Part 2 of the “Things we wish we knew” Blog series
By: Tina Oddleifson, Business Advisor
Being a successful entrepreneur means understanding how much capital you need to start a business so that you have room to grow. Not having enough capital can be a major pitfall for a new business owner, making it the second most important post in our “Things we wish we knew” blog series.
So what is capital exactly?
Capital refers to the money you need to start, operate and grow a business. You can “raise capital” through equity (your own or an investor’s money) or through debt (like a bank loan). Capital can also come from the accumulated profits of a business.
If you don’t have enough money to adequately start, operate or grow your business, then this can lead to a downward spiral. When this happens business owners sometimes rely on high interest credit cards or reach out to predatory lenders to fund their business. Sometimes they stop paying their sales and payroll tax obligations, or they use up personal retirement funds. This can be a tough situation to recover from and is a sure sign a business is in trouble.
So why does this happen? Underestimating startup costs
Understanding all the costs associated with starting your business is essential. If you underestimate these costs you’ll be playing catch up from the get go. It’s better to overestimate than underestimate these expenses to give you a comfortable margin. Also, be sure you carefully analyze the impact of a high fixed cost like rent. You’ll need to pay it no matter what your sales are, so your lease should be something you feel you can comfortably pay. An SBDC advisor can point out these pitfalls and help you figure out a way around them.
Being risk-averse
Ironically, being too conservative by not being willing to take on debt, like a line of credit from your bank, can also lead to problems. As one SBDC client told us “ I was risk averse and wanted to borrow as little money as possible. I didn’t borrow enough operating capital and used up my cash reserves too quickly. It resulted in me scrambling to pay bills.”
Not understanding and managing cash flow
There may be times when cash in the bank gets too low, making it tough to pay your bills or make payroll. This can happen for many reasons, like seasonal sales trends, having a business that invoices customers who don’t pay you right away, or paying a large expense all at once. One of the best ways to mitigate this problem is by creating cash flow projections. If you see that things might get tight, you can strategize ahead of time to mitigate this problem.
So what’s a business to do? Start with enough working capital
Working capital is that cushion you need in your bank account to help pay the bills while you build up your business; or to help with an unexpected large expense or if you are shut down for reasons beyond your control. Working capital is also needed to handle cash flow challenges – like when you owe your vendors but your customers haven’t paid you yet. Make sure to budget this as part of your start up or expansion costs.
Work with Customers, Vendors and Lenders
You can also manage your cash flow needs by working with vendors, customers and lenders.
Negotiate favorable terms with your vendors so you can pay them later on after you’ve sold the products or services you purchased from them;
Offer incentives for customers to pay their bills early, or ask them for deposits;
Work with lenders to develop a loan payment schedule that works best for your seasonal business;
Talk to your bank about a line of credit to help with seasonal cash flow issues
Having enough capital for your business is like having enough fuel in the tank before starting a long road trip. You need to understand how big your tank is and where you can get a fillup along your route. An SBDC advisor can help you map your trip so that you don’t run out of fuel.
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