It's quite astonishing to me just how many people can't clearly articulate their business model and how and why it will be a success. Why is it a good idea? Is there a customer who will pay for your product? How have you validated that? How big is the market? Who is your competition and what's your point of difference? How many units do you have to sell, and at what price and margin, to be profitable? Who are your potential customers and how will you communicate with them? How much money do you need? These are confronting questions, but if you're going to have the best chance of success they need to be answered.

Developing a start-up business plan is absolutely fundamental to success. If you're bringing partners on board, either for their skills or financial support, you must be able to clearly articulate and demonstrate what the opportunity is and how the business will be profitable.

In chapter 11, I'll present a great business presentation format for all potential stakeholders, not just investors. Then, in chapters 12 to 17, I'll detail the important business aspects that will feed into your business plan. But first, in this chapter, we're going to look at the key information that every plan must contain.

Market validation

After talking to family and friends about your business idea, the next step is to approach potential real customers and suppliers to validate your model. This is an essential step (because chances are your family and friends are just being nice to you). Testing the model in the real commercial world will give you the hard answers before you invest your valuable time and money. Is the timing right and what would customers be prepared to pay? Are there manufacturers or suppliers who could manufacture the product and at what cost, factoring in freight, import duties and taxes if it's coming from overseas? Does this allow enough margin to make a profit that would cover your operating and marketing costs, and pay the salaries?

Before you talk to potential commercial partners, you might want to consider protecting your idea by having a non-disclosure agreement (NDA) drafted up by a solicitor (you'll recall we discussed NDAs in chapter 1). This is a standard document and should be relatively inexpensive to prepare. It will give you some peace of mind, but be aware that NDAs are more a deterrent than ultimate protection because they can be challenged. Once your idea is out there and you have strong validation, you need to move quickly to protect it. At some point early on, you may decide to register a provisional patent on the product, technology or process (chapter 13 will give you more information on this). To find out if a potential business name is available you will need to search your Government’s business name register. In Australia use the Australian Securities and Investments Commission (ASIC) website to conduct this search. After this you will also need to register the web domain and relevant social media pages  —  and even a trademark on keywords within the proposed business name if you deem this necessary to protect yourself from a branding perspective.

Revenue and profit

At this point, if you're serious about moving forward, I would start looking for an accountant and/or mentor who can be a sounding board to test your business model and ideas. Finding the right accountant can take a bit of time and research. I suggest looking for a smaller, personable accounting firm with an accountant who specialises in start-ups. Talk to a few until you find someone who is enthusiastic about what you're doing, and who you're very comfortable with on a personal level. The right accountant knows they have to be cost effective for start-ups to use, and that money will be tight initially. The right accountant will also have a longer term view to building a valuable future customer and a long-term strategic relationship. As you grow and reach the stage of forming your first board, your accountant will often be one of the first people you ask to be on your board.

If you have no basic accounting experience, I would strongly recommend you do a short accounting course to learn the basics. This will help you understand the principles involved in planning a successful business. Being able to read and understand a simple profit-and-loss statement, balance sheet and cash-flow statement is essential to successfully managing a business at all levels, particularly during the volatile early stages of start-up and scale-up (growth).

The revenue model should show clearly how many units of your product or service you predict to sell each year over the first three years as well as the revenue dollars and profit attached to this. Sales should be broken down by product and customer type to indicate a clear understanding of why you believe you'll sell these quantities (your go-to-market plan) and how you'll reach your customer. The first year is the main focus at this stage, and the one you'll have most clarity about. The second and third years are purely forecasts designed to get you thinking about what could be achieved and how.

Go-to-market plan and operations

Your operating model indicates how you're going to make your idea happen. It should demonstrate a clear understanding of what makes your product or service unique in the market. Will you market and sell it directly to your clients (online and/or through retail outlets) or will you distribute it through reseller/wholesale distribution channels? If you choose the latter, be sure to include an allowance for your resellers by building in substantially more profit — and remember to consider the cost of marketing for them too. How are you going to overcome market barriers to entry: will this require physical warehousing and logistics? What staff, processes and governance are involved? Who is your competition and who could become competition by tweaking their existing business?

