Assessing Your Financing Needs
It doesn't necessarily take a lot of money to make a lot of money, but it does take some. To beat the odds and avoid running out of money, successful entrepreneurs prepare by developing rigorous financial plans that forecast essential information such as how much money it'll take to get off the ground and what to expect in the first few years so they can best allocate resources. Smart financial planning is crucial, but actually developing a reliable plan can feel impossible. In this lesson we show you how to assess for and plan for your cash needs.
How Much Money Do You Need?
Whether you want to open a bookstore in Texas or launch a Web design company in Oregon, it's possible to see exactly how existing companies have done it and truly plan for business in the real world. Here are a few principles to consider when planning your startup's finances:
- Prepare a Cash Flow Statement. Before you start investing in or operating your business, prepare a detailed, monthly cash flow statement for the first 1 months. The first step is to anticipate all expenses you will incur prior to receiving any revenue (month zero). Then list anticipated revenues and expenses for each month; this will determine your monthly cash flow. Anticipate negative cash flow for at least the first six months, since expenses generally precede revenues in a startup situation. Both SCORE and the SBA have cash flow templates available as part of their business planning tool. This analysis will indicate how much startup cash you will need, and the additional cash required to cover operating losses during the early stages of the business.
- Forecasting Startup Costs. The importance of being truly prepared for the financial reality of a startup business applies to all entrepreneurs. Even if you're aware of all the different types of startup expenses, it can be tempting to sugarcoat the numbers when you're anxious to get started. But be honest with yourself. Creating an accurate tally of startup costs can be the difference between success and failure. Knowing the actual cost of preparing to open a certain type of business can ensure you save adequately and time the start of your journey well for the best chance of success.
- Where Do You Get Early Cash. Before you start spending, determine whether you have sufficient cash on hand, or can raise that cash. Early cash generally comes from personal savings, friends and family, or loans backed by personal assets. If your startup costs include purchasing assets that have a resale market (i.e. a vehicle), you should be able to borrow a portion of the cost from a lending institution. If you learn that you will not be able to raise sufficient cash to support your plan, you should either delay your launch until you can save additional money, or scale back the early business plan, if that is a viable option.
- Prepare a Sensitivity Analysis. The one thing I can assure you about your cash flow projections is that they will be wrong. What we don’t know is how wrong and in which direction. So once you have prepared your “best estimate” cash flow projection, do some sensitivity analysis. What happens if revenues are 20% below expectations? How about 20% above? What if cost estimates are understated by 20%? If you are buying inventory to support future sales, underestimating sales volume can be just as dangerous as overestimating it.
- Heed Expert Advice. Even the best financial forecasting and fiscal planning don't guarantee success in business--because those critical markers of the startup experience don't account for the impact of realistic expectations for how much time and energy a new business requires and other sometimes-surprising aspects of entrepreneurship.
Once you have completed the above steps, you will have a reasonable understanding of your business’ cash requirements under a variety of circumstances. You will know how much cash you need to get started, and when you might require additional cash infusions to cover early operating losses or inventory buildups. You can then make that all important decision: go or no go.
Developing a Cash Flow Statement
The financial picture of your business is generally reflected in three financial statements:
- Income statements
- Cash flow statements
- Balance sheets
The most important when looking at the start of your business is your cash flow statement which details the cash coming in to your business and cash going out of your business:
- Cash Coming In. Cash comes in to your business in the form of sales from customers and investments in the form of loans or equity.
- Cash Going Out. Cash goes out of your business in the form of expenses and payments due on loans and other financing.
Preparing a cash flow statement for the first year (and even beyond) is a necessary tool for determining what your cash needs are. Based on your cash flow projections, you can plan for if and when you will need an investment of cash.
So even though it doesn't necessarily take a lot of money to make a lot of money, you still need to take the time to assess your realistic financial needs during the early stages of your venture.