Build a forecast for your business, determine the business value, break-even point and optimum price point.
Business Analysis Software will quickly build a forecast for your business (up to 10 years), determine the business value, break-even point and optimum price point.
The Business Forecast Module generates a forecast to assess business performance for up to a 10 year period. The forecast is built by considering future changes in the macro and micro business environment and the impact on current business performance. From this basic data future revenue and costs are determined. Sensitivity Analysis (Optimistic, Expect and Pessimistic) can be applied to the generated forecast allowing a range of scenarios to be easily tested. This forecast provides a high level strategic budget overview, assists in the identification of business opportunities and risks, and delivers a quantifiable framework for business development strategies and actions.
Developing a business forecast provides management with strategic and operational insight leading to improved business performance. It is the basis of budgeting and provides the information that allows managers to manage. Without a business forecast a business is simply responding to the day to day operating environment and has limited capacity to maximize future opportunities or minimize potential risk.
What is a Business Forecast
A Business Forecast is a prediction of a businesses future financial performance. It includes forecasts for revenue and expenses from which future profitability can be determined. It is not a detailed breakdown of revenue and expense items (as in a budget) but a higher level view of the business considering the main drivers of business revenue and expenses.
The term Sales Forecasting is often used were a forecast only encompasses the revenue component of a business forecast.
Benefits of a Business Forecast
Building a Business forecast provides insight into both the current and future performance of a business. Building a forecast should involve an assessment of the dynamic environment in which the business operates. Simply considering these issues often allows a business manager to perceive the business in a more strategic manner. This has the capacity to improve decision making and the overall strategic development of the business.
A Business Forecast can (and should be) the precursor to budget development. Developing an overall forecast and using this as a frame work for budget creation improves budget accuracy. This occurs due to the quantifiable approach applied in a valid forecast. It is not simply changing the revenue or expense by some arbitrary percentage. Instead a forecast considers changes in the factors that influence the revenue or expense and uses these to calculate the future value.
The impact of business decisions on business performance can be analyzed using a forecast. This includes decisions related directly to the business micro environment eg products and services offered and the macro environment eg changes in the target market.
Sensitivity Analysis applied to a business forecast allows a range of possible outcomes to be reviewed. Providing worst case to best case scenarios and allowing the business manager to assess, monitor and implement actions to best deal with these possibilities.
In essence a business forecast provides a high level strategic budget overview, assists in the identification of business opportunities and risks, and provides a quantifiable framework for the development of business strategies and actions.
Building a Business Forecast
Business Forecasting methods range from arbitrary year on year variations to complex data driven algorithms. The best choice depends upon the business being analyzed, the quality and quantity of data available, the purpose of the analysis, the analytical expertise of user, and time, usability, and cost constraints.
Where a business operates in a very stable environment and has demonstrated consistent incremental variations over a number of years it may be possible to successfully apply year on year variations directly to current business performance data. This can easily be undertaken using a spreadsheet.
At the other extreme where a volume of high quality data is available, and there are few cost or time constraints the use of complex modeling algorithms may be justified. However most businesses operate in dynamic environments, with limited hard data, and considerable time and cost constraints. Therefore building a usable and value adding forecast for these business requires a streamlined approach, that considers the business environment and requires minimal hard data. This is achieved by utilizing the intuitive business and market knowledge of the business manager/owner and converting this into quantifiable values that can be applied to basic current business performance data (ie revenue and broad expense categories) to build a business forecast.
The Business Valuation Module applies the base Forecast Analysis to generate a Business Valuation. It considers Owners Earning Power and the Required Return on Investment to develop a Business Valuation that reflects the potential to value add and considers the future business environment. This valuation provides strong support for business purchase, sale or financing negotiations. Outputs include up to a 10 year Forecast, Sensitivity Analysis, Investment Return, Net Present Value Analysis, and calculated Business Valuation (Expected, Optimistic and Pessimistic).
Determining the value of a business is required for buying, selling, establishing or financing a business. From an investment perspective a business is simply an asset the value of which is determined by its future returns (profits).
What is a Business Valuation
A Business Valuation is a calculation of the value of a business. This value is effectively the price a business could sell for or the maximum amount of capital that should be expended in setting up a business.
Benefits of a Business Valuation
A justifiable Business Valuation is the key negotiating tool when buying or selling a business. Without this there is no compelling logic behind the investment.
Using a business forecast that considers the dynamic environment in which the business operates and the potential for developing future opportunities is the basis of a verifiable business valuation. Applying Sensitivity Analysis allows a range of scenarios and corresponding valuations to be analyzed.
In essence a business valuation is the maximum amount of money that can be invested in a business while ensuring the required return on investment is achieved.
Determining a Business Valuation
Business Valuation methods include Industry Multiples (ie revenue times a multiple), past market prices, asset based valuations, and a range of return on investment approaches.
When considering the business return (profit) as an income stream from an investment (the amount invested in the business) the Return on Investment approach is most suited and widely applied. This approach considers the specific business performance. Using the Return on Investment approach requires a business forecast to determine future business returns. If this forecast applies market knowledge and allows business potential to be quantified a solid basis for valuation is provided.
