(basic raw material) plus an oven to bake the cookies (plant and machinery), and also a place to keep the oven (premises). Plus, not to forget, skilled labor (You’ve got to know how to make cookies OR hire someone who can.). Last but not the least, your have to find a way to sell the cookies – either hire a salesman with a fixed pay or hire an agent with a fixed share in profits (Selling and distribution overhead). All these factors would sum up to be the ‘Cost’ incurred on making the cookies. Based on this cost, you may decide your expected ‘Selling Price’ and thus the ‘Contribution’ per unit. (Activity Ratios)
Also, to keep things going, you would need enough money readily available for your short term requirements (like buying more raw materials, paying rent, electricity bills, wages to employees, etc.) as well as for long term requirements (paying off debts, more money for further expansion, etc.). Also, you very well know that your creditors will supply you material on credit only if you are worthy of it. i.e. you are able to pay them in time. (Liquidity Ratios)
In both the cases, money doesn’t come free of cost. Business should be profitable enough. Both the parties would again, check your credibility as well as the worthiness of the business. In the first case, you would be liable to pay a fixed interest to your bank, regardless of what you make. In the second, you’ve got to make enough money so that you and your friend are glad that you invested in the business. Therefore, to be sure of what you are doing, at every moment you would be analyzing your ‘profitability ratios’, like you would constantly be calculating your earnings as against your investments (EPS) and comparing it with what ever was the next best use of your money (opportunity cost).
Further, you could even decide your debt-equity ratio - how much share in the profit should be sacrificed for funds and how much should you borrow from the bank. And if ...
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