Now consider a few more basics of business and entrepreneurship as you establish your business plan.

 

SETTING GOALS: BE S.M.A.R.T.

Having goals is important for you personally, and important for a business. There is an old saying: “If you don’t know where you are going, you are sure to get there.” In other words, you might end up nowhere if you do not decide where you want to go and focus on trying to reach that specific goal. In setting goals, consider the following things:

 

Specific. Be as specific as you can. If you plan to take a trip, for example, and someone asks you “Where to?” and you reply, “Out West,” you have named a general goal but not a specific destination. “Out West” could mean Seattle, Los Angeles, the Grand Canyon, or many other places. Your experience at one place would be quite different from your experience at another. The same is true of a business. If you have only a general goal, you could end up at any one of several different “places” or business situations. It is hard to make decisions about how to reach your goal when you don’t have a clear goal. 

 

Measurable. As much as you can, make your goals something you can measure. That will

help you know how far along you are and when you have achieved your goals. On a trip, it

helps you to know, for example, that your destination is 1,400 miles away and there are

certain cities and landmarks through which you should expect to pass in a particular order.

Similarly, for your business goals, it helps to know how far you have to go, what to look for on

your way there, and how to tell when you have arrived.

 

Attainable. A goal can be challenging, but you should be able to envision how you can
reach it. To be attainable, a goal should fit your personality, your values, your priorities, and your dreams and aspirations. Understand what can be achieved in the business you plan to start and run. If the steps to reaching that goal fit with the expectations you set for yourself, then your goal is attainable.

 

Relevant. All your goals need to relate to achieving your vision of starting and running your own business, no matter how large or small they are. If the goal is not connected to reaching the vision, it probably isn’t necessary.

 

Timely. Set goals for various “time horizons”—short-term, medium-term, and long-term. Make them interesting enough to motivate and inspire you, and space them so you can feel ongoing satisfaction as you achieve them. Set realistic timelines for your goals. These do not have to be precise, but you should identify what goals you hope to achieve in (for example) three weeks, six weeks, six months, one year, or five years from when you start. Timelines will help you chart your course, check your progress, and make decisions. As you can see, the letters SMART make a handy way to remember the main points just discussed.

 

Aim for goals that have reasonable targets—not too easy, not too hard, but difficult enough to motivate you, inspire you, and provide a real sense of satisfaction once you have achieved them.

 

TO MARKET, TO MARKET

When you discover an idea for a product or service, based on an opportunity you have identified, you must consider the nature of the market to which your business will be targeted. In some cases, an entrepreneur might try to develop a new market for a brand-new product or service. In many cases, existing markets have opportunities for entrepreneurs because there is not enough of a particular product or service available, or customers want an improved, less expensive, or more convenient or accessible version of an existing product or service.

 

Consider the car market. Why do so few entrepreneurs enter the car market today? In the early 1980s, a carmaker named John DeLorean tried to produce a new line of cars. If you saw the movie Back to the Future, maybe you noticed that a souped-up DeLorean car was used as a special-effects automobile for “time travel.” Despite that moment

of fame in the movies, the DeLorean was not successful in the automobile market. Entering

the car market today is extremely expensive. It requires a massive amount of financial

investment in many areas including design, production facilities, and major advertising and

promotion campaigns. A brand-new car manufacturer would also face stiff competition and

have a big challenge convincing customers to purchase its product—as DeLorean discovered.

Because business markets vary so much, a key challenge for new entrepreneurs is to choose

the best market to enter, and to avoid markets with too many obstacles.

 

This example shows that some markets are hard to enter because of the high start-up costs required. It also illustrates how difficult it is to compete with the strength of existing producers. Markets may be difficult to enter because they are already crowded with strong sellers. On the other hand, markets can be too small for entrepreneurs to enter successfully. For example, an entrepreneur might try to start a computer-cleaning service in a small town, only to discover that there are not enough people with computers, or who want their computers cleaned, to support the business.

 

The level and quality of competition, and start-up costs are just some of the ways in which markets can vary. Therefore, as you consider your business idea, scrutinize the nature of the market your business will enter. Some markets may be more suited to you than others or may offer a better chance of success than others. Try to identify a target market in which you believe you will have your best competitive opportunity for generating sales, based on your knowledge, observations, experiences, and market research.

 

FUN WITH FINANCIALS

Financial considerations are essential to a business. It takes money to start a business, and every business will face different kinds of costs. For starters, the business will always need enough cash available to pay its bills and meet its other financial obligations. Eventually, a company will earn profits (or so its owners hope).

 

You, the entrepreneur—as well as your partners, lenders, and investors—will want to have financial information about your company that will help you understand the costs of starting the business and its prospects for earning profits. The following describes some basic financial information that a new business typically provides in its business plan and (where appropriate) continues to track as the company moves into operation.

