Let's think about profit, durability and profit potential. So as we mentioned in the previous section, the dynamics of the market and your business do change over time. One should consider how these changes will impact the business's ability to generate profit and how sustainable is profit might be. Take the example of LEDs or the sort of lighting that we're starting to use it in everyday situations in both the homes and offices. If your business is one that imports and sells a new type of LED lighting, for example, this is a fairly new technology and as of yet it doesn't have that many adopters. This in a way is down to it being a new technology and many consumers don't want to be the first to try it out.

Another reason is that prices are high and as a business you must make a good gross profit percentage and plan your business and your finances based on this high profit percentages. or high profit percentage sorry However, as this technology matures, and the costs come down, more and more customers are going to be demanding the products, and more suppliers or competitors will enter the market. This will have a combined effect of reducing your profit margins because you're going to have to reduce your costs accordingly in order to compete with these other organizations. And obviously, if you don't factor this into your planning, or your business model, or your financial model, and it's no longer going to make sense, you're not going to be able to make the profits that you planned on making. And while it's not possible to predict the future, it is important to understand that there will be a change and this change will impact your business.

If you're relying on a new technology to generate your profit, you'll need to plan to sell more units as the profit percentages decline. Or you'll need to plan to supplement your offerings or your products with newer and more profitable products. If your business is built on a product in a declining market, for example, incandescent light bulbs, so the old kind of light bulbs and then some other ones At Aslan use, he needs to plan to replace these products you sell with something else something new. Another scenario is that your business may be able to increase its profitability, as it improves either its manufacturing or business processes. And this can come about in the form of reducing things like waste or improving sales cycles, improving things like office and administration processes. Building and embedding this kind of knowledge or intellectual property can become a valued valuable differentiator between you and your competitors.

As you can see, there are a number of levels or leavers that can be manipulated. And while the future is never certain, you can certainly plan for a number of eventualities and understand again, like I've said, which are the levers that you can pull and help maintain that profitability. Let's take another look at fixed and variable costs and and how these impact the bigger picture. We touched briefly on these in the previous example or an earlier example, when the screen How profits should be planned for and it's important that you consider these and describe them in more detail when preparing your business plan. So to recap, variable costs are those that go up or down depending on how much of an item you sell. Fixed Costs remain as they, they are they regardless of the amount you sell, as a startup or a small or a more established business, these variable costs are usually less of a concern.

Let's face it, you know, selling more of something is a positive thing. It's the fixed costs that can easily sink a business or stop getting off the ground, things like expensive and sometimes unnecessary office space. full time employees and loan repayments are good examples of this. And while these costs are often necessary when the business grows, and has the revenue or gross profit to cover them, it's best to try and avoid these expenses or to try and keep them as low as possible in in a new business. It's worth noting that your business will require certain inputs such as administration, meeting spaces and infrastructure. And one should be aware that there are a number of alternatives You can employ us to keep these costs as low as possible, either by encouraging them only when your business requires the service or by using them less than you might have originally planned.

Examples of this are things like using a virtual office or outsourcing administration and accounting to an individual or organization on a part time or an as required basis. When organizations are small, many intrapreneurs fulfill a number of roles within the business themselves. This can work well if intrapreneur has the necessary skills and the time, but it's often not scalable, and this will distract the intrapreneur will you the owner of the business from the more important tasks of either things like product development, or sales or marketing activities. Let's take a look at fixed and variable costs in the diagram below. As you can see from this example, the business has got a fixed cost of 1000 pounds per month. And that's illustrated by this line here.

And you can see it right here. Fixed regardless of the amount of items that are sold, so 501,000 1500 your cost remains the same. So, whether you sell 1000 units or you sell none, this cost remains the same. The triangle above this highlights the variable costs in addition to the fixed costs. For example, if no units are sold, the cost is still 1000 pounds, plus zero which is the variable bits. But if 3000 units are sold, as you can see over here, the total cost is 4000 pounds or $4,000.

And this is made up of the 3000 which is the variable cost and 1000, which is the fixed cost. And these combined make up the mix cost. The total cost Dave always sometimes referred to as the semi variable costs. The worthwhile exercise to do is to research the cost structure of similar businesses. In your own industry, and understand how fixed and variable costs work within these businesses. Next, let's look to understand the monster break even.

So now that your business plan contains a suitable amount of detail describing your plan revenue, your profit your costs, you should use these figures to understand how long it will take the business from starting up to reach a break even point and the break even point is the specific point in time when you or the business is no longer making a loss. That is when the revenue and the costs are equal to each other. specimen specifying the amount of months it will take the business to reach this point informs any reader with a business plan especially banks or many lenders, how long it will take the business to become a viable one. It also assists in determining the level of investment that will need to be made to ensure that the business gets to this point and this is discussed in more detail in the following section.

