How do you work out whether a business idea can make money and stay solvent?
Assess the financial viability of a venture using start-up costs, break-even analysis and a cash flow forecast.
How to test whether a venture can make money and stay solvent using start-up costs, fixed and variable costs, break-even analysis, pricing and a cash flow forecast.
Reviewed by: AI editorial process; not yet individually human-reviewed
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What this dot point is asking
You need to show you can estimate the numbers behind your idea and judge whether it can realistically make money and survive, not just describe the product.
Profit versus cash flow
These are different, and confusing them is the classic error. Profit is revenue minus expenses over a period. Cash flow is the actual movement of money in and out of the bank. A business can be profitable on paper but still run out of cash if customers pay late while bills fall due now.
The costs you must estimate
- Start-up costs - one-off costs to launch (equipment, registration, initial stock, a website).
- Fixed costs - costs that do not change with output (rent, insurance, subscriptions).
- Variable costs - costs that rise with each unit sold (materials, packaging, delivery).
Total cost for a period is fixed costs plus (variable cost per unit multiplied by units sold).
Break-even analysis
Break-even tells you how much you must sell just to cover costs. The formula is:
Break-even (units) = fixed costs divided by (selling price per unit minus variable cost per unit).
The bottom part, price minus variable cost, is the contribution margin - the amount each sale contributes towards covering fixed costs and then profit.
Pricing for viability
Price must clearly exceed variable cost per unit, or every sale loses money. Beyond that, price should reflect the value to the customer and what competitors charge. A low break-even point and a healthy contribution margin make a venture far more robust.
The cash flow forecast
A cash flow forecast lists, month by month, cash coming in (sales receipts, loans, owner's funds) and cash going out (purchases, wages, rent, loan repayments). The closing balance of one month becomes the opening balance of the next. The key test is that the closing balance never goes negative; if it does, the venture cannot pay its bills that month.
If a forecast dips negative, fixes include bringing revenue forward, delaying spending, arranging finance, or reducing start-up scale.
Linking forward
Your cost structure and revenue streams come straight from the Business Model Canvas, and these financials feed directly into your pitch and the external Business Plan. Markers reward realistic, evidenced numbers and a clear judgement about whether the venture is viable, not just a neat spreadsheet.