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Start-Up Costs

To figure your start-up costs, you total the amount of money you will need to get your business up and running. These costs are for only the initial start-up period of your business. Costs might include starting expenses for items such as rent for office or shop space, telephone, equipment, advertising and marketing, supplies and labor for the first units you will produce, and insurance. As an entrepreneur, you estimate your start-up costs to help determine whether it

makes financial sense to start your business. Your estimate will also help you

predict how much money, if any, you will need from others to start the

business.

 

Cash Flow Forecast

Even a potentially successful business can meet major difficulties or fail if it

runs out of money to pay its bills and salaries on time. A good cash flow

forecast helps avoid this common but serious business problem. A cash flow

forecast estimates the cash that will be coming into the company and the cash

that will be flowing out during a given time period. It is called a forecast

because it makes predictions about the cash flow for a business. One of the

main purposes of a cash flow forecast is to predict whether the cash coming into the business over a given time will be enough to provide the cash the company must pay out during the same time. A cash flow forecast might show that sales will bring in a lot of cash in December, but during September and October the company can expect cash shortages. Knowing this, the entrepreneur can prepare for the predicted cash problems. For example, the entrepreneur might arrange for temporary financing (a loan for a short time) to help the business through the shortages. The company could then pay off the short-term loan with the strong cash flow expected in December. Larger entrepreneurial ventures usually need month-by-month cash flow forecasts that cover at least the first year of operation. Week-by-week cash flow forecasts can be more practical for smaller ventures.

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Try to include in your business plan a basic cash flow forecast for your company covering at least the first four to six weeks of operation. For any cash shortages your forecast may predict, state your plans for covering the shortages.

 

Revenue and Expenses

As an entrepreneur, you will like the word revenue. Business people use that word to refer to the money that comes into their company. Revenue (or sales revenue) is the total dollar amount a company receives from the sales of its goods or services over a particular time period, such as a week, month, or year.

 

After start-up, a typical business must face two main categories of ongoing expenses: product costs and operating expenses. Product costs, or “cost of goods sold,” usually refer to the cost of the actual materials and labor used to produce the goods that are sold to customers. Product costs vary directly with the quantity of the goods that are produced. For example, if you were producing stackable wooden storage cubes, the amount of money you would have to spend on the wood, fasteners, paint, and labor to make the cubes would be your product costs. Your total product costs for a particular period—say, one month—would vary depending on whether you produced 12 cubes or 200 cubes that month.

 

In casual conversation, you may hear people refer to operating expenses as “overhead.”

 

The additional costs that are required to cover the basic operation of the rest of the business are called operating expenses. Salaries, advertising, rent, utilities, and office supplies are typical operating expense categories. Operating expenses are fixed—they do not vary directly with the quantity of the goods produced. For example, if you rented a small shop in which to make stackable wooden storage cubes, you would pay the same amount for rent every month whether you produced 12 cubes or 200 cubes in any particular month. For a small service business that does not produce a physical item, it is common to ignore the idea of product costs and include all business expenses in the category of operating expenses. For simplicity, you may want to take the same approach if you start a service business.

 

Profit and Loss

If, over a period of time such as a year, the total revenue a business earns exceeds the total expenses (product costs plus operating expenses) the business pays out, the difference (revenue minus expenses) is called profit. Profit is the net income (before taxes) earned after covering all expenses.

 

Profits can be reinvested in the business to help it grow, distributed to the people who share ownership (you and your investors), directed toward a predetermined philanthropic cause, or divided among these options, according to your business plan.

 

If the total expenses the business pays out exceeds the revenue earned, then the difference (expenses minus revenue) is called a loss. To stay in business, the business would have to have enough money available to cover the loss. In your business plan, you will want to forecast the potential profit or loss you expect for the company over the start-up period of operation. It is common for a business to show a loss during its early stages as the company establishes itself in the marketplace and begins to attract customers. Over time, however, the entrepreneur, and any lenders or investors, will want to see that the company is on the road to earning satisfactory profits in the future.

 

PRICING YOUR PRODUCT

You will have to decide on a price for the product or service you are going to sell. You can take several approaches to pricing. The following example shows one method you can use to establish a possible price after you have researched market demand, the prices competitors are charging, costs of materials and labor, operating expenses, forecasted sales, and desired profits. Ray, a young entrepreneur, plans to sell T-shirts.

 

Ray has calculated that his product costs (materials and labor) will be $10 per T-shirt (that is, per unit of production). Ray has also estimated that the total operating expenses for his business will be $50 a week (covering rent, utilities, telephone, advertising, loan payments, and license fees). Suppose Ray’s market research has led him to believe he can sell eight T-shirts in a week. To calculate his total product costs for one week, he multiplies the number of units (T-shirts) per week by the unit product cost: 8 x $10 = $80.

 

Next, he must set a target for the profit he wants the business to earn over the same period (one week). Assume that Ray decides he would like to earn a profit of $30 per week for the business to be worth the investment of resources he will be making.