All operational details should be described here so that you or a potential investor have a clear understanding of how the business will operate and are convinced of its chances of success. You're sure to be surprised at how this process helps to clarify your own thinking about how you'll operate and achieve success.

Cost validation

What will your costs be to run the operating model so that you're confident of making a profit and, more importantly, a return on your investment that's appropriate for the risk you're taking?

There are three key financial reports that you must be across when running a business: the profit-and-loss statement, the balance sheet and the cash-flow statement. In your model, it's best to break down the operating costs, as you would in a profit-and-loss statement, by showing your top-line revenue (sales) and then deducting your direct cost of goods sold (stock purchases) to come up with your gross profit. You then deduct your operating expenses (all the detailed operating, logistics and administration costs, and wages), giving you your net profit (before tax). Some costs are variable: that is, they will change depending on the amount of product you produce or deliver; delivery costs may be an example of this. Other costs, such as rent, are fixed; that is, they don't change. Costs are usually separated into the categories ‘variable’ and ‘fixed’ in your profit-and-loss statement. Allowing for costs that are due at certain times of the year — including insurances, licences, subscriptions and taxes — is important when planning. These costs should be entered in your cash-flow statement so you can see clearly when they are payable and the impact they may have on your available cash at the time. See figure 2.1 for an example profit-and-loss statement.

The balance sheet displays the company's total assets and how the assets are financed, either through debt (borrowed funds) or equity (retained profits or owner contributions). There are three key measures in a balance sheet: assets, liabilities and remaining equity (being the assets less the liabilities).

Assets are a combination of things you own and those that have value in your business and they include physical items such as buildings, plant and equipment, and vehicles. They also include cash in the bank and money owed to your business. These are split into ‘current assets’, being items that can be quickly converted to cash to meet liabilities due in the short term — such as cash in the bank or money owed to you — and ‘non-current assets’, being the remaining items that can't be turned into cash quickly.

Liabilities include current liabilities such as cash owed to suppliers, banks and others in the short term. Non-current liabilities include anything that doesn't have to be repaid in the short term, such as long-term finance.

Equity is the fundamental measure of the health of your business because it's the remaining value a business has after liabilities are deducted.

So:

Assets – liabilities = equity

which is the business's value and includes any contributions and retained earnings from previous years. If this goes into a negative balance — meaning you have negative value in the business, and your liabilities exceed your assets — you most likely won't be able to meet your liabilities when they are due, and as a result you're technically trading ‘insolvent’ and are required by law to wind up your business.

The real focus is on your current assets less your current liabilities. This is deemed the ‘acid test’ and it clearly indicates if you'll be unable to meet your payments when they're due. Of course, this can be quickly resolved by putting more money into the business, but you'll have to decide whether the business is viable to continue and whether the problem is a temporary issue that will be overcome. You don't want to be throwing good money after bad. See figure 2.2 for an example balance sheet.

The cash-flow statement (see figure 2.3 for an example) is designed to help you manage and provide for future cash requirements in the short and long term. It shows cash coming in, usually by month, and liabilities for cash going out so you can better manage the business operations to ensure the money is available when payments (current liabilities) are due.

Profitability

What profit margin are you going to make on your product or service (that is, the gross margin as a percentage and the gross margin as a dollar value) so you're confident of covering the operating costs with an appropriate profit still remaining (the net profit)?

Acceptable returns will vary between industries and sectors — whether they're retail or wholesale — and are usually related to trading volumes and business maturity. However, as a rule of thumb for a start-up or a scale-up business, a minimum 10 per cent net profit before tax after all costs are deducted is a good guide for most trading businesses in today's market. A technology business, however, may target a 70 per cent + net profit because its ongoing costs are often quite low once the software is developed and operational. Costs are based more on software updates and improvements, as well as providing support.

