For our example, we will use $30,000 as the amount of the loan requested and a term of five years at 15 percent annual interest rate. The calculation of the annual payment is as follows:
$30,000 over five years at 15 percent $30,000 / .023790* = $713.70/month $713.70 x 12 months = $8,564.40/year
*(.023790 comes from loan amortization tables which are available at local bookstores or in most finance textbooks.) This $8,564.40 represents the total interest and principal repaid on the loan the first year of operation. If we round this figure to $8,600 and estimate personal living expenses to be withdrawn from this business at $15,000, we have a total of $23,600 which must be generated to sustain our personal needs and keep current with the lender. The next step is to determine the level of sales necessary to earn the $23,600. From industry statistics, we can ascertain average performance data for various types of business operations. One of the most commonly used sources for this information is Annual Statement Studies , published by The Risk Management Association. Other sources can be found in the library and include Dun and Bradstreet, Industry Norms and Key Business Ratios™, the Almanac of Business and Industrial Financial Ratios (CCH) and local and national trade associations. Be sure to determine that the industry standard being applied includes the owner’s draw as a part of profit. If it does not, this withdrawal amount will have been deducted as a salary expense in the operating statement and will have to be added to the stated profit to get an accurate indication of the total percent of sales available as profit to the business owner. For our example we will assume the industry sources show that, for the type of business under consideration, the average profit, including the owner’s draw or salary, is 11 percent of sales. To determine required annual sales volume: $23,600 is 11 percent of X X = minimum required annual sales .11 X = $23,600 X = $214,500 We have now determined that, if our proposed business is assumed to be average, we will need to sell $214,500 of our products or services to cover expenses, keep our loan current through the first year and withdraw the desired $15,000. This in no way implies that we will sell $214,500, of products or services, but this dollar amount serves as a goal that must be met. We now have available a minimum target sales figure to test and verify through the techniques of market analysis. For some, it will be readily apparent that the required sales target is not realistic. For others, careful market research will be necessary before any conclusion can be drawn. The desired income approach of determining required sales can help us answer the question of whether we would start a particular business, begin the business as we have it conceptualized or whether the idea we have is likely not to grant the desired return. It gives a benchmark that must be met. It provides a realistic financial goal that must be achieved. If our research shows that this goal is attainable and that estimated sales are likely to meet or surpass this level, we can enter business with that much more confidence. If our market investigation does not thoroughly
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