 

Finally, Ray adds up the product costs, operating expenses, and profit forecasted for the week to calculate the total sales revenue needed to cover these three items. He then divides by the number of units he expects to sell to get the price per unit. It is not unusual for an entrepreneur to increase price hoping to increase profits. In fact, total profits may decrease depending on how much less customers will buy at the higher price. In this example, Ray’s business sales over the course of a week must generate $80 to cover the product costs, $50 to cover the operating expenses, and $30 to cover the profit Ray would like to earn. That adds up to $160 of sales revenue that he needs to generate in one week. Dividing the weekly sales revenue needed ($160) by the number of units he believes he can sell in a week (8), Ray calculates $20 as the possible price for each T-shirt.

 

$160 (Total sales revenue) ÷ 8 (Units sold) = $20 (Price per unit)

 

Following these steps is one way to establish a price you might charge for your product or service. There are many other possible approaches to pricing. Some can be as simple as doubling your product’s cost of materials or cost of materials and labor or by checking out your competitors’ prices and charging a little less. You can see that there is a close relationship between price, costs and expenses, and the amount of profit. The entrepreneur must consider if the profit desired is realistic, based on the prices that can be charged, the business costs and expenses, and the sales that potentially can be made at those prices. In general, no matter how they first establish a price, most entrepreneurs find they must adjust their initial pricing several times as they try to take into account the tug-of-war between such factors as the low prices competitors charge, the profit entrepreneurs want to make, and the quantities people are willing to buy at various prices. Keep in mind that as you test the potential results of different prices, you are seeking a price that will allow you to earn the most profit, based on the actual sales you can make in your market at that price and on the difference between revenue and total expenses at that price.

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PRICING A SERVICE

If you have a service rather than a product, the cost of your service often is expressed as an hourly rate—the amount of money you charge for one hour of your service. You can use a similar approach to set an initial price—or hourly rate—for your service. Add up your operating expenses and desired profit to find the total revenue needed from your service business during a period (such as one week). Then divide by the number of hours of service you believe you will provide to customers during that same week. The result of that calculation is a possible hourly rate you can charge for your service.

 

As you test the potential results of different hourly rates, your financial goal is the same as that of an entrepreneur selling a product. You are looking for that price (hourly rate) that will let your business earn the most profit.

 

Again, plan to adjust your initial hourly rate several times as you take into account the same issues as for product pricing—the tug-of-war between the low hourly rates competitors charge, the profit you wish to make, and the number of hours of service that people are willing to buy at various hourly rates. Debt is money that must be repaid to its lender. The borrower also must make regular payments to the lender called interest—the price paid for using someone else’s money.

 

DEBT AND EQUITY

Entrepreneurs often need financial help when they start up a company. If you expect your start-up costs to be more than you can finance personally, then you will have to get money from others to launch your new business. If you borrow the money for the business, that is referred to as debt financing. The most typical debt financing for small businesses does not give the lender any ownership in the company, and the return to the lender is not based on the company’s profits. The return to the lender is based on the interest rate that was established for the loan and the period of time over which the loan will be repaid. A lender’s interest in the health of the business is usually focused on the business’s ability to pay the interest it owes to the lender on time, and to pay off the full amount of the loan when it is due. With debt financing, the entrepreneur is responsible for paying back the debt and interest even if there is no profit.

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On the other hand, if an entrepreneur raises money from investors or partners in return for a share in the ownership (and therefore the profits or losses) of the company, that is referred to as equity financing. Those with equity in a company are part owners. The returns (earnings) to equity holders will be based on the success and the profits of the company. For this reason, equity holders will often take an active interest in all aspects of the company, its operation, and its future. For example, if a relative invests money in your business as an equity holder, that family member will share in the ownership and business profits. If the same family member loans you money for your business, then you will owe the parent or relative the amount of the loan as a debt and will have to pay interest.

 

SOURCES OF MONEY

Common sources of money include personal savings, family members, friends, a bank, partners, early forecasted earnings of the company (if the company is set to start making profits right away), a home equity loan, venture capitalists, and “angels.”

 

A venture capitalist or a venture capital company can be a source of money for entrepreneurial ventures that are riskier than banks prefer. Banks generally avoid lending money to higher-risk ventures. Venture capitalists, however, if shown a good business plan for a good idea, may be willing to invest as equity partners. They may be willing to assume the higher risk if they have enough confidence that a new business will generate large returns in the future for its equity holders. However, venture capitalists fund only a tiny percentage of all new ventures.

 

An angel is typically a wealthy individual who—in selected cases—is willing to invest personal money in interesting, higher-risk business ventures with prospects of high returns in the future. In some cases, angels may be willing to provide funds simply to support promising new entrepreneurs, particularly if the angels themselves earned their wealth as entrepreneurs. That does not mean they are willing to make a bad investment just to be helpful. However, they might be willing to take a chance on a venture with higher-than-normal risk in the hope of helping a new entrepreneur—with a good idea and a good plan—to succeed. One of the decisions you will make as an entrepreneur is whether you would rather share your ownership and profits (equity financing) or pay interest on a loan and eventually repay it (debt financing).