Friday, August 10, 2012

How to Evaluate a Business Idea

You've got a great idea for a business, well, you think it's good anyway. How do you know? How do you evaluate a business idea and when in the evaluation process do you decide whether to move forward or ditch the idea and look for another opportunity?

I work the idea viability analysis as a continuous pass-fail process. What I mean by that is I continually evaluate the idea and make it pass, or move on. For folks who are looking, there are way more ideas than time to evaluate them. So it's important to be honest with yourself and pass on everything that doesn't meet your evaluation criteria or your needs.

When evaluating a business idea, start by doing a little research. Understand the market, how business is conducted, and the competition. Consider how the current trends in the industry will affect how business is done in the future. Identify your target customer and determine if the market is large enough to support another competitor of your size. 

Next, think about how you will position your company and products in the market. Determine how much budget you'll need to accomplish your revenue goals and create a basic marketing strategy.

Now comes the hard part. Based on your preliminary research and marketing strategy, how many units of revenue do you expect to achieve? Create a sales projection for a couple of years, by month. Yes, I realize that anything past about 3 or 4 months is a guess, but at least it's an educated guess. You need to understand the profitability and cash flow model in order to evaluate the idea. So, give it your best guess. Make sure to consider how normal industry or seasonal cycles will affect your projections. Don't take a yearly projection and divide it by 12. Think about what the revenue will look like each month. 

The rest is just math. How big an organization is needed to support a business with that revenue level? Subtract the cost of generating that kind of revenue, subtract it from the net sales to get gross margin. Then, subtract operating expenses to determine net income. Next, figure out the cash flow implications. If everything seems to make sense, then continue with your evaluation. If not, abandon the idea and move on.

This is a quick and dirty top level evaluation to determine whether to move forward with an idea. It's not a business plan. It's not a full-fledged marketing plan. It's just a go/no-go first evaluation, before you spend weeks or months working out the details, forming the partnerships and spending money building a business idea into a company. 

If you need help evaluating your great idea, give us a call.


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