How to evaluate business plan risks? To begin with, it is necessary to determine the purpose of evaluation. When it comes to the risks the investor should be aware of, the evaluation is carried out as follows.
Business Plan Risk Evaluation for the investor
First of all, the investor determines all the risks that are essential for a particular business. Each of the risks receives an evaluation mark, i.e. a coefficient from 0 to 1, where 0 is the minimum value and 1 is the maximum value of the risk.
- marketing risk – 0.2
- informational risk – 0.5
- risk of user approval – 0.7, etc.
If you multiply these coefficients, you’ll receive the value that never exceeds 1. The lower the value, the better for business. This assessment is quite subjective and is defined by an expert, so the method of calculations can be determined independently, depending on the pursued goals.
Assessment of business plan risks by means of indicators
There is a set of indicators that should be calculated in order to assess the possible risks of a business plan.
- Size of the market. The indicator is determined multiplying the average price by the number of consumers able to buy the product.
- Profitability of business plan. The indicator is calculated dividing the average cash flow over five years by the volume of the initial investments.
- Average cash flow. It is determined dividing the cash flow over the planned period by the number of periods.
- Payback period. It is determined dividing the sum of the discounted cash flows by the amount of initial investments.
- Net present value. It is determined as the difference between discounted cash flows over five years and the amount of initial investments.
After, the calculations of similar indicators for other startups are carried out and medium-scale indicators are defined. The startup with the best indicators is worth investing.
Business Plan Risk Evaluation for the entrepreneur
The following methods are used to perform the assessment of business risks for the company:
- Increase of the discount rate with relation to risks
- Decrease in the value of total cash flows.
The discount rate contains information on profitability and alternative costs for raising capital by other enterprises. If the risk factors are overestimated, then during the calculations the discount rate increases. The more risky the project, the higher the discount rate.
It’s necessary to understand that the evaluation of business in different countries relies on different discount rates. For example, the average discount rate in Ukraine based on the T-bills rate is about 17%, while in the USA this rate varies from 10 to 15%. The dependence is simple: the greater the economic security of the country, the lower the discount rate.
Taking risks into account, the following rates are used:
- 3-5% to introduce new equipment
- 8-10% to increase sales volumes
- 13-15% to produce new products
- 18-20% to develop innovative products.
The method of reducing total cash flows means calculation of the minimal amount of cash flow an enterprise can obtain under any conditions during a certain period. This is a kind of a pessimistic scenario of the development that needs to be prepared in advance.
Using Excel, one can create a model that will show the changes in project profitability, cash flow and payback level depending on various risks. It is conducted on the basis of discounting, where the rate of a risk-free investment project is complemented with the existing business risk rates.