Wade Armstrong

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Feasibility Analysis Step 1: The Quick-and-Dirty Best Case

Posted Thursday February 9, 2006 in Entrepreneurship

Most descriptions of the feasibility analysis process start with industry research, but, let’s face it, research is a lot of work. The first thing you want to find out is whether or not you should be expending any effort on this idea at all — after all, your time is incredibly valuable and it’s best if you don’t waste it pursuing a pipe dream that will never make you enough money to buy lunch. Fortunately, a very simple Excel spreadsheet can give a quick-and-dirty approximation as to the profit potential of your idea.

The goal in this exercise is to get a ballpark figure of what you could make on your idea, if everything goes right and all of the things that you assume now turn out to be true. This is really a best case scenario and, I hate to say it, things will probably never look this rosy again. But, the idea is, if your best-case scenario doesn’t make you enough money to quit your job, well, then maybe you should pick up some overtime instead of going through the next few steps of digging deeper.

The Excel file itself is simple; it attempts to generally forecast your costs associated with producing your product or service, and the profit you can make. It looks at two types of costs: fixed costs, which are the basic costs you have to pay no matter how much of your product you make or service you provide (rent, insurance), and variable costs, which are a function of the number of products or hours of service you produce (printer paper, screws).

1. In one column, list the names of everything you need to buy to get started, but which you won’t use up in providing your service — things like desk chairs, printers, or an office go here. Go ahead and don’t be precise, just guess. Don’t forget to add in salaries for all the founders. Now put a price next to each one. The total of these prices is your fixed costs.
2. In another column, list all of the things you need to make and sell your product, that you’ll use up making and selling your product. If you’re providing a service, you might choose to include, say, toner in this column, but most likely it will be empty. Try and break this number down so that when you total this column up, you have how much it costs you to make one of your product, or, perhaps, some useful number of instances of your product. It’s OK, you haven’t done any research so we don’t expect this number to be right, just have a general impression if it’s lower than what the actual value is likely to be or if it’s higher. These are your variable costs.
3. Now make a guess about the number of your product or your service that you will sell (if you provide a service, use the number of hours of your service you expect to sell, or something like that). Divide the number in the first column by this number. This number is known as the “contribution”, or the amount of overhead each unit has to pay for at the level of production or hours of service you plan to offer, if you hope to cover your fixed costs.
4. Add up the last two columns. This is about what one instance of your product costs to you.
5. Now guess at what you can sell one instance of your product for. Yes, I said guess; use your gut because we’re taking a best-case scenario here (and, if you know anything about your market, you’ll probably have a general idea of what price it will bear). Subtract the cost from this number, and multiply the result by the total number of your products that you’ll sell. This is how much profit you’ll make.

So, is pursuing your idea worth it? The spreadsheet shows a number that is pretty much your best-case result, and if that number’s not big enough, then it may be time to give up on your brilliant idea. If you like the number, be comfortable with the idea that it will change dramatically as you go through your feasibility analysis, but prepare yourself to jump out into that gulf known as entrepreneurship. If the number’s close, well, if you love your idea then it’s probably worth your time to find out the truth; that means going through the rest of the process. With some luck, you’ll have a real moneymaker on your hands.

It’s true, this is a tremendously simplified model of how most companies work; but it’s also useful for quick glances. Best of all, as you get more information you can refer again and again to this quick model, and use your model as a good trip-wire to help you know if you’re in trouble or if you should call the people at the Treasury now and ask them to start printing more hundred-dollar bills right now, because you’ll need all of them to spend the profit you’ll make.

Next: the Industry Analysis