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.
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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.
Sensitivity and the margin of safety
A single forecast assumes one set of numbers, but reality is uncertain, so strong SACE financial analysis tests how robust the venture is. The margin of safety is how far actual sales can fall below the forecast before the venture drops to break-even; a wide margin means lower risk. Sensitivity analysis asks "what if" questions: what happens to break-even and cash if the price is 10 per cent lower, if variable costs rise, or if sales come in 20 per cent below plan? Presenting a base case alongside a pessimistic case shows the assessor that the entrepreneur understands the risks and has thought about how the venture would cope, which is far more convincing than a single optimistic spreadsheet. The aim is a model that still survives if things go moderately worse than hoped.
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.
Exam-style practice questions
Practice questions written in the style of SACE Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
SACE 20224 marksA venture has fixed costs of 40 per service and has a variable cost of $16 per service. Calculate the contribution margin per service and the break-even number of services per month, and explain what the break-even figure tells the entrepreneur.Show worked answer →
Contribution margin per service dollars.
Break-even (services per month) services.
The figure tells the entrepreneur that 50 services a month must be sold just to cover all costs and make zero profit; every service above 50 contributes $24 to profit, while fewer than 50 means a loss. It is a reality check on demand: if the venture can realistically book only, say, 30 services, the model is not yet viable and the price, costs or sales volume must change. Markers reward the correct contribution margin, the correct break-even, and an interpretation linking the number to the demand the venture must actually generate.
SACE 20236 marksExplain the difference between profit and cash flow, and analyse why a profitable venture can still fail through a cash shortfall. Refer to how a cash flow forecast helps manage this risk.Show worked answer →
Profit is revenue less expenses over a period, measured on an accrual basis; cash flow is the actual movement of money into and out of the bank.
A profitable venture can fail because of timing: it may earn a profit on credit sales that are collected weeks later, while suppliers, wages and rent must be paid now. If cash going out exceeds cash coming in during a month, the venture cannot meet its obligations and becomes insolvent, regardless of the profit on paper. Rapid growth makes this worse, as inventory and receivables tie up cash ahead of collection.
A cash flow forecast manages the risk by listing receipts and payments month by month and carrying the closing balance forward, so a future negative balance is visible in advance. The entrepreneur can then act early: bring revenue forward, delay spending, arrange finance or scale back. Markers reward a clear profit-versus-cash distinction, the timing-based reason for failure, and a specific role for the cash flow forecast.