Sin number 5 - Underestimating how much working capital you will need when you start a business
By Greg Carroll
When you are starting out in business you are going to need a substantial amount of cash to carry you through the start up and early growth stages of your business. Even before you open your doors you will have your hand in your pocket to pay for things like:
- Business registrations
- Accounting fees
- Legal fees
- Business cards and letterhead
- Website development
- Licensing and permits
- Plant and equipment
- Furniture and fittings
If you put some figures next to each of the items above you'll quickly arrive at a few thousand dollars. If you are buying into a franchise system or a business involved in reselling someone else products you will probably also have to pay franchise fees and purchase product. So now you may be ten of thousands of dollars out of pocket - and you haven't even got any customers yet.
This is where the financial forecasting discussed earlier becomes important because it can help you estimate the likely costs your business will incur over your forecast period. The costs and expenses for each business will be different but the list below covers some of the items that will be common to most businesses
· Advertising and promotion
· Bank charges
· Bank interest
· Equipment leasing
· Internet expenses
· Motor vehicle expenses
· Wages and salaries
Even a very simple business with minimal overheads and one owner/operator working from home is going to cost a few thousand dollars a month to run.
So once you've worked out your set up costs and your operating expenses you should end up with a figure somewhere between $20,000 to $30,000 for your first 12 months, for a very simple business. Add some staff, rent on a premises, and that figure is going to increase substantially.
Whatever that number ends up being that is how much it is going to cost you to keep the doors open for the next twelve months, whether you have one single customer or not. So my first piece of advice to anyone setting up a business is you should have sitting in your bank account or access to that amount of money before you even start your business. If you don't then you should be seriously reviewing your options.
Now that might sound like I am trying to dampen your entrepreneurial spirit but I can assure you I'm not. There are plenty of stories around of the guy who started with just $5 in his pocket and turned it into millions. But this is significantly outweighed by the stories you don't hear, of all the failed businesses that slipped away silently into the night because they ran out of money. There is probably not a week goes by that I don't get a phone call from a small business person looking to raise extra money because they have run out or have underestimated their requirements, so please trust me on this one.
But if you thought that was negative it's about to get a lot worse. Because now I want you to take that figure and double it. That's right double it. This one is not just my opinion. I get almost the same answer every time when I ask a business owner how much they spent in the first 12 months of business compared to what they thought they were going to spend. This is for a number of reasons:
- Things don't always go according to plan - while planning is absolutely essential you only need to be in business for 5 minutes to realize that turning that plan into a reality is never as simple as you thought. There could be a change in market conditions, an industrial dispute that affects your business, a change in legislation, a whole range of factors that are outside your control, but still impact your business. Having a bit more up your sleeve buys you time to adjust to changing circumstances.
- Things don't always happen to your timelines - while you may have planned for a certain event to happen by a certain date in your budget, timelines have a tendency to get pushed out. Again this will most likely be due to factors beyond your control.
- You are going to make mistakes - we are all human and therefore will make mistakes in our business, particularly in the early stages when we are getting a feel for our business and the various "levers and pulleys" that determine outcomes. Most of the time these mistakes are going to be centred on expenditure decisions which with hindsight probably wouldn't have been made. But don't get upset about this, it's all part of the learning curve and everyone in business goes through it.
Obviously the better your initial planning and research the lower this figure will be.
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