The Breakeven Analysis Module applies current performance data to determine breakeven points for Annual Revenue and Number of Sales. It applies the Annual Revenue, Total Variable, and Total Fixed values with the Breakeven Data values Average Sale Price and Number of Sales to calculate breakeven points. A Breakeven plot shows Annual Revenue and Total Expenses by Number of Sales. The Breakeven point is where Revenue and Expenses cross. Below this point the business surplus is negative (loss) and above this point the business surplus is positive (profit). The amount of surplus is the difference between the Annual Revenue and Total Expenses.
Break even analysis is a relatively simple and effective indicator of a businesses profit relationship to revenue and in turn number of sales. It can also provide insight into the impact of future sales volume changes on business profit.
What is Break-even Analysis
Break-even Analysis applies business revenue, variable and fixed expenses to determine the point at which revenue equals expenses. This point is the break-even point. At the break-even point business profit is 0. Revenue above the break-even point results in a profit. Revenue below the break-even point results in a loss. The break-even point can also be expressed in terms of the number of sales.
Benefits of Break-even Analysis
Knowing your break-even point provides a quick and clear reference point for business performance. Below it you are making a loss above it a profit. A break-even plot also clearly displays the profit/loss relationship to revenue and number of sales.
Extending break-even analysis we can gain further insight into the variable expense, fixed expense and profit relationship.
Looking at current data for the Example Business in the Business Analysis Software the Fixed Expense per unit is 17% of Revenue with the Number of Sales being 10 000 and an Average Sale Price of 100.
At the break-even point Fixed Expenses are 55% of Revenue with the Number of Sales being 3 090 and an Average Sale Price of 100.
This clearly demonstrates the reduction in per unit Fixed Expenses as the Number of Sales increases. The reduction in per unit Fixed Expenses with each additional sale results in a decreasing marginal cost for each sale made. Basically considering Fixed Expenses the next sale always provides more profit than the current sale due to the reduced Fixed Expense per unit.
However in most business operating environments each additional sale becomes a little harder (ie the easiest sales are made fist). So to complete the next sale it may require increased marketing effort or a reduced price. But as Fixed Expenses per unit decrease for each additional sale we actually have the amount of this expense reduction to either contribute to increased marketing or compensate for a price reduction without undermining our profit margin.
Performing Break-even Analysis
To calculate a businesses break-even point costs are identified as either Variable or Fixed expenses.
Variable expenses change with the volume of product or service provided. These costs include materials, production, distribution, and transaction costs. Variable expenses are incurred each time a product or service is produced or delivered. If the number of sales (product/service delivery) is 0 Variable expenses are 0.
Fixed expenses remain constant (up to a point) while the number of sales vary. This includes administration, location, and finance costs. Fixed expenses are incurred even if the number of sales is 0.
Break-even Revenue Formula
Break-even Revenue can be calculated as:
Break-even Revenue = Total Fixed / ( 1 - (( Total Variable / Number of Sales ) / Average Sale Price ))
this is equivalent to
Break-even Revenue = Total Fixed / ( 1 - ( Variable Expense per Sale / Average Sale Price ))
Revenue less than break-even revenue results in a loss. Revenue greater than break-even revenue results in a profit.
Break-even Number of Sales Formula
The Break-even Number of Sales can be calculated as:
Break-even Number of Sales = Break-even Revenue / Average Sale Price
Less than the break-even number of sales results in a loss. Greater than break-even number of sales results in a profit.
The Price Analysis Module determines the impact of a price change on your business. It applies current Annual Revenue, Total Variable, and Total Fixed values with the Price Data values Sale Price Change % and Number of Sales Change % to project business surplus over a range of prices. Price Analysis projects outcomes for pricing from 50% to 200% of the current price and calculates the optimum price. The optimum price provides the highest surplus (profit). It can be utilized to test the impact of pricing changes on revenue and surplus and identify the Optimum Pricing to maximize business surplus. A Price plot shows Annual Revenue and Profit/Surplus by Average Sale Price. The optimum Average Sale Price is where Profit/Surplus is highest. By stepping through price ranges of 50% to 200% of the current Average Sale Price, calculating the corresponding Profit/Surplus and identifying the point of maximum Profit/Surplus the optimum Average Sale Price is determined.
What is Price Analysis
Price Analysis combines the business revenue, variable and fixed expense relationship of a business with price and number of sales changes to determine the point at which the greatest profit/surplus is achieved. This is the Optimum price.
Benefits of Price Analysis
The impact of price changes and sales volume is not intuitive. Due to variable and fixed expense ratios business profit is not directly proportional to business revenue. Price analysis provides a quick and easy approach to exploring a range of price and number of sales relationships to determine the impact of price changes on business profit. A Price plot clearly displays the profit/loss relationship for prices from 50% to 200% of the current price.
Performing Price Analysis
Price Analysis is performed by using Step Values of 0.5 to 2.0 (ie 50% to 200%) of the current Average Sale Price to step through price ranges, calculating the corresponding Profit/Surplus based on the Price change data and identifying the price providing the maximum Profit/Surplus.