Starting a Business - Don’t Undercapitalize

General Business News

February 2009

Starting a Business - Don’t Undercapitalize

In these difficult economic times, you might be asking yourself why anyone would start a business. With all the bad news, how could a new business possibly be successful? The truth is, with the right idea and a sound business plan, there is no reason you shouldn’t be successful. How do you know if your idea is the right one? How do you gauge whether your business has a good chance of success?

The answer to these questions can be summed up in one word – research. To begin a new business successfully, you need to do a lot of research. You need to know the market for your product, the availability of materials and supplies you will need, their cost and, of course, what capital you have available to begin and sustain your business during the startup phase. While the task may be daunting, it’s not impossible and this article will explore a few things you can do to work toward building your new business.

Market Research

If you are seriously considering starting a business, you’ve probably done some preliminary research regarding the potential market for your product or service. Now it’s time to take things a step further and formalize your search.

To begin with, who will be buying your product or service? Will you be selling to the general public or will you be selling to businesses? Who are your competitors? How will you reach your target audience?

If you will be selling to businesses, you might want to contact some of the businesses you propose to serve and talk to them - this may be the best way to gauge the potential reception of your product. If your idea has been tried successfully in other cities similar to yours, ask those businesses what helped them succeed.

Determining the market for a retail business could be a bit more difficult. If you are working with a franchisor, you should be able to get advice from other franchisees.

You might also want to obtain information from the Bureau of the Census to determine how many businesses are in your area that could use your services and even the number of businesses you might be competing with. You can also find demographic information to see if your area has a population that will support your product or service.

Cash, And Plenty of It

One of the main reasons new businesses fail is that the owner doesn’t start with enough capital. One general rule is to sit down and forecast your need for cash and then double it. That’s because new business owners are excited about their products or services and think their target audience will be too, which is seldom the case.

You need to plan for two types of costs in starting your business. While you may think that the startup cost is the key expense to consider, your personal living expenses are far more important - you have to eat and have a roof over your head. If you don’t have enough money to meet your basic needs, the business won’t survive for long.

Create a budget of your personal living expenses. Include all the items you need to live including food, shelter, clothing, utilities and every other expense you incur on a monthly basis. Make sure your budget covers a year so that you will pick up those extra items that occur less frequently than monthly. It is very possible that your business will not provide enough income to meet your needs in the first six to twelve months and you need to have a plan to sustain you and your family.

After you know your personal living expenses, take a look at your resources. Do you have a spouse whose income will support you while the business gets off the ground? Are your savings sufficient to meet your living needs? Will you have to take a part-time job to keep the lights on until the new venture takes off? If you find that you can meet your personal needs, press on. If you are not at a point of having the resources to fund your needs, you may want to slow down on your business plans.

If you do have a plan to meet your personal living expenses, the next step is to look at the costs of establishing your business. Some typical costs will include advertising, inventories, employees, insurance, licenses, professional fees, rent and other expenses in addition to the cost of purchasing equipment and finishing out work or retail space. Many of these expenses will occur before you even open your doors. Therefore, plan on having enough cash on hand for from 90 days worth of expenses to as much as six months, depending on the business you intend to start.

Even after you open your doors, cash may not come in as fast as you assume. In your business planning process, be realistic about your sales. Unless you have firm commitments, err on the side of caution when forecasting sales. In many businesses, you will be required to sell to your customer on credit. Take into account the average time it will take you to collect receivables in your industry - the sale will not count for much until you convert it into cash.

Conclusion

Starting a business can be exciting, but it’s also a lot of work. Your keys to success will be starting on a firm foundation of knowledge about your industry and adequate startup capital. Many business owners have lost their companies because they forgot that cash really is king. If you are in the process of starting a business, give us a call. We can help with your planning process to minimize the likelihood of being undercapitalized.

Happy Valentine’s Day.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.