Chapter 4_The viability of a business idea.ppt

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Entrepreneurship and how to establish your own business 6e
Chapter 4: The viability of a
business idea
• Setting up a business
• Cultivating an entrepreneur’s creative attitude
• Generating business ideas
• Developing and evaluating business ideas

Learning outcomes
• After you have studied this chapter, you
should be able to:
– Explain the term ‘viability study’
– Explain the term ‘market research’
– Explain the needs analysis and characteristics of
customers
– Explain the structure of the business

Learning outcomes (cont.)
– Explain the mission statement and objectives of
the business
– Calculate the expected market share of a business
– Calculate the income of a business
– Calculate the expected net profit of a business
– Calculate the break-even point of a business
– Explain cash planning in a business

Introduction
• This chapter is concerned with the planning
stage of the business idea
• Two phases are linked to business planning:
– To establish the viability of the business idea
– to draw up a business plan

Viability study
• Entails estimating the interest in the business and
its product or service, the expected sales in units
and at a certain price, the expected costs
associated cost with generating the sale, the
strengths and weaknesses of the business
• Before a viability study can commence, market
research must be done

Viability study (cont.)
• Once market research has been done,
assumptions, on the following, can be made:
- The estimated number of units to be sold
- The acceptable price the market is prepared to
pay
- Cash flow requirements for a business
• Essential that an entrepreneur does a proper
needs analysis of the market and identifies the
characteristics of the customers

Market research
• Entails gathering, analysing and interpreting
information on a certain market, on a product
or service to be offered for sale in that market,
and on the past, present and potential
customers for the product or service

Market research (cont.)
• Is there a need for my product or service? (Needs
analysis)
• What type of person (customer) will buy my product
or service? (Customer profile/characteristics)
• What can realistically be expected to be sold of this
product or service based on the estimated market
size? (Market share)
• How much are customers willing to pay for the
product or service? (Price analysis)

Needs analysis and the characteristics
of customers
• Firstly: Find out who your potential customers are
and what their needs are and how they make buying
decisions
• Key to success is making sure your product is exactly
what the customer wants
• There is a distinction between the physical products
the customers buy and the image the customers
have of the products
• Focus must be on customer profiles which is a
description of the potential customers

Needs analysis and the characteristics
of customers (cont.)
• Four questions to establish if there is a need for your
product:
- List the features of the product or service-: helps to focus
on each aspect of the product or service
- Determine who the major competitors and industry leaders
are as well as suppliers and other major role players in this
market-: This section forces you to examine the industry as
a whole in order to determine its place in the market
- Identify the possible customers and segment of the market-
: each market must be examined carefully in terms of
overall size/ demand and potential profitability
- Draw up a final list: includes all of the above

The business structure
• Types of business structures:
- Sole trader/ sole proprietor
- Partnership
- Close corporation
- Company

The business structure (cont.)
Legal considerations
- New Companies Act
- Companies
- Funding statement
- Transparency
- Consumer Protection Act

The business structure (cont.)
• A practical check list when starting a business:
– Decided on the type of business you wish to form:
Public/private company
– Choose the name and consider alternatives
– Draw up a business plan
– Await your enterprise registration number from the CIPC
– Apply for your VAT/income tax/PAYE/SDL and UIF number
– Register your logo as a trademark with CIPC
– Ensure all enterprise’s intellectual property is copyrighted
– If you have an unique product, register a patent with CIPC

The mission statement and objectives
of the business
• Once you have decided on the type of
business, you must define your business, using
the following questions:
- Who are the customers of the business?
- Which customer needs will the business satisfy?
- How will the business satisfy these needs?

of the business (cont.)
• Mission statement:
- Defines the fundamental and unique process of a
business and identifies its products/ services, as
well as its customers. The mission of a business is
defined by customers satisfaction by its products
and services
- Certain questions need to be answered when
developing a mission statement

• After setting the mission statement, you can
formulate objectives for your business
• Objective is something the business wants to
achieve over a set period of time
• Objectives are necessary so that you have
something against which to measure progress
• Objectives are usually adjusted over time based
on changes that take place in the industry
• Defining your mission statement and objectives
clarifies what your business is all about

• SMART Framework:
– Specific: Provide a clear description of what needs to
be achieved
– Measurable: Include a metric with a target that
indicates success
– Attainable: Realistic, yet it should still provide a
challenge
– Relevant: Should relate to the business’s mission and
strategic goals
– Time bound: Should have a specific time limit

Market analysis
• Calculating the total market potential:
• Used as a basis to estimate the potential income of
your business
• Must not be over estimated
• To calculate the expected market share, you need to:
- Estimate the total potential market for your product or
service
- Estimate what portion of the market is occupied by your
competitors
- Estimate what portion you can expect to sell

Market analysis (cont.)
• Calculating the total market potential (cont.):
– When calculating the potential market you should
begin by dividing it into various market segments
– Establishing your target market consists of three
steps:
- Market segmentation
- Evaluation and the target-market decisions
- Market positioning

