Life is filled with many choices and every choice has a cost associated with it. Every change you make in your business affects cost one way or the other. Being able to predict the impact of the cost of a business decision is important. To understand what I mean let us take a look at Tom Longman. Tom Longman is an entrepreneur who owns Bacon Party Enterprises. Bacon Party specializes in serving pork based products to large corporate events. Bacon Party is planning to expand to a new location and needs to figure out how this will affect existing cost structure.
Before Tom should think of going into this new location, he should ask himself the following questions:
- How is the new location going to increase sales
- What is the cost of expanding to new location
- Will the business as a whole be better off as a result of this expansion
How is the new location going to increase sales?
Will the new location increase sales or simply cannibalize existing sales? Expanding to a new location is great if it will allow Tom to serve customers which the current location limits him for serving. Overall, Tom will want to make sure the new location brings in new sales.
What is the cost of expanding to a new location?
Bacon Party will need to start by seeing how cost has behaved in the past. There are different methods Bacon Party can use to estimate cost with the easiest being observation. In very small businesses, simply examining prior year’s financial statements and making prediction based on past results is not uncommon. While observation could provide good results it is not the most reliable way to predict cost. Rather than simply estimating, Tom can determine cost behavior patterns by using statistical analysis like least square regression. Predicting cost allows Tom to estimate the cost of doing business in the new location. Adjustments will be needed for the additional fixed costs like rent and utilities expense.
Will the business be better off as a whole?
Based on the revenue and cost prediction, Tom will need to determine if net profits increases as a whole. Bacon Party should not become worse of as a result of this expansion. If Bacon Party is keeping less of its revenue as profits, then his expansion choice is not a very smart one. Tom will need to evaluate other growth strategies and choose the one with the highest return. It is not what you make in business but what you keep that counts. Keeping down cost means keeping more in profits.
In summary, making the wrong choice not only affects your cash flow but your energy level. Making smart choices in business takes more than gut feeling but laying out the numbers to see if the choice makes sense in the long run.