Evaluating Business Opportunities
Saying no to an opportunity that looks good on the surface can be one of the hardest things we do in our professional (or personal) lives. We’ve heard most of our lives that “opportunity knocks but once” and that we need to “strike while the iron is hot”, but does that mean we should say yes to every opportunity that meets our criteria, whether it’s financial, relational, or other? The answer is….it depends. Impactful business decisions should not be made in a vacuum, and I’d like to discuss some of the factors that need to be considered when evaluating a business opportunity.
Business opportunities could include mergers or acquisitions, launching new product lines, planting new crops, buying new land or equipment, hiring a new position or replacing an existing one, etc. The thing that all these types of opportunities have in common is that they require some sort of investment (time, money, often both) that will hopefully pay off in the future. When deciding whether or not these opportunities are worth pursuing, here are some of the key questions to answer:
What is the opportunity cost?
Opportunity cost not only includes the cost of the investment being made, but also the value of your alternative decision. Essentially, what are you giving up in order to pursue this opportunity? If a farmer is deciding whether or not to plant trees in a field that he owns, he needs to account for both the cost of developing an orchard and the revenue lost from having his field not produce a crop for a few years.
Could a better opportunity be around the corner?
Business opportunities can often be unpredictable and present themselves with little to no warning. Before jumping into action, I think it’s worthwhile to take a step back and think about the scarcity of the opportunity. If you’re looking to expand your business and need to purchase land for a new facility, do some research on how many suitable properties have been available for sale over the past several years. If land is frequently available for purchase in your area, you are more likely to feel comfortable waiting for a better deal rather than jumping on a property with an above-market asking price.
How does the investment impact your business in the short term?
When looking at the long-term financial projections for an investment, it can be tempting to focus on the profits that you’ll see 10 or more years down the road and not spend enough time focusing on how you will survive the first 10 years. Will you have the cash flow to keep operations on track until your investment breaks even? Is ownership willing to forgo or limit dividends over the next few years? If you’re taking out additional financing for this investment, will there be a significant, negative impact on your financial ratios? These questions may not be fun to answer, but they may be the most important to consider.
Call me risk averse if you want, but I don’t subscribe to the notion that opportunities are once in a lifetime. The key is to measure the costs and the risks of an opportunity before making a decision, even if it means missing out on a potentially profitable investment.
+Tim Peters is a consultant with Morrison, providing business valuations, business planning (including budgeting, cash flow forecasting, strategic planning), feasibility studies, interim controller services, recruitment, and special projects that don't fit into any conventional category. You can contact Tim directly at email@example.com or via telephone at 530-893-4764 ext. 208.