Build Good Estimates of Costs of Production and Compare Them with Expected Revenues from Doing Business
It is critical that you have the best information you can put together about costs (including start-up costs) of any products that you are considering producing and marketing in your business. It is equally critical that you have the best information you can compile regarding the costs associated with any changes you are considering for an existing business (relocation, expansion, changing product lines), including "front-end" costs that must be invested before production can begin.
The steps in the process of estimating costs are:
- Describe, with as much detail as possible, all of the steps that will be necessary to get each product you are considering to the market.
- Estimate the costs of the capital items (buildings and equipment) that must be purchased before beginning to do business.
- Estimate annual costs of doing business for each of the first few years of your plan, including:
- Annual operating costs -- costs of all variable inputs needed to produce the number of units of each product you plan to sell each year. -Annual principal and interest on capital items (buildings and equipment), amortized over the lives of the items.
Now, compare expected annual revenues with expected annual costs. Are expected annual revenues greater than expected annual costs for each of the first few years of your plan? Do you still think that your idea is a good one? If so, do your estimates show that there will be enough cash left over to meet your personal needs?
If you are not borrowing money to pay for capital items used in your business, your actual annual cash costs may be less than calculated above because you will not be making principal and interest payments on these capital items. However, if the success of your business depends on not having to make such principal and interest payments, you should be sure to do a detailed financial analysis as a part of a full business plan. Otherwise, you may find that you cannot afford to replace the capital items when they are worn out or become obsolete.
Worksheet 7 (description)
