reward for me. It’s your job to convince me that the reward of investing in your new company is better than the other rewards I might have. Banks will typically want straight numbers (though not exclusively). In other words, they want you to show that they will earn more investing with you than they would by simply putting the money in stocks. This is especially true since most small business fail. Your Aunt Clara may accept a lower return than she gets on her stock purchases because she has always loved you and she wants you to succeed.
Return on Investment (ROI) – You should have a clear plan for how you will make money. Small publishing companies use simple spreadsheets for ROI that include the book title, how many copies you intend to print, the cover price, and then it goes on to list how many of the books will be sold to big stores, catalogs, directly, and so on. Each of these venues has a different sale rate. For typical stores, products go in at about 50% of retail value. So, if I list my book for $7.99, I will only get $3.99 for it. The store gets to keep the rest. I also have to account for problems. With books, it would include damaged books and books that just don’t sell. I might have 10% of my book production as my estimate of unsold or damaged. That means I get nothing for them and so the burden of earning back my investment and making money would rest on 90% of my print run. My ROI will also show costs. How much am I paying to make the books, ship them, store them, advertise, etc. At the end, my ROI will compare my costs with projected revenue. An Excel sheet is nice because you can put in formulas that allow you to make small adjustments to fine tune the projections easily.
Your investors are going to want to see your overall business ROI for your business plan. That means you need to show costs and revenue over the 3-5-year period of the plan with at least yearly breakouts. More importantly, you’ll want to see the breakouts to be sure you want to do this. Potential freelance consultants often find they don’t want to freelance because of how the ROI comes out. Here is a summary of one:
- Time:
- 52 weeks in a year – 2 week vacation – 1 week for winter holiday – 1 week sick = 48 weeks for work.
- 40 hours per week x 48 weeks = 1920 hours for work
- Since starting from scratch, need 60% of time for chasing customers. 60% x 1920 hours = 1152 hours, leaving only 768 hours.
- Need at least 2 hours per week for administrative stuff–billing, paying for supplies, etc. 2 hours x 48 weeks = 96 hours. 768 – 96 = 672 billable hours.
- Starting salary in my field is $18 per hour. That is an annual salary of $34560. If I made at least $35,000, I could meet my budget expenses–but wait, I have to pay self-employment tax, my own retirement plan, and my healthcare. Depending on who is asked, I should figure I need an income at least double a traditional worker to cover those extra expenses. 2 x $35,000 = $70,000. Divide $70,000 by my billable hours of 672 and I need to charge clients $104 an hour to make this work.
You can see how this can quickly become a problem. You should carefully map out what your costs are going to be–including living expenses–and have an answer for how to meet them.
Don’t let this example discourage you. It should make you think and decide to plan well. There are many rewards for owning your own business and people successfully launch and sustain businesses all the time.
Assignment
Create a funding plan with two parts. Part I should be your ROI or budget. What are you offering? How much will it earn you in year one, year two, and year three? What are your expenses? Separate fixed expenses from one-time expenses. Fixed expenses are like rent, utility bills, wages, and the like. One-time expenses would be business registration, equipment purchases, vehicle, and so on.
In Part II, explain how you plan to fund your business. Typically, traditional investors like to see it spread out with you personally taking a significant chunk of the risk. Then they want to see your family and friends throw in, and finally they may be willing to chip in. It’s okay to be creative here. Be sure you have enough capital to go the year even if your product or service don’t take off right away. In some cases you may need to plan even farther out. In the book example above, it’s not uncommon for sales to be paid six months after they are made. That means you have to hold on after paying for the book to be printed and shipped for six months before you start to see any money coming back. Plan for what works for your product and service.
