Determining the amount of money you need to start a new business and to operate it for the first twelve months is something entrepreneurs fail at very often. Trying to calculate all of the costs associated with launching a new endeavor isn’t easy and there are often surprise expenses that entrepreneurs need to be prepared to tackle. Randall Castillo Ortega, the founder of RACO Investment, provides best practices for determining how much cash is needed to start a business.
One aspect that leads to failure very often is the lack of working capital. Explains Castillo, “Miscalculating the amount of money can lead to a business breaking apart. Estimating the cash flow for the first twelve months of operation is not reserved for experts; you don’t need to be a financier or an accountant to do it. At least the first sketch you can do, like when you draw your home layout before calling the architect to develop the plans.”
A cash flow is simply the breakdown of two things, where the revenue will come from and what that money will be invested in. It is the foundation of every business success and is much more important for survival in the short term than the same profits. A company may have profits, but if it doesn’t have cash flow, it can go bankrupt very soon. In addition, a company without cash flow generates tension, stress, mistrust, insecurity and difficulties in thinking clearly.
Everyone is aware of the commitments, the form, the payment to the suppliers they are pushing, the supply of raw materials. That covers the days of the businessman and his people. A lot of opportunities are missed. It is vital for a company’s survival to control cash flow; no one should start a new business until it does. Even if you don’t prepare it yourself, you have to understand its structure. The ideal cash flow is in which you project to five years. The first year month a month. It is true that many things can happen that can radically vary a budget. But you have to.
Make it by hand on a sheet, for starters. Then sit down with your accountant or your financier and prepare something more elaborate. Translate the idea into numbers. At the end of the day, if you’re thinking of opening a business, you’re thinking of making a profit. Profits are money in your accounts or properties. Wealth is measured in numbers.
Lenders often only lend money at a good interest rate and on a good term if you show them that the business is “feasible,” that the estimates of the ins and outs are conservative, well thought out and that cash flows are reliable and that they will be able to cover the debt with their interests, without affecting the business operations. If you can show that you have done the difficult job of deciphering the numbers, lenders are more amenable to working with you.
Unless you have unlimited resources, you’d never start building a house without a budget. You would never hire the labor or management of its construction without a budget. Why? Because you need a benchmark, to know if you have enough money and also to monitor and control that the people you hire fit the budget. In a business, the budget is only part of the cash flow, and it’s much more complex than building a house.
In a business, you need to calculate pre-operative expenses, legal expenses and expenses for obtaining permits and patents. You also must calculate in detail the costs to condition the facilities, the purchase of machinery and equipment and the purchase of the basic supplies to operate. In addition, you have to calculate the initial inventory of raw materials and inputs to manufacture your product and operate the first few weeks, as well as calculate the costs of hiring staff.
There are additional costs, as well, such as sales and collections for those sales. You must consider the sales taxes you’ll have to make each month. You must also estimate the direct cost of first sales, replenishment of inventories, and payments to suppliers. You must calculate the fixed expenses for the first few weeks and the first twelve months. You must estimate the money requirements for the time when sales collection tickets are not able to cover all departures.
Of course, you need to think about the number of units you need to sell to cover all your costs. But it’s more than that. You must think that sales start from scratch and are growing. This evolution of sales, month by month, is the basis of all cash flow calculations. Properly calculating all of the variables will mean the difference between success and failure.
