Small Business Start-Up Cash Needs and Sources
Copyright © 2014 Eric Tyson. All rights reserved.
To start a small business, you should have a number of things in place, including a well-thought-out and researched business plan. You also need money. The start-up cash needs include one-time start-up costs, working capital, and a reserve:
One-time start-up costs: Start-up costs include such one-time expenses as legal fees, licenses and permits, utility and lease deposits, furniture and fixtures, inventory, leasehold improvements (remodels or additions to the store or office space you rent or lease), signage, and everything you need to initially open for business. Consult another company’s profit and loss statement (P & L), or a pro forma P & L sample on a business plan template, for a listing of the typical one-time and day-to-day ongoing expenses you’re going to incur.
Working capital: Working capital is the cash you need to remain open for business. This includes such ongoing, everyday expenditures as inventory and raw materials, accounts receivable, hiring of employees, and the general day-to-day operation of your business until such time as you become consistently profitable and can fund the cost of operations out of internally generated cash flow. Don’t forget to include debt payments — both interest and principal — when arriving at this figure. (Although principal payments aren’t an expense, they reduce available capital.)
Reserve: The reserve consists of enough capital to overcome forecasting mistakes and/or make up for variances from your budget. Just about every small business start-up has forecasting mistakes and budget variances, so plan accordingly.
So where’s all this money going to come from? You have two basic methods with which to finance your start-up:
Bootstrapping: The internal generation of initial financing, using primarily your own personal resources, sometimes complemented by various forms of equity investments or loans from family or friends.
Outsourcing: The external generation of financing for both start-up expenses and ongoing business needs, using outside resources such as banks, angels (affluent investors who invest in small business), and venture capitalists.
Bootstrapping is a much more likely source of funds than outsourcing for most start-ups. Besides, providers of outsourced funds aren’t likely to give you the money you need unless they see that you’ve done your bootstrapping first.
Whether you bootstrap the financing of your business or finance it using money from outsiders, you must first estimate your cash needs. If you plan to go the bootstrapping route, estimate your cash needs to minimize the chances of running out of money, a situation that can lead to the failure of your company and the loss of all the invested capital. If you plan to outsource your capital infusion, estimate your cash needs to ensure potential lenders that you have solid projections for your future cash needs.
If you do end up obtaining outside capital, nothing shouts inexperience like having to go back to your source at a later date and ask for more money. Looking for a surefire way to raise a red flag in front of your banker or investor? Tell her that you made a mistake in forecasting and you need more capital than you had originally asked for. Whether you’ll get your capital the second time around is up for grabs, but one thing is certain: You’ll get increased scrutiny. Bankers and investors don’t like oversights and mistakes, especially when it comes to their money.
So, what’s the obvious solution? Just as remodeling work on a home almost always takes longer and costs more than expected, many entrepreneurs find that their start-up requires more cash than they originally expected. That’s why you should allow yourself sufficient time to investigate, reflect upon, and estimate the costs associated with starting your chosen business.