Academic journal article Journal of Business and Entrepreneurship

Decision Thresholds and Developmental Stages in the Expanding Business

Academic journal article Journal of Business and Entrepreneurship

Decision Thresholds and Developmental Stages in the Expanding Business

Article excerpt

ABSTRACT

Business owners and those who counsel them are often surprised by the crisis nature of operating a young, growing business. Even after the business has passed the breakeven point and seems comfortably in the profit range, these financial crises seem to occur. In this paper the authors present an explanation for these crises and suggest how they may be anticipated and planned.

The traditional breakeven model has one crisis point, the point where the business "breaks even" or passes into the profit range. It is suggested here that fixed costs are not truly fixed in an expanding business, but rather increase in a staircase fashion. This produces discontinuities in the fixed cost and total cost curves. That is to say, a growing business must be continually expanding and must pay for the higher costs of expansion. There is a series of breakeven points (or times when profits will be quite thin) rather than a single breakeven point. As a result, expanding businesses face three stages in their life cycle - startup, profit management, and expansion. To some degree, they will alternate between profit management and expansion as long as they continue to grow. Entrepreneurs should recognize that the profits generated in the profit management stages need to be conserved and handled wisely in anticipation of the expansion stages.

INTRODUCTION

Business owners often find themselves overwhelmed by the seeming crisis nature of operating a small business. Just when the outlook seems rosy and the owner thinks the business is reasonably established, another crisis seems to come along. Those who counsel small business owners also seem to be surprised by the number of times a business appears to be healthy and then flounders.

In this paper the authors discuss an explanation for the crisis nature of a young, growing business and suggest how decision thresholds and stages in the life of a business can be anticipated and planned.

A BREAKEVEN MODEL FOR A GROWING BUSINESS

A tool that is often used by new business owners and their consultants is breakeven analysis, or what is also referred to as cost-volume-profit analysis.7 The traditional breakeven model for a business is presented in Exhibit 1. If a business owner and his or her financial consultant think of the operation of the business in this fashion, they will adopt the view that the business will struggle to expand volume to the breakeven point or to the point of an acceptable profit level. After this point is reached, the owner can breathe a sigh of relief because he or she is past the crisis point.

In other words, there is only one major decision point (or so it would appear); the decision to start the business. Likewise, there is only one major turning point; the point where the business begins to make a profit. Waiting in the wings is this one financial crisis that will determine whether the business will succeed or fail. (For those unfamiliar with breakeven concepts, the Horngren and Foster cost accounting text3 has an excellent discussion.)

The problem with this one-crisis type of thinking is that after the business is comfortably in the profit range, the owner feels that he or she "has it made." The startup struggle is behind, and it is clear sailing ahead. When crisis after crisis seems to be the norm, the business owner feels he or she is the victim of particularly bad luck; his or her consultant may feel the owner is particularly inept at managing the business.

It must be remembered that the traditional breakeven model is a financial model rather than a model for decision making. In addition, this model is intended to be used only for what accountants refer to as the "relevant range" of production. It is not intended to be operational over a long period of time, nor is it supposed to be accurate at low or high ranges of volume. If breakeven analysis is to be applied to the early life of a growing business, then a better breakeven model is needed. …

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