Financial planning: How much money do you need
Financial planning: How much money do you need?
Cash. Capital. Funding. Whatever you choose to call it, starting a business takes more than talent and hard work. It takes money. Of course, to be a successful business owner, you need a dose of the following:
• A knowledge of the business
• Luck (it never hurts)
But without sufficient money, you're back to dreams. Don't get lost in the visions of fortune and freedom before you ground yourself in the reality of making it work.
Most small businesses are undercapitalized right from the start, according to the experts. Without budgets and a simple cash flow statement, you risk condemning your business to failure because of lack of money. Enter your project prepared for the financial challenges, and you'll stand a much greater chance of thriving.
In order to ensure a profit for your business, you have to think ahead in terms of expenses and income. By preparing a budget as your "profit plan," you map out projected incomes and outflows for your company. Some experts recommend preparing a master budget for the entire year, then breaking it down into manageable sections, such as quarters or months.
To determine the capital costs portion of your budget for the first year of business, you'll have to start by totaling what you have on hand, what you'll need to open up shop and what you'll need to operate for the first quarter.
Financial planning: How much money do you have?
More than 75 percent of small-business owners self-finance their company startup, according to the Small Business Administration. So before you launch a new enterprise, examine your resources -- not only those you will put into the business, but also those that will keep your household afloat.
In other words, how much capital can you count on? First you will have to prepare a personal financial statement that describes your assets and liabilities. This financial statement will eventually become part of your loan proposal package, so make sure the entries are accurate. Financial planning: Family budget
You'll need to add up what the family will require to make it through. You have to examine the saving and spending habits of your family to do this. The best way to understand your family's personal cash flow needs is to create a budget.
If you already have a budget, look back over the past year's expenses. If you don't have one, try to recreate what the family spent last year, at least in the major categories like loan payments, food, utilities and entertainment. Since many of the expenses are variable, identify which can be cut back, and which can be cut out.
Remember, too, that at least one partner's income will change, maybe for the worse, for the first few years of business startup and growth, so you will have to write your new budget to reflect the loss of income, or change in income. If the budding entrepreneur is the sole breadwinner, you'll have to plan on a larger loss of income.
Put at least one-fourth of the family's annual expenses in a bank account before you open your business. Financial planners always recommend an additional three-month liquid emergency fund, such as a money market account or short-term certificate of deposit. You may want to increase that to six months to cover the family during startup Use these figures to create a one- to three-year family survival plan in case the business does not generate the expected revenues.
Financial planning: Calculating business costs
The family expenses have been calculated, now what about the business? Startup necessities will vary depending on the type of business. To open the doors of a new construction company you need heavy equipment, while a boutique needs clothing inventory.
Once again, you must create financial statements. This time they break out what it will cost to open the doors, and what it will cost to keep the business operating. Most of the numbers you need can be found by calling vendors, suppliers, and professional and government offices.
Some items to consider in startup are the physical property and its condition, inventory, legal fees, supplies and services, and insurance. You'll also need to include advertising costs, because if the public doesn't know you're in business, you won't be.
A basic startup worksheet would look like this:
|Advertising |
| |
| |
|Equipment |
| |
| |
|Insurance |
| |
| |
|Legal fees |
| |
| |
|Licenses |
| |
| |
|Remodeling |
| |
| |
|Rent |
| |
| |
|Supplies |
| |
| |
|Utilities |
| |
| |
|Other |
| |
| |
|Total: |
| |
| |
Once the doors are open, you have to be able to keep them open, so you need to know your operating costs. The Small Business Administration recommends that you be prepared for three months of operating costs, without relying much on income from the new company.
A basic operating worksheet would include the following:
|Advertising | |
|Cost of living: see family budget | |
|Insurance | |
|Utilities | |
|Rent | |
|Supplies | |
|Taxes | |
|Wages | |
|Total: | |
Again, you can get a good estimate of the amounts you need by using that shoe-leather, or calling suppliers and professional and government offices, and checking the reference section of the local library. For a broad overview, the Department of Commerce and U.S. Census Bureau have compiled statistics on assets and expenditures.
To determine the cost of wages, look at the Bureau of Labor Statistics' Occupational Outlook Handbook, check on the minimum wage in your state as listed by the U.S. Department of Labor or call a temporary employment agency to price hiring a temporary worker. Hiring a temp may be a way to get started without your having to foot the bill for the benefits that attract quality employees.
If you total up three months worth of operating costs (you should already have the cost of living portion, if you calculated the family budget) you have a good idea of what you need to go into business. The operating cost statement, coupled with the net worth statement, will tell how much you can personally afford, and how much you'll need to finance. Investigate financing options in Capital Sources.
Financial planning: When will you break even?
To stay in business, you have to make a profit. So how many widgets do you need to sell to start making money? You'll know the answer when you calculate your break-even point. It's an important concept to learn before you get started, because below the break-even point you generate losses, above that point it's profits. How do you figure it out? It's fairly simple. The break-even point is where sales cover costs.
Here's the formula in units: Total fixed costs divided by (Price per unit minus Variable costs per unit) equals sales at the break even point.
For example, you calculated that your sunglasses manufacturing plant has fixed overhead expenses of $7,000 a year. That covers items such as the rent, electric bill and payroll. To make, advertise and mail the sunglasses costs $4.50 a pair. That is your variable cost. You think you can easily sell the sunglasses for $12 each, based on your industry research.
So: $7,000 divided by ($12 minus $4.50) = 933
You would have to sell 933 pairs of sunglasses to break even.
In dollars, you can calculate the sales volume needed to reach the break-even point by multiplying the number of sunglasses you need to sell by the selling price: 933 x $12 = $11,196
Break-even analysis can show you profit levels of sales and help you determine the success of your project before you start. However, it does not help you to examine cash flow, the actual movement of cash in and out of business. Getting a handle on cash flow is essential to maintaining financial control.
Financial planning: Figuring cash flow
While your worksheets help you build a budget for the future, you will need to check periodically on the immediate financial health of your company. Cash flow analysis can help you do that. A projected cash flow statement estimates what the flow of money will be like in the coming months or years based on a history of sales and expenses. A monthly cash flow statement reveals the current state of affairs.
A cash flow budget is your core tool in maintaining control over company finances. While you can almost always cut back on costs, or the cash going out, you can't always generate sales, or income. So you need to know where the money is, and where it's going.
The basic elements of cash flow are:
• Starting cash, or starting balance -- What you have on hand at the beginning of the month.
• Cash in -- All cash received during the month, including sales, paid receivables, interest or cash from sales of assets or stock.
• Cash out -- All fixed and variable expenses
• Ending cash, or ending balance -- Add Starting Cash to Cash In for total cash, then subtract Cash Out.
Here is an example of how you measure cash flow by subtracting your monthly ending balance from your starting balance.
Let's say you started the month with $3,500. You brought in $1,000 in sales and you paid out $400 in rent and $600 in wages for a total of $1,000 in expenses. So your ending balance is still $3,500. While you did show some sales, your monthly cash flow would be $0. To survive in business, you want positive cash flow, which means you are taking more in than you are spending. Positive cash flow gives you forward motion to build and grow.
Even a small lag in sales can make a dramatic impact on cash flow, but you might not know that without your cash flow budget. At the end of every month, compare your actual business sales with your estimated cash flow projections. If they are out of whack, consider the cause. Maybe you didn't factor in the need to hire summer vacation replacement help or the jump in paper prices for your printing business inventory. Cut back on the outflow where you can, and adjust monthly cash flow projections to more realistically meet your needs.
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