• Market segmentation:
- A market can be divided into the following
segments:
1. Demographic
2. Geographical
3. Psychographic
4. Behaviouristic

– Evaluation and the target market decision:
- One segment must be selected, to focus on
- Choice of the segment should be governed by things
such as accessibility and size
- Market positioning:
- If you choose more than one segment as your target
market, you must design a different marketing
campaign for each segment

• Calculating the size of the market:
– Traditional method for estimating the market size
of your target market:
• Number of customer units (a)
• Average annual gross income per unit (b)
• Total income for area a × b = (c)
• Percentage ( %) of income spent on item (d)
• Potential rand value for item c × d = (e)
• Realistic percentage ( %) of entrepreneur’s market share (f)
• Rand value of entrepreneur’s market share e × f = (g)

• Determine the target market:
– A target market - specific group of consumers
at which a business aims its products and
services
– A SWOT analysis - study undertaken by a
business to identify its internal strengths and
weaknesses, as well as its external
opportunities and threats

• Calculating the expected market share:
– It is important to determine what your expected
market share would be under varying
circumstances
– The expected market share is that part of a target
market that a business will be able to serve on the
basis of its production capacity and the state of
the economy

• Calculating the expected market share:
– To calculate the expected market share, estimate:
• the total potential market for your product or service
• what portion of the market is held by your competitors
• the market portion you can expect to sell to

Calculating income
• Work out the selling price of your product or
service
• It is important to calculate the selling price of
your product or service, by identifying the costs
to manufacture and sell the products
• Once all the costs have been established, you
must add a percentage (mark-up) to the costs

Calculating income (cont.)
• Calculating the cost price of the product
– Variable and fixed costs
• Variable costs are fixed per unit but vary in total
• Fixed costs are fixed in total but vary per unit
– Direct and indirect costs
• Direct costs are those costs that can be allocated
directly to the manufacture of the product
• Indirect costs are costs that cannot be allocated directly
to a product
– Calculating the total costs per unit of the product

Calculating income (cont.)
• Calculating the selling price:
– The price you charge for your product or service is directly
influenced by the price your competitors charge for their
products or services
– Your product or service can only be more expensive than
your competitors if you offer more benefits than your
competitors
– To determine what you can charge for your product, make
a list.

Calculating the expected net
profit
• A Statement of Comprehensive Income - a
summary of the income and expenditure of a
business over a specific period of time
• A Pro Forma Statement of ‘Financial
Performance’ with ‘Comprehensive Income’ is
one that is drawn up using estimated figures

Calculating the expected net
profit (cont.)
• Once you have calculated the costs and the mark up
of your product, you must test the viability of your
business
• Viability = Profitable
• Profitability = [(expected sales x expected selling
price)- expected costs]
• Income > expenses= profit

Calculating the break even point
• Break even is the volume where all fixed
expenses are covered
• Firstly, determine all fixed expenses that occur
on a monthly/quarterly/ yearly basis
• It is important to look at your profit and loss
statement on half yearly basis, and recalculate
your break-even number

(cont.)
• Ways to lower the break-even volume:
– There are 3 ways to lower the break-even volume;
only two of them involve cost controls:
- Lower direct costs, which will raise the gross margin
- Exercise costs controls on your fixed expenses
- Raise prices

(cont.)
• The aim is profit
– You are in business to make profit not break even
– Break-even point allows for better management of the
business:
- Allocate the sales and marketing effort to the point you need to be
- You can control costs in a slow month
- You can maximise profits by understanding the elements of your
break-even figure

Cash planning: The cash budget (cash
forecast)
• Cash budget - a formal plan for forecasting future
receipts and payments of cash over a specific
period of time, such as a month, quarter or year.
• Do not attempt any business venture if you
cannot sustain profits over time

Cash planning: The cash budget (cash
forecast) (cont.)
• Profits over time are not enough, you need cash
to manage the business on a daily basis
• If you don’t have enough money to meet
expenses as they occur you are technically
bankrupt
• It is important to pay close attention to the
planning of actual money flowing in and out of
your business

Cash planning: The cash budget
(cash forecast) (cont.)
• The purpose of cash budgeting
- Helps establish the in and out flows of cash
- The budget can:
1. Be used to plan your short term credit needs
2. Be presented to your bank to show proper financial
planning
3. Help predicted months when there might be a cash
shortfall
4. Highlight problem areas in your payment schedule

Cash planning: The cash budget
(cash forecast) (cont.)
• Consistent budgets:
– Cash budgeting is a continuous process that can
be checked for consistency and accuracy by
comparing budgeted amounts with amounts
expected from using ratios or financial statements

Summary
• first phase of the planning stage of the
business, which is to establish the viability of
the business idea
• Performing a viability study is an integral part
of the planning process for any business

Summary (cont.)
• The viability study’s market potential
determinants involve:
– doing market research to establish exactly who
your customers will be;
– whether your product or service will satisfy their
needs;
– who your competitors will be; how to set up a
mission and objectives for your business;
– how to do a market analysis

Chapter 4_The viability of a business idea.ppt

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Chapter 4_The viability of a business idea.ppt