So you have a small side business idea, but is it a good one? Can you make money from it? Is it worth investing my time into it?
Research suggests that around 20% of small businesses fail in the first year*, and the percentage rises each year, so that by year five over 50% have failed. How do you know whether your business will be successful or end up being a waste of time and money?
* 20 November 2022, Fundera, G McIntyre, What percentage of Small Businesses Fail? (And other need to know stats) - accessed 11 May 2022.
Photo by Parul Gupta on Unsplash
I set up my first business whilst I was studying at Uni, and although it got me through Uni as a side income it was not something that was going to sustain me on an ongoing basis, financially or mentally. This realisation came only after I had been running it for about a year. To be honest, in hindsight, I was lacking self-knowledge and important profit analysis skills. Fortunately, I realised the problem and moved on without any damage being done. To be honest it was a good option to supplement my income while studying, but was not a good fit for a long term career.
I am not alone in these errors, they are repeated often by people setting up a business. There are many things to look at when determining whether a business has a chance to be successful or not, and more importantly, whether it will be a success for you. In this blog post we will address the time and money elements. The following tips will help you to realistically assess the financial aspects of the businesses opportunity.
Tip #1 - How much money do I need to make?
This is pretty straight forward but many people skip it or gloss over it.
Depending on what your business is, it might be possible to start it as a side income option at first to see how it goes before jumping in full time. If this is possible, then great, this question might not be your priority - wrong. Before you start you on any level, you need to know whether the time you invest in it is worth the return, (Return on Investment in business speak) regardless of whether it is a part time, minimal investment business scenario or not. Even if you only want to spend one day a week on it at the moment and you can earn $300 in that one day (8 hours) at full capacity, is that a good use of your time, if, for example you can earn $600 a day in your day job, then, no it's not.
When doing the calculations you need to be honest with yourself about the amount of time the business will take, the money you need to invest in it and whether it is something you love doing. A side business is still a lot of work and needs to be worth doing. Consider what you would be doing instead of the business, for example, spending time with family and friends, getting fit, learning new skills etc., working elsewhere. this is the opportunity cost of doing your business. It needs to be worth the effort.
Tip #2 - How much time do you have?
Answer this question realistically and even pessimistically. It is natural to be optimistic, excited and motivated when we first start a new enterprise, however life tends to get in the way, so plan for that from the start. Our suggestion is to track your available time for at least a week. Check your mood after work, are you motivated to work on your business, or do you need to relax, do chores, spend time with family? If you do work on your business, are you still performing well by the end of the week?
Keep a journal and note how much real, effective time you are able to spend on your business each week. Note your mood and quality of life. If possible track this for a month but if you are too eager to dive right in, a typical week will give you an idea. When you have that time, reduce it by a third, and this is about the long term sustainable time you can allocate to your business.
"Our innate optimism encourages us to think in best-case scenarios." – The Planning Fallacy, Daniel Kahneman, Amos Tversky
Tip #3 - What are your costs?
This is the fun one. No seriously it is. Start a list of all the expenses you will have starting your business. We recommend MS Excel or another spreadsheet for this but it can also be done in MS Word if you are not used to MS Excel. Think of everything you can that might be a cost of running your business including things like, phone, laptop, software, printer, stationery, design costs, website costs, base products, licences, equipment, insurance, use of a car if needed, books, courses, desk, chair, video conference equipment, etc.
Sort them into three categories, large capital items that you need but don't use up in the business e.g. laptop, printer are examples. These items are usually amortized (used) over three years. So for these items, take the total and divide by 36 (months in three years), and this is your monthly cost of these items in the business.
The second category are items that are exclusively used for the business immediately, and may last for years, but are no use to you if the business closes. These are sunk costs and include things like website or logo design, any branding costs including stationery or packaging costs. Depending on your business and the total amount of these costs, try to divide this amount by 12 (one year) and include it into the monthly cost. If you don't think it is fair on the business to re-coup these costs in the first year, then spread it over 24 months.
The third category is the product costs, or Cost of Good Sold (COGS), these are the costs that go into the final product and might include all your ingredients, if you make cakes for example, or monthly software fees if you deliver online services. Total your monthly costs.
Add up the monthly amounts for each of the three categories to obtain the average monthly cost of the business.
Note: this calculation is not a full COGS in the true sense and does not include your time, product loss, and a number of other factors, but it will get you thinking about your expenses.
Tip #4 - How much can you make for your product?
A lot of factors go into this and without knowing your business this is tough one to calculate in a non-personalised blog post, however we will give you a few things to think about to help to develop your price point.
First and foremost, understand who your client is, be very specific, working this out may be the subject of another blog post, but try to imagine your ideal customer very precisely. With that in mind:
1. Look around you at similar businesses, with similar products. This doesn't mean you need to set your price under theirs, but it will give you some information on what the market is looking at for your product. You may well decide that yours is for example, a luxury version of their product, or is tailored to a more specific market, etc., and be able to charge more than what they are charging.
2. Look at your Cost of Goods Sold and apply a mark-up percentage to arrive at your product price point. Remember that the COGS we described above does not include the cost of your time, stock loss from damage or spoilage, unexpected price increases, or a number of other costs. So you will need to factor in some element of those as well.
3. Ask friends, colleagues and family what they might be willing to pay for your product. Bearing in mind of course that they might not be your ideal client.
4. Test the market. Whatever your product is you can always do some type of a proof of concept to see how well the product is received and what people are willing to pay for it.
5. Use your own experience and intuition. If you have worked in this industry before you will probably have a good sense of what the market and clients will pay. Use that experience to guide your pricing.
Note: if you price the product too high and you are not selling enough, you can always lower it with a sale or a return customer discount etc. However, if you price it too low, you cannot immediately increase your prices without annoying your clients.
Tip #5 - Now how much profit can you make?
Now that you have some understanding of your costs, your price point and how much product you can make in the time available to you, you can now calculate how much profit you could make.
So let's put it all together.
First, calculate how long it takes you to create one product. Next, calculate how many you can make in a month with the time available to you.
Use the total COGS (including the sunk and capital monthly costs) as your final COGS for each month and then divide that amount by the number of products you can make in a month to determine the final COGS per product.
Calculate your profit by using the final price of the product less the final COGS.
For example, if the final COGS of making a pair of earrings is $9 and you decide that these one of a kind pieces can sell for $22 each and you can make 10 pairs of them a week. Your profit in a week is $130 ($13 profit per pair x 10). If it takes around 30 mins to make one pair or you are using 5 hours of time per week to make them and run your business, your hourly rate for this work is $26. If you are a student this might beat working as a waiter, but not necessarily if you are already a professional earning a salary in excess of $75,000 pa. plus benefits. Having said that, you may see it as a fantastic creative outlet and a good use of your spare time to earn some extra cash.
These are all decisions you can make now that you have an idea of how your business works financially.
Can you afford to start your business?
This blog only touches the surface of the analysis, research and thinking that goes into a successful small side business. Apply as relevant to your business idea and personal circumstances. If you need more help, or are interested in learning more about the analysis and set up of your business idea, refer to our online courses or set up a 1:1 coaching call with us to discuss your specific circumstances and business idea. Or Subscribe to our email list for updates and future blog posts.
Tania
GET Solutions Training