A business plan must include a realistic profit model that outlines how a company will generate profits, including pricing strategy and estimated costs. This is important for convincing investors and planning for the future success of the business.
A profit model outlines how a business will generate profits. When an entrepreneur prepares a business plan for a new venture, it is not enough to simply describe how customers are to receive added value and what strategy is to be used for sales and marketing. The business plan must also include a profit model that examines the prices of products and services in detail, calculates the profits and compares them with the costs incurred. The profit model must include calculations that are realistic enough to convince investors and lenders to back the venture. Earnings forecasting must be based on realistic assumptions supported by research and evidence.
The value proposition that is part of the business plan will show investors and lenders how the company intends to generate profits. For example, an Internet business may sell products online, receive revenue for advertising third-party products, or charge for a subscription to an online information service. This information can be combined with pricing strategy details and estimated customer numbers to arrive at estimated revenue. To arrive at a viable profit model, the firm must go further and present a realistic estimate of the costs and overheads that will be involved in earning revenue from customers.
Developing a realistic profit model is a useful exercise, not only to help raise money from investors and lenders, but also to help the entrepreneur plan for years to run the business. If the business is making a profit in its opening years, it should be able to generate enough cash to continue as a going concern. The liquidity position of the company also depends on the need for investment and the extent to which funding is available for it. In addition to the profit model, a separate cash flow forecast is needed to ensure that cash is available to service the company’s debts when they fall due.
The profit model should demonstrate that profits will be sufficient to cover the firm’s costs and overheads. Some businesses may suffer losses in their opening years due to the need to build a customer base by proper marketing before turnover has grown to a sufficient level to generate profits. In this case, the profit model should be supported by estimated results for the opening years that show how soon the company will be able to break even or earn profits.
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