Join Jim Stice for an in-depth discussion in this video Estimating the number of customers, part of Finance Essentials for Small Business.
- Answering the question how many customers can we expect is the hard part, please don't gloss over this question. Your business will fail or succeed based on the answer to this question. How many customers can you realistically expect? In our restaurant business we need to know how many customers to expect every shift, so we will hire more or less people depending on expected customer demand. We will need more or less food based on customer demand. Many costs will vary based on anticipated customer demand.
Answering this big question is beyond the scope of this video, but it would involve such things as scoping out your competitor's volume of business, assessing expected population growth in your area, surveying potential customers, and a whole host of things. Your forecast of sales will be critical in helping to prepare your forecast of cash inflows and outflows. To our example, I've done a very careful analysis and determined that I can expect 5,000 customers per month, or about 167 customers per day.
Implicit in this 5,000 customer number is a selling price that number will impact customer traffic. In developing this sales forecast I have assumed that each customer will spend on average $8 per visit. We will do some sensitivity analysis with these numbers to determine what might happen to our profits if more or fewer customers show up. Now that we have a reliable forecast of our cost driver, at least as reliable as possible, we can now compute our variable costs.
Please note that as our business grows and matures we will be able to determine a much more reliable estimate on the number of customers we can expect. For our fast food restaurant business we will assume that I have three types of costs that vary depending on the number of customers, food, packaging and labor, the more customers the more food of course, the more workers, and the more cups and napkins and such. Of course, there will be more costs but hopefully you get the idea. Based on my forecast of the number of the customers I can expect, I anticipate the following variable costs for a month, food costs of $12,000, packaging costs of $2,500, and labor costs of $6,500, for a total forecasted variable cost of $21,000 for the month.
Now, with variable costs of $21,000, and the number of customers expected to be 5,000, we can determine that our variable costs are $4.20 per customer. That number is useful in doing sensitivity analysis with our cash forecast. Let me sum up, we forecast $16,000 each and every month in fixed costs, and $4.20 in variable costs for each customer. At 5,000 customers per month, with each customer paying on average $8 per visit, I expect cash inflows of $40,000 per month.
I now have my first draft of a cash forecast. It looks like this, revenues of $40,000, variable costs of $21,000, leaving a contribution margin of $19,000 to cover my fixed costs. With fixed costs forecast to be $16,000 that leaves me with a forecasted net cash inflow of $3,000. As you can see good for me. I forecast a positive cash flow in my first month of doing business. I forecast generating $3,000 each month, but remember I will only generate this $3,000 in cash only if the following are accurate, the number of customers I expect, the average sales price of my product, my forecasted variable cost per customer, and my forecast of fixed costs.
If I nail all those estimates then I can expect to generate $3,000 each month, if I nail all those estimates.
- Describe the most common reason small businesses fail.
- Identify two reasons why your business plan needs to budget cash inflows and outflows for the first six months of your business’s operation.
- Write the formula to forecast cash flow for the first four months of your small business.
- Explain the first step you should take if your new small business is not making the profit you anticipated.
- Identify the most important thing to keep in mind if you are considering faster growth for your small business.