So, you think you have a great business idea?

Welcome to the world of financial analysis. So you think you have a great business idea. You have identified a target group of customers and a unique business solution to fulfil their unmet client needs. But does this business idea have a financially sound foundation? We believe unique and valuable solutions should be confirmed by fair rewards and we don’t want to enter broke. I will introduce three frameworks to assess and improve your business idea, if needed.

The intriguing game of finance. It’s all about risk versus return. Naturally, high return is associated with high risk. You can only achieve high return if you’re willing to take the risks others don’t dare to take. Think about investing money in developing a totally new product which takes high upfront investments. Low risk is associated with limited return. There’s nothing wrong with a limited return as long as this return is highly certain. Think about a flexible consultancy business working with hourly rates and invoices for the hours worked. High return combined with low risk is exceptional, but highly attractive. Sometimes brokers know how to achieve a position like this with a commission-based revenue model.

The scenario we would like to avoid is high risk combined with low return. This is the vulnerable path of the enthusiastic entrepreneur, working on a great idea, investing money, without the confirmation that customers are willing to pay. Some people say this about LinkedIn. Great platform, but no viable earnings model. Your business idea. How about your idea? Take time to think about this and share your ideas with the other learners. Especially because great ideas not always have a great risk return profile. Let’s take a closer look at the financial part of a business idea. The concept of return on investment combines three elements in a logical way. Let’s take a look at these three core components.

The revenue potential in the markets. How many clients are willing to pay what amounts? After deducing the costs, are you able to make a strong profit margin? And how much should you invest to achieve this margin? The percentage of required return on investment depends on your ambitions and on the risk level of the startup. To give you an idea, high risk private equity investors often search for ROIs of 18% to 20%. Mature low risk firms, like commercial banks, strive for an ROI of 6% to 10% for their finances.

Now the challenge for a startup is that it is a long way to get there. You first have to invest and build before you can achieve this return on investment. In finance, we call this the valley of death. Why? A lot of entrepreneurs think they are healthy the moment they are profitable. The moment they make more revenues than costs. But it’s a bit more difficult. If you look at the cash needed for the business, the curve goes way deeper than the profitability curve. First, businesses have start up costs before they generate their first revenues. Second, the moment you generate structural business, you need to scale up your organisation.

And third, you need working capital to fund your flow of business activities. Some companies succeed in making their customers first pay before they perform. But most companies need working capital. Just think about the investments working capital in a shop full of merchandise. This is why it’s so important to work from the start on building a network to anticipate and funding the business the moment it starts to scale. Now, what if the risks are quite high compared to the return the business idea promises? What if the valley of death looks quite scary? How can you reduce the risks? A lean startup up approach might work for you.

Can you start in small steps and try to achieve the first revenues without investing a lot of money?

Change the business model or the core of the business. For example, by starting as a consultancy firm supporting other companies instead of investing yourself in new product development. Risk transfer and corporation can help to reduce risks. Be aware this is not for free. Partners need a fair reward for the risks they are taking. That is the real meaning of good cooperation.

You have a great business idea. Take time to analyse the risk return profile. A strong business idea needs a strong foundation.