How to Plan for Your Next Big Business Purchase

The business is going well. You have lots of customers, you're making a profit, and all signs point to growth. At this rate, you'll need to expand. But when? And how?

You don't want to risk your whole business by making a financial mistake. You're eyeing a new piece of equipment and hiring more help. Both would allow you to serve more and do better by your customers. But you're not sure if you can afford both or one. And if you have to choose, which would be better than the other. Before you make any commitments, you want to make sure it's a smart decision based on data.

To grow your company, you will come across hard decisions like these. It's a tough balance. You want to keep the company healthy and you have to live off the profits. Yet, you know you need to invest money back in your company to reach the next level. You don't want to risk the whole business and “bet the farm,” and you don't want to miss out on the opportunity.

At this crossroad, you need data and analysis. There is a process you can use to find clarity and make an informed data-driven decision. Every opportunity has tradeoffs. None are clear cut. Hence, you need to perform a few analyses to make an educated and less risky decision.

Let's go through the process to assess if it makes sense to pursue a new business opportunity, shall we?

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1. Identify all expenses and when they'll happen

First, you need to know how big of an investment this opportunity is. You need to understand all the costs and when they’ll happen. Consider how you will use it and brainstorm the potential costs. To go deeper, research it online and talk to others who've made a similar investment.

You'll need to know the timing, amount, and frequency later in your analysis so note these details now. Some expenses will be one time, like a setup fee and shipping. Others will be recurring. Even for small expenses, track them. These make a huge difference in the total investment and are all too often overlooked.

For instance, the cost of equipment isn't the price tag. You need to add in annual maintenance and operating supplies like grease, fuel, and labor. On the flip side, you may be able to sell your old equipment and lower the total cost.

For contractors, look for expenses beyond their base fee. Check the fine print of any contract to understand what you'll be responsible for. It makes no sense to work with a consultant and not use their work. Be sure to ask what tools they'll need and any other expected costs.

A common example is a marketing consultant. They may create Google ads, but you're responsible for the costs of those Google ads. It's rarely baked into their fee. And they may recommend tools, like an app to improve and track SEO.

Getting your arms wrapped around all the costs is tough, so take the time to do thorough research. You can't make a wise decision without this data.

2. Consider the opportunity costs to your business

What benefits would you miss out on if you don't make the investment? What would it cost you to continue with the status quo? This is the opportunity cost.

You want to think of everything you could miss out on. Create a list of all the possible benefits of making the investment. Assign a dollar value to what you can, and write down your assumptions.

In this step, it's easy to get carried away with the possible benefits. Be realistic. Don't expect that everything will work out better than your wildest dreams. It's good to know the best and worst-case scenarios, but most likely you'll end up in the middle.

This cost can stray away from the numbers and be even harder to estimate. Some benefits are intangible, like quality improvements. It's difficult to estimate how better quality will increase your bottom line. (It's possible but based on lots of assumptions.)

In the case of the marketing consultant, hiring an expert should free up your time. How much is your time worth and what could you do with those hours? Could you serve more customers? Create a new product or service line? Or what is it worth to spend that extra time with your family?

The opportunity cost is paramount in determining if an investment is worth the risk.

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3. Use the data to compare costs and opportunities

Next, you want to compare the expected and opportunity costs. You need to do this with both qualitative and quantitative analysis. Here you are using the data you collected in the first two steps.

On the qualitative side, make a list of pros and cons in favor of the new investment and a second in favor of the status quo. When you write the lists, don't edit yourself. After you have the draft down, you can review and make edits.

Seeing these lists side by side often spurs new insights. Note that not every pro and con is equal in importance. You may want to rank the lists in order of importance or put like items side by side. This means you have to decide what's critical and what's a deal-breaker.

By this point, you may have an idea of what is a better strategic decision.

For the quantitative analysis, you'll do a cost-benefit analysis. Here is where you run the numbers. Pick a time frame, such as the life of the equipment or length of the contract, and tally the costs and benefits.

To make financial sense, the costs should be lower than the benefits. But, qualitative factors may make the investment worthwhile. It depends on your purpose behind the purchase.

4. Consider your cash flow

You may think the money should be the first step, but that'd be incorrect. First, you have to determine if it's a wise investment, i.e. see if it passes a cost-benefit analysis. You can move on to seeing if you can afford it after the analysis.

You'll need the net cost and timing/frequency from steps one and two. This will help you build a forecast of how much cash is moving in and out and when.

Once you have the cash requirements, you'll compare it to your current cash balances and cash flow.

To find your current net cash flow, look at your Statement of Cash Flows report. If your books aren’t up-to-date, you can do a back-of-the-envelope calculation. Look at your ending bank account balance month after month. If it's trending upwards and you’re on top of all your bills, you likely have positive cash flow.

For the initial investment, you'll compare the amount to your cash on hand. For ongoing costs, you want to ensure you have enough positive monthly cash flow to cover them. If you have the cash on hand and enough net cash flow, then great. Continue. If not, you need to pause.

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If you're short on the initial or ongoing cash needs, what you do next depends upon your risk tolerance.

For the initial investment, you can get more cash by increasing debt or equity. You could raise the funds via a loan (debt), invest your personal money (equity), or add a partner who has the cash (equity). Keep in mind if you take the loan, you'll need to factor the loan payments into the ongoing cash flow.

If you don't have enough monthly cash flow to cover the ongoing expenses, that could be a deal-breaker. If you're able to generate more revenue, you may be able to weather negative cash flow for a short while. But you want to return to positive cash flow as soon as possible.

As you work through this step, you need to consider all other commitments on your cash flow. Like if an annual insurance premium is due soon or if you're a seasonal business gearing up for your busy season. Especially for seasonal businesses, cash flow is unsteady. You may need to wait until after the busy season to make a big investment.

5. Set goals and track results

By now you've identified all the costs, done your analysis, and reviewed your cash flow. You want to go ahead with the investment. Before you sign an agreement, you need to create a few goals to ensure you make the most of your investment. This way you can track if the investment meets your expectations.

Be specific and write down what improvements you expect and by when. These goals could include:

Increase sales by X percent
Add a new product line
Free up X hours of your time each week
Decrease labor costs by X percent
Increase the number of qualified leads

You may include a goal on the return on investment if you can quantify the future benefits (read: lots of estimates and financial formulas, like the net present value of future cash flows.). 🤓

Write down your goals before you make the decision so you can be objective when you look over the results. Schedule regular check-ins to see if you're on track. If the results are below expectations, you may need to reassess the investment.

With repetition, you'll learn ways to improve this decision-making process. Be sure to write your insights down and apply them next time!

It's always hard to decide which opportunities to pursue and which to let go. You'll have many opportunities so you need a good system to make the best decision. To make a data-driven decision, you need to: