Assessing the Economic Viability of Business Ideas for Productive Use

Good practice from the INSABA programme in Sub-Saharan Africa   Introduction

Introduction

TheIntegrated Southern Africa Business Advisory (INSABA) project was implemented in pilot regions in Botswana, Namibia, South Africa and Zambia over the period from 2005 to 2008 with funding from the German Federal Ministry for Economic Cooperation and Development (BMZ) and the European Commission. The programme developed and delivered adapted tools for identifying marketable goods and services that can be produced and performed using various locally available renewable energy sources (mainlyphotovoltaic (PV) solar power systems and small wind generators). The 30-month project included training, business advisory services and policy dialogue intervention.

Economic Viability

For advance assessment of the economic viability of any business idea, experience from INSABA has shown that seasoned business consultants may be capable of qualitatively evaluating the viability of specific business ideas based on their in-depth understanding of local economic structures. Proper appraisal of a business idea’s viability requires extensive data collection and in-depth technological study to assess the idea’s feasibility under given socioeconomic conditions. If similar business ideas have already been implemented elsewhere in the region or country, those real cases can and should be analysed and possibly transferred and adapted to the location under study.

Feasibility

INSABA developed a sophisticated set of tools for assessing the feasibility of small businesses powered by electricity generated from renewable sources (see example below). These tools guide future entrepreneurs through a simple equation calculating the return on investment (ROI), a sensitivity analysis measuring changes in key business parameters as a function of changes in ROI, a competitiveness analysis, and a cash flow analysis.

The following data are required for these calculations:

• investment capital and lifespan
• production price per unit
• variable cost per unit
• cost of energy per unit
• amortisation per unit
• direct costs per unit
• gross margin per unit
• fixed cost per unit

Since most micro and small businesses in rural environments might not be able to calculate or even estimate all these data, the INSABA approach provided the facilitating services of aninterdisciplinary advisory team (IAT). These experienced business advisors were trained in the methodology in a five-day INSABA toolkit seminar. They, in turn, trained local potential producers and suppliers of goods and services in how to obtain the necessary data and use the various tools. The methodology tends to be rather costly when considering small investment opportunities valued at less than USD 5,000.

The table below presents an INSABA business pre-assessment tool for calculating the ROI for a particular economic activity undertaken by a micro, small or medium-size enterprise (MSME). The example chosen here is a fruit drying business that utilises a solar dryer. The same computational tool can be applied for calculating ROI in electrical equipment. 

Calculation of Return on Investment (ROI)

Calculation of ROI for a solar dryer used for drying fruit
	Apple dryer		Determination of parameters	Definitions
Investment capital	9,957		Estimated, then computed for ROI0,3	Total cost of technology investment
Investment lifespan	5		Estimated for solar dryer	Service life of the technology - i.e. period before it must be replaced
Production	520		2 kg of dried apple chips sold daily 5 days per week for 52 weeks/year = 520 kg per annum	Units produced per year
Price/unit	19.50		Current market price	Sales price per unit produced and sold
Revenue	10,140		Euro	Sales price multiplied by number of units sold
Variable cost/unit	8.00		Costs for fresh apples: 10 x €0.55/kg = €5.5/kg (sales price of €0.55/kg is relevant as this is the opportunity cost of the farmer); costs for packaging: €0.50/kg; costs for preparation: 10 kg fresh apples can be prepared in 15 minutes at an hourly wage of €8.00: 2.00 €/kg	Cost per unit produced e.g. material, processing packaging
Cost of energy/unit			no other additional cost</span>	Costs of power and fuel added to variable cost
Total fixed costs	1,000		Cost for display, handling	Annual indirect costs such as rent, telephones and salaries
Amortisation/unit	3.83	1,991		Amount needed per unit to cover investment in lifetime
Direct costs/unit	11.83	6,151		Variable costs plus amortisation plus cost of energ
Gross margin/unit	7.67			Sales price per unit less the direct costs per unit
Fixed costs/unit	1.92			Total fixed costs divided by the number of units produced
Total costs	13.75	7,151		Direct costs plus fixed costs
Net margin	5.75	2,989		Revenue less total costs
ROI	30%			Return on investment = net margin divided by capital investment
Payback period in years	2.00			Capital investment divided by cash flow until initial expenses are compensated by the net margin

Further Information

www.insaba.org