Three Tests of a Sound Business Plan

To get external financing, an entrepreneur’s plan must pass three tests with potential lenders and investors:

The competitive test
The reality test
The value test

Competitive test – The external part of the competitive test evaluates the company’s position relative to its key competitors. How do the company’s strengths and weaknesses match up with those of the competition? Do these reactions threaten the new company’s success and survival?
The internal competitive test focuses on management’s ability to create a company that has an edge over existing rivals. To pass this part of the competitive test, a plan must prove the quality, skill, and experience of the venture’s management team. What other resources does the company have that can give it a competitive edge in the market?

Reality test – The external component of the reality test revolves around proving that a market for the product or service really does exist. It focuses on industry attractiveness, market niches, potential customers, market size, degree of competition, and similar factors. Entrepreneurs who pass this part of the reality test prove in the marketing portion of their business plan that there is strong demand for their business idea.

The internal component of the reality test focuses on the product or service itself. Can the company really build it for the cost estimates in the business plan? Is it truly different from what competitors are already selling? Does it offer customers something of value?

Value test – To convince lenders and investors to put their money into the venture, a business plan must prove to them that it offers a high probability of repayment or an attractive rate of return. Entrepreneurs usually see their businesses as good investments because they consider the intangibles of owning a business—gaining control over their own destinies, freedom to do what they enjoy, and others; lenders and investors, however, look at a venture in colder terms: dollar- for-dollar returns. A plan must convince lenders and investors that they will earn an attractive return on their money.

A new business enterprise must have both long-term strategic vision and a practical focus on operations. In their business plans, entrepreneurs must be able to communicate clearly an understanding of the following:
? Cost of raw materials and supplies
? Unit labor costs
? Market-determined selling prices and gross profit margins
? Break-even point for their businesses