Choosing the right location is crucial for business success. Here is a breakdown of key factors and financial techniques involved in making an informed location decision.
Financial factors mainly include:
- Sales Revenue. Consider potential sales volume from customer proximity and location prestige, e.g., a lawyer’s office in a city center).
- Costs. Analyze Fixed Costs (FC) like site acquisition/rent, utilities, and salaries, as well as Variable Costs (VC) such as transportation for raw materials, finished products and supplies, as well as labor availability.
Once these quantitative factors have been identified and costs and revenues estimated, the following techniques can be used to assist in the location decision.
1. Estimating costs and revenues. Estimating costs and revenues is a crucial step in making informed location decisions for your business.
a. Cost analysis: Estimate Fixed Costs (FC) and Variable Costs (VC) associated with each potential location. Fixed Costs (FC) of the location might include site costs, availability of grants and subsidies, cost of loans associated with set up, cost of utilities such as gas, water, electricity, cost of hiring fixed salaried staff, cost and availability of technology, etc. Variable Costs (VC) of the location might include nearness to market, cost of raw materials, cost of sourcing supplies, transportation costs (bulk increasing or bulk reducing, nearness to a supply of skilled/unskilled labor, etc.
b. Revenue forecast: Project potential revenue based on customer base, pricing strategy, and location factors like foot traffic or visibility.
2. Evaluating profit potential. Compare estimated revenues and costs. Identify the location with the highest projected annual profit. Capital cost consideration is the factor in the capital cost of acquiring and developing the site, but should not solely rely on annual profit forecasts.
3. Investment Appraisal techniques. When making a location decision, especially one involving significant capital investment, utilizing investment appraisal techniques is crucial.
a. Payback Period (PBP). Estimate the time required for each location to recover the initial investment. Prioritize locations with faster payback periods, especially if capital is limited or economic uncertainty is high.
b. Return on Investment (ROI). Calculate annual profit as a percentage of the initial investment for each location. Choose locations with higher Return on Investment (ROI), but acknowledge the inherent uncertainty of long-term forecasts.
4. Break-Even Analysis (BEA). Break-Even Analysis (BEA) is a technique used in location decisions to assess the level of production or sales required at a specific location to cover all associated costs (both fixed and variable).
a. Calculate break-even point. Determine the production volume required at each location for revenue to equal Total Costs (TC). Choose locations with lower break-even points, especially for businesses with high Fixed Costs (FC) and potential benefits from lower overheads.
b. Use with caution. Be aware of the limitations of Break-Even Analysis (BEA), as it relies on estimations and may not capture all relevant factors.
By effectively analyzing various factors, estimating costs and revenues, and employing appropriate decision-making tools, businesses can increase their chances of selecting the optimal location for their long-term success.
