Depending on the size and type of your business, you might have to decide things like whether to purchase a new car or truck, upgrade your computer system, hire a new employee, redecorate your retail store, undertake a major expansion, or even whether to buy another related or unrelated business. Every business owner wrestles with these types of questions: Is it time to make a major purchase? Could we undertake an expensive project?
You can make a decision based on your gut feeling that it will be good for business when you're replacing essential equipment that is no longer functional. However, what happens when the project, purchase, or investment is a significant amount of money or its life span is greater than one year? In these situations, it will be appropriate to evaluate the costs and benefits of the project and do a little number crunching, perhaps with the aid of your accountant.
Make an objective decision to proceed. Depending on the size of your operation, draw the line at a certain dollar amount such as $1,500, $5,000, or any other amount that makes sense. Anything below that amount would be treated as a normal budget expense; however, anything above that amount would require a more in-depth analysis or study.
Clearly, the bigger the project, the more formal analysis you'll want to perform. The fact that your business is small does not mean you can avoid this process - in fact, smaller businesses usually have a smaller margin for error, making careful analysis even more important. Overspending on an expansion or new equipment can sink a small business, where a larger business would be more likely to have deeper pockets and be able to recover.
If your project requires major financing, a fairly detailed analysis is often necessary. Banks or financing institutions will probably want to see a cash flow projection or even a full-blown business plan. If you're thinking on purchasing or starting another business, financiers will require a complete study of the project. Involve your accountant and go through some serious financial analyses before you make a firm commitment to the project.
In making your decision about a major purchase or project, you should:
- Consider all the benefits of the project
- Consider all the costs
- Create a projected cash flow statement that quantifies costs and benefits and places them in the correct time frame
- Use financial analysis tools to determine whether the project makes sense.