Funding

How are you going to fund your business? Can the business be based on a self-funding model early on or will you need significant capital to get started? Will it be self-funding using its own profits after that? Are you putting in the initial money or will it be shared across a number of founders (this is known as ‘bootstrapping’)? The most common source of initial funds for a start-up come from what's known as the ‘three Fs’: family, friends and fools. These will often be your first investors: those who want to support you to give your idea a go. Banks are unlikely to lend money against an idea because it's generally risky if there's no proven track record or guarantee you can pay the money back (unless you have some assets you can borrow against, in which case you take all the risk). Check to see if there are any grants available that you could apply for to assist you in getting started. Or you might find investors who can bring both money and additional skills to the table. We'll talk more about this in chapters 11 and 12.

A business start-up grant in a particular industry sector you're looking to enter, if you're lucky enough to qualify, can be very useful. But before you get too excited, be aware that not all grants are 100 per cent free money. Many require a contribution from the founders so that there's some skin in the game, which ensures a much higher commitment to success. You'll find that many grants are 1:1, meaning you'll be up for an equal contribution. Some are 1:2 or even 1:3, which are better odds for you as they provide a greater leverage of your money. If you succeed in getting your business through to a rapid growth phase and consider venture capital (VC) money later on, the VC funders will also look for private investment to match or leverage against, because part of their due-diligence process is to ensure others besides the VC fund are confident your business has what it takes to be successful.

Creating a three-year forecast

As we've seen, to set yourself up for success it's a good idea to create a simple profit-and-loss statement for the first three years of your proposed business. Hiring an accountant who has experience with start-up business models, and who can help you review those financial models and assist you in preparing a plan that potential investors or partners can clearly understand, will help give others confidence in your business concept and capability. The plan should allow for the following expected and unexpected scenarios:

• performing above expectations
• performing at expectation
• breaking even
• failure.

Starting a business is an exercise that will consume a large portion of your life and cause a great deal of stress, so you need to feel you'll be suitably rewarded. There's no point in starting a business if the profit you're going to make gives you the same return as putting your money in the bank (or other safe haven) — you might as well go surfing instead.

Once you have a plan in place, you must go over it time and time and time again with an accountant or a mentor who has experience in supporting or starting a new business, until everyone is confident that this business is ready for action. Successful business people are often willing to give back by helping others who are starting out, so look for an expert in the field you're considering and don't be afraid to invite them out for a coffee and ask them some questions about your new business concept. Most universities in major cities have a business incubator with access to mentors and they often have positions available in start-up programs, so that might be a place to start.

An experienced mentor will be able to quickly test a model and ask the hard questions related to market reality and readiness as well as how to support and justify the numbers used in the model. This is not to put you down, be difficult or make your life hard — it's to ensure you don't lose everything in the process by making fundamental mistakes that could have been avoided through careful planning. Starting a business isn't easy; if it were, everyone would be doing it and succeeding. Unfortunately, the vast majority fail and it's usually due to poor planning and/or poor execution.

Setting yourself up

Once you and your accountant agree that you have a sound and workable business concept, they will be able to help you with advice on setting up a business entity to suit your personal circumstances.

With your business entity organised, your next step is to purchase or subscribe to an accounting package such as Xero or MYOB, and your accountant can assist you with this too. They can offer online support, training and assistance with the set-up of your business using your chosen software for easy processing of sales invoices, purchasing, stock, payroll, expenses and financial reporting. A good accountant will also help you answer the following key questions to make sure you understand the different options and implications of owning a business and to get you ready to start trading:

• What type of business structure should I use (sole trader/company/trust/partnership)?
• What compliance do I need to have in place (GST registration/BAS reporting/statutory reporting/PAYG tax)?
• What governance requirements need to be in place?
• Are there research and development (R&D) tax concessions available for my business and how do I track the R&D expenses to prepare a claim?
• How do I set up a payroll if I'm employing staff (payroll/workers compensation/withholding tax/superannuation)?
• What insurances do I need (public liability/product liability/professional indemnity/key person)?

In addition, you'll need to have a business dashboard in your accounting package so the key performance metrics for your business are in front of you when you log in. This will also provide you with quick online access to your financial statements (profit and loss, balance sheet and cash flow) for easy monitoring.