Take a look at an example of breakeven analysis. As you can see here, the costs are indicated by the green line. So those running over there in this might be higher in the beginning because you've got some some high startup costs then tend to normalize and and kind of follow more of a flatline after as time goes on, and the revenues indicated by the red line. As you can see, in month one, the costs are higher than the revenue resulting in a loss. So you can see here your costs are higher, revenues lower and the difference between those two points would be your loss. And again, as as this progresses, you can still see you making a loss until eventually around about one seven.

Revenue is the same as as as costs and this is known as your breakeven points. It's important to note that the break even point that illustrated above or in this example does not take into account any losses made prior to that point. In the early days of a new business, its expenses will often Eclipse its income, meaning that losses been made. These months to month losses accumulate over time, as you can see here, so month one, month, 234, etc, etc, these all accumulate. And you should know how long it's going to take to recover these losses, the losses are recovered from a point forward in time after the business begins making a profit. So as you can see, from month seven or eight, you're going to start making a profit and those profits are going to accumulate and eventually, ideally, cancel out your losses made over here.

So, this is going to happen as you go forward from a point in time, making a profit that is when the income is higher than expenses. As we've said, this will accumulate and then towards the accumulated loss to the point where the net effect is zero. And after this point, the business will hopefully remain profitable, as well as being in a position to continue accumulating this profit. Obviously, the more profit That can be accumulated into the beta as this allows the business to both absorb any future losses, and ultimately pay the profit or a portion of the profit to the shareholders on a quarterly or annual basis. Let's take a look at positive the months to reach positive cash flow. Now, it's often said that cash is king or happiness is a positive cash flow.

And this is very true. One of the primary reasons for businesses failing is poor cash flow. So why is cashflow so important? Well, it's important to differentiate between profitability and cash flow. So up until now, all the examples we've been speaking about have been about profitability to profitability as being explained previously, so let's start with a simple example to explain cash flow. Imagine you buy an item for 100 pounds and you pay your supplier for it.

And then you sell it on for 140 pounds, meaning You've made 40 pounds profit. Your customer, however hasn't paid you yet because you've provided them with a credit facility or credit terms. So while you're in profit by 40 pounds, you've got a negative cash flow of 100 pounds until of course your customer pays you repeat this a few times, and suddenly you've got no money in the bank at all. But it'll be okay when your customers pay you right? Well, maybe not. In the meantime, your business needs cash to continue operating.

There's more inventory to buy and sell for a profit. And there are expenses and overheads such as salary and rent that need pain as we've shown in the previous examples. And this is why it's important to always have sufficient cash cash on hand to support your business activities. In addition to customers paying slowly there are a number of other factors that can type your cash and some of these are things like holding too much inventory. So over buying an item and holding it in stock, things like deposits and securities so money you need to fork out when you when you rent a new office. We're in Since and have to pay a few months upfront, things like pre payments, things like discounts you received from your suppliers but at a later stage and you have to cover these costs yourself and things like VAT refunds.

These all need to be understood and planned for as your business plan needs to explain exactly how much cash will into the business and how it will be and how the cash will leave the business. This is done by using a cash flow statement. And the cash flow statement should list all the items resulting in cash flowing in not specifically revenue Remember to differentiate between money coming into the business as in actual money and not specifically revenue and all the items resulting in cash leaving the business and again not specifically examples, but things like deposits, etc, etc. And there are a number of items to consider. Will all of your sales for instance to customers be for cash or will you offer them credit And what will those credit terms be? So how long will it take a customer to pay?

How long you're going to have to fund this for? How long do you think realistically take to collect this money? You know, if you've given your customers 30 days of credit, will they pay within 30 days? And will you have credit terms with your suppliers to ease your cash flow. And this is a problem with many new businesses that don't have a trading history, your supplies aren't going to give you any credit facilities, and you're going to have to pay cash for items. So if the amount of cash is greater than the amount of sorry, the amount of cash out is greater than the amount of cash in, then you're going to end up with a negative cash flow and this is a good indicator of problems in your business have big problems actually.

Conversely, having more cash flow in then out is a good thing. And this is described as the positive cash flow. Using the monthly cash flow statement, your business plan can illustrate at which point the business is projected to reach a positive cash flow. That is when you've got more money coming in than flowing out. And this will be the first month in which you're going to start building up a bit of cash reserve and be in a stronger position. They are, there is an example of a cash flow statement provided in the template that you'll be able to use to construct this part of your financial plan.

And it's important to note that a business that has a constant negative cash flow will require continual funding from either the shareholders or lending source in order to continue operations. So even if the business is profitable, if it runs out of cash, you're going to need to get some money from elsewhere. So then let's let's restate what we've learned in this module. We've been able to calculate gross profit and operating profits. We are in a position now to understand net profit and profit percentages and how we calculate these. We On are able to start thinking about things like profit potential and durability.

So how we're going to keep making a profit as our business grows and matures, we understand and are able to describe fixed and variable costs. We've been able to demonstrate the monster break even. And we've been able to calculate the months to reach positive cash flow. So I hope this hasn't been too overwhelming. Take a look at the templates that have come with this course and it'll make a lot more sense and see you in the next module.