Businesses need a continuous flow of customers, products or services to sell, and space to work from or store unsold goods. But they need money to make all these things happen. The more the business actually does, the more money it needs.
You should work out from the outset how much money you need to get your business off the ground. If your proposed venture needs more cash than you feel comfortable either putting up yourself or raising from others, then the sooner you know the better. Then you can start to revise your plans.
There is no definitive answer to this question since every business has unique needs. Starting a business can require anywhere between $100 and $100,000, depending on your goals.
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Startup costs for different business models
The following are rough estimates of how much money you will need to start specific businesses.
- Brick and mortar retail: $5,000 – $100,000
- Full-service restaurant: $100,000 – $750,000
- Bar: $100,000 – $500,000
- Online store: $50 – $5,000
- Mobile service (car detailing, pressure washing, etc): $1,000 – $25,000
- Home-based business: $100 – $500
Several factors will determine your startup cost. Still, you want to ensure that this is a worthwhile endeavor. The Small Business Administration’s break-even point calculator can help you determine how much revenue you need to generate to justify the startup costs before you commit to an expensive lease or purchase order.
How to estimate the amount of money a business needs
1. Forecasting cash flow
Forecasting cash flow is the most reliable way to estimate the amount of money a business needs on a day-to-day basis.
Do’s for creating a cash-flow forecast:
- Do ensure that your projections are believable. This means you need to show how you’re going to achieve your sales.
- Do base projections on facts not conjecture.
- Do describe the main assumptions that underpin your projections.
- Do explain what the effect of these assumptions not
- happening to plan could be. For example, if your projections are based on recruiting three salespeople by month three, what would happen if you could only find two suitable people by that date?
- Do for all forecasting come up with best and worst outcomes as well as the most likely outcomes.
- Do make sure that you include things like job losses and losses of confidence in the markets that you serve. After all, even if your products and services are excellent, if people have lost confidence because of the bad actions of one of your competitors, you may suffer also.
Don’ts for creating a cash-flow forecast:
- Don’t use data to support projections without saying where it came from.
- Don’t forget to allow for seasonal factors. At certain times of the year most businesses are influenced by regular events. Sales of ice cream are lower in winter than in summer, sales of toys peak in the lead-up to Christmas and business-to-business sales dip in the summer and Christmas holiday periods. So rather than taking your projected annual sales figure and dividing by 12 to get a monthly figure, you need to consider what effect seasonal factors may have.
- Don’t ignore economic factors such as an expanding (or shrinking) economy, rising (or falling) interest rates and an unemployment rate that is so low that it may influence your ability to recruit at the wage rate you want to pay.
- Don’t make projections without showing the specific actions that can get those results.
- Don’t forget to get someone else to check your figures out – you may be blind to your own mistakes, but someone else is more likely to spot the flaws in your projections.
2. Projecting receipts
Receipts from sales come in different ways, depending on the range of products and services on offer. And aside from money coming in from paying customers, business owners may, and in many cases almost certainly will, put in cash of their own. However, not all the money necessarily goes in at the outset.
For example, you can budget so that £10,000 goes in at the start, followed by sums of £5,000 in months four, seven and ten respectively. You may be drawing on other sources of outside finance, say from a bank or investor, but these are best left out at this stage.
In fact, the point of the cash-flow projection, as well as showing how much money the business needs, is to reveal the likely shortfall after you, the owner, have put what you can into the business and the customers have paid up.
Be sure to have contingency approaches in place, in case people are late in paying you.
You should total up the projected receipts for each month and for the year as a whole. You’re well advised to carry out this process using a spreadsheet program, which saves you from any problems caused by faulty maths.
A sale made in one month may not result in any cash coming into the business bank account until the following month, if you’re reasonably lucky, or much later if you’re not. Make sure you know the ways in which people pay their bills in the sectors of which you’re working.
