The other day I posted on Twitter: “What’s the biggest Problem facing Your business” and I got the following response from a follower  – “Honestly? Cashflow!”.

Great timing. In this post we are going to look at costs and understanding how much cash you’ll need when starting your business.

This is day 5 of the 10 days to starting a business series. In case you missed the earlier articles in the series you can catch up here.

To get your business up and running you’re going to need enough money until your business brings in sufficient income to cover it’s costs (this is called break even).

Some experts recommend that you have at least 6 months cash set aside to cover your expenses, but in reality your business may need much more than this, so it’s important you work out exactly how much you’ll need and then add a contingency.

Even when you anticipate that income will come in quite quickly, you’ve got to remember that things don’t always work out like you plan and sometimes things go wrong. So you’ve got to prepare for the worst that can happen. If your business starts bringing in cash far earlier than expected and you don’t need your cash reserves, then so much the better.

Expense checklist

To workout how much cash you’ll need start by producing a list of everything that you plan to spend your money on in the first year. Where some costs are annual expenses, like insurance, divide the costs by 12 to get the monthly figure, similarly for expenses that are quarterly like rent or utility costs divide that by 3.

• List the equipment, office furniture, and other one off purchases that you’ll need to get you started.
• Work out what supplies you’ll need to operate your business
• Calculate the rent, utility costs and property tax costs – If you’re going to be needing premises (read bootstrapping section first)
• Work out what you’ll be able to do yourself and what help you’ll need to hire in – whether these are full time people, part time workers, temporary staff, consultants or virtual staff, look at the skills that you have and the skills that are needed to get your business going.

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• Your own income – work out what income you’ll need to pay yourself to cover your own mortgage, rent and living expenses

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• Itemise any stock, signage and marketing expenses – that you’ll need to buy to start trading

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• Costs of manufacture, shipping and storage – what are the costs of the materials, tooling and equipment required to manufacture your product. If you’re outsourcing the manufacture, how much will the supplier charge and what is the cost of shipping to get it to your warehouse? How much will it cost to store your products?

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• Costs of funding – if you’re borrowing money to fund the start up how much will interest / repayments be?

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• Costs of Insurance – if you’re offering a service to your customers then you need to make sure you have appropriate professional indemnity insurance in place. Similarly if you’re employing people you need to make sure that you’re covered for any mistakes that the employees may make or damage to a customer’s property/premises – get appropriate advice from an insurance broker and don’t just guess what the costs maybe. For some professions the costs of insurance can be significantly more expensive than for other businesses.

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Bootstrapping – Re-use, make do, go without

In tough economic times it’s not always easy to access funding, especially for new businesses. Therefore it’s not uncommon for entrepreneurs to max out their credit cards and personal borrowings to raise cash. Whilst this is an expensive funding option long term, it could be a viable option to get you going. But the key is to only borrow what you need, which of course makes the repayments smaller and avoids the temptation to spend more money on things you don’t really need.

In my experience businesses which are short of cash are more focused on shipping the product quickly, cash collection and managing the cost base, than those with a lot of cash. Nothing focuses the mind like having to pay the rent in 90 days.

Consequently many new businesses bootstrap and you’ll  often hear stories like in the early days at Google, programmers sat at desks made from old doors sitting on saw horses. When you haven’t got much money, you need to think creatively and look at other options. Many businesses start from the spare room. Many businesses have the car parked on the drive and the garage becomes a warehouse. What could you do to reduce your start up costs?

Look for ways that you can reduce your outgoings, things that you can make do with or reuse. Buy second hand – tough economic times throw up a lot of opportunities for buying desks, chairs and stock from businesses that have failed. You don’t necessarily need new.

Cashflow

Once you’ve got all your expenses mapped out you need to build a cashflow forecast, so you can see on a page, exactly what you’ve got coming in and what you’ve got going out.

You can download a free Excel Cashflow Forecast Template here to help you work out what you’re going to have coming in compared to what you’ve got going out.

Simply enter all of your expense headings on the left hand side and the monthly amount under the appropriate month column.

If you have a net outflow each month i.e. your outgoings exceed your incomings, then this is the amount of money that you’ll need to have set aside each month to fund your business. The total amount of cash that you’ll need is the total monthly amount of cash you’ll need until you break even (cummulative cashflow).

Most entrepreneurs by their very nature look for opportunities and therefore are typically optimistic about when and how much sales that they make.  Often it takes longer to get the sales than first thought, especially if you’re selling products to larger businesses who may need to go through a whole set of internal processes before they commit to purchase, which you have no control over. So moving your expected income to the right by 3 months, helps you plan for any unforeseen problems. Don’t forget, the amount of income that goes in the cash flow statement is the amount of cash you receive, and not the sale. If you sell something in January you might not actually get the income until March if you’re giving your customer credit terms.

However, typically costs are higher than you expect and therefore a sensible approach is to have cash in hand of 1.5 – 2 times the amount that you think you’ll need to break even. That’s called a contingency. Hopefully you won’t need it, but if you do and you haven’t set aside a contingency then you’ve really got problems. New businesses eat cash for breakfast, so you better make sure you business doesn’t go hungry or it will wither and die.

What about you? Do you have any lessons to share about bootstrapping your start up?