Join Jim Stice for an in-depth discussion in this video Insufficient capital, part of Finance Essentials for Small Business.
- Let's begin with the money needed to start a business. Too many new businesses start their business without enough capital. They just don't have enough money in the bank to support them while their cash flows get up to speed. It turns out that the rent has to be paid, the utilities have to be paid, equipment may need to be purchased or rented, the employees have to be paid, inventory has to be purchased. All of your expenses have to be paid, while you're waiting for potential customers, first to find you, and then second to pay you.
There's often a lag between when you get paid for provided a good or a service, and when you have to pay your vendors. And generally, that lag is not in your favor. Also, when starting a business, it takes time for your customers to find you, and for you to get your sales and marketing efforts up to full speed. During that time, your expenses will continue to need to be paid. It would be nice if all customers would pay immediately. It would also be nice if vendors would wait to be paid until you are paid.
Yeah, that would be nice. Many businesses are forced to close before they are able to find out if their business model has a chance to demonstrate that it's sound. They just run out of money! I found when working with small businesses that owners have two tendencies. First, they overestimate their cash inflows, and second, they underestimate their cash outflows. When starting a business, realize that it will take time for cash inflows to start flowing. But the cash outflows start flowing immediately.
Make sure that you have access to sufficient capital to allow your new business venture enough time to succeed. Consider a simple example. I have dreamed my entire life of opening up a small restaurant. I'm a good cook! Many have suggested that I have a talent for cooking. I enjoy interacting with people. Why not give it a go? I found a location. That costs money. I've rented equipment. That costs money. I've hired employees. That costs money. I've done the advertising, and that costs money.
What about insurance and utilities? Cash registers and menus? Now, am I forgetting anything? Oh, yeah. What about food? I will need an arrangement with vendors. Since I'm new in the business they will want payment quickly. It may take a little time for word to get out about my new restaurant. But the customers will come. But will they come fast enough? My employees have worked and they would like to be paid whether customers have been coming or not. Those who rented the equipment and the building to me need to be paid whether customers have been coming or not.
More advertising to get more customers coming requires more money. I'm a good cook. I'm a people person! I have a great business idea. It's just going to take time for the customers to come. Do I have enough to get me through the start-up phase? So, how much cash is enough cash? The answer to that question can only come through a careful budgeting of cash inflows and cash outflows. It is critical that as part of your business plan, you sit down and carefully and realistically map out your expected cash inflows and outflows for at least the first six months of your new business.
This exercise will allow you to determine any forecasted cash shortage, and will allow you enough time to arrange for needed financing, either from partners or from creditors. Knowing well ahead of time that you will need cash, allows you to make necessary arrangements for financing. Finding out today that you need cash tomorrow puts you in an unnecessary bind. We will talk a little later in the course about the specifics of cash management, but it is critical upfront, that you have an understanding that not having enough money to get started can result in a good idea meeting an early demise.
Make sure you have sufficient capital, or access to sufficient capital before you open the doors to your new business. Again, many new businesses with great business ideas don't make it through the critical first few months. A great idea is not sufficient. You need to insure that you have access to enough capital to get you through those first few months. By the way, if you plan on going to a bank to ask for financing for your new business, one of the first things they will ask about is your cash forecast.
They will want to know what capital you currently have available through you. If you plan on asking friends and family to invest, if they are smart, they will ask about your cash forecast. To obtain capital from others, you need a cash forecast. You might as well prepare one for yourself. The cash forecast will allow you to determine how much capital you will need to get you through those critical first few months.
- Describe the most common reason small businesses fail.
- Identify two reasons why your business plan needs to budget cash inflows and outflows for the first six months of your business’s operation.
- Write the formula to forecast cash flow for the first four months of your small business.
- Explain the first step you should take if your new small business is not making the profit you anticipated.
- Identify the most important thing to keep in mind if you are considering faster growth for your small business.