3. Estimating expenses
Some expenses, such as rent, rates and equipment leases, you pay monthly. Other bills, such as telephone, utilities and bank charges, come in quarterly. If you haven’t yet had to pay utilities, for example, put into your forecast your best guesstimate of how much you’re going to spend and when.
Marketing, promotion, travel, subsistence and stationery are good examples of expenses you may have to estimate. You know you face costs in these areas, but they may not be all that accurate as projections.
After you’ve been trading for a while, you can get a much better handle on the true costs you’re likely to incur. Total up the payments for each month and for the year as a whole.
The accounting convention is to show payments out and negative sums in brackets, rather than with minus signs in front.
4. Working out the closing cash balances
This is crunch time, when the real sums reveal the amount of money your great new business needs to get it off the ground. Working through the cash-flow projections allows you to see exactly how much cash you have in hand, or in the bank, at the end of each month, or how much you need to raise.
This is the closing cash balance for the month. It’s also the opening cash balance for the following month, because that’s the position you’re carrying forward.
5. Testing your assumptions
Little disturbs a financier more than a firm that has to go back cap in hand for more finance too soon after raising money, especially if you should’ve seen and allowed for the additional requirement at the outset.
So in making projections you have to be ready for likely pitfalls and the unexpected events that knock your cash flow off target. Forecasts and projections rarely go to plan, but you can anticipate the most common pitfalls and to some extent allow for them.
You can’t really protect yourself against freak disasters or unforeseen delays, which can hit large and small businesses alike. But some events are more likely than others to affect your cash flow. In particular watch out for sales taking longer to come in than you thought.
Customers take time to make decisions, particularly if they already have a satisfactory alternative supplier. Also make sure they will pay on time. Costs are also a difficult area to predict as not all are easy to anticipate.
Finding out, for example, that your motor insurance will be much higher as a consequence of using a car for your business is one cost missed from projections. Even if you haven’t anticipated events you can allow for them when estimating financing needs.
Analysis using a cash-flow spreadsheet enables you to identify worst-case scenarios that can knock you off-course. After this you end up with a realistic estimate of the financing requirements of the business or project.
You can check out potential customers by using a credit reference agency such as Snoop4 Companies (www.snoop4companies.co.uk) for businesses or Experian (www.experian.co.uk) for private individuals. Basic credit reports cost between around £3 and £35 and may save you time and money if you have any reservations about a potential customer’s ability to pay.
During periods of economic downturn, recessions to you and me, unsurprisingly customers take longer to settle their bills. Big firms, though perhaps a safer bet and more likely to survive, are rarely sympathetic to a small firm’s plight. Expect them to go to the wire when it comes to settling up.
Research by Bacs Payment Schemes Limited (www.bacs.co.uk), the organisation behind Direct Debit and Bacs Direct Credit, published in March 2010 shows that since the Credit Crunch struck British small and medium enterprises (SMEs) are having to wait an average of 41 days longer than their original agreed payment terms before invoices are paid.That’s an increase of 9.5 days compared to before the Crunch.
Reviewing Your Financing Options
Knowing how much money you need to get your business successfully started is an important first step, but it’s only that – a first step. Many sources of funds are available to small firms. However, not all are equally appropriate to all firms at all times.
These different sources of finance carry very different obligations, responsibilities and opportunities. You have to understand the differences to allow an informed choice.
Most small firms confine their financial strategy to long-term or short-term bank loans, viewing other financing methods as either too complex or too risky. In many respects the reverse is true. Almost every finance source other than banks shares some of the risks of doing business with you to a greater or lesser extent.
SCORE is a good place to get help. Previously known as the Service Corps of Retired Executives, this volunteer organization works with the SBA and offers training to small business owners and aspiring entrepreneurs. SCORE offers counseling from people who have already been in the business that you might want to be in and know the specific issues that you may encounter.
Here are some resources you can look into if you need funds to get started:
- Small business loans
- Small business grants
- Private investors
- Crowdfunding platforms
Learn more about how to get money to start a business.