Nearly everyone who has ever started a business has underestimated the costs, and then faced the danger of running with inadequate capital reserves. We are told regularly that the key to avoiding this pitfall is to adopt a rigorous approach to your research and planning prior to committing to even go in to business.
Begin by estimating expenses. What will it cost you to get your business up and running? The key to accuracy here is attention to detail. For each category of expense, draw up a list of everything you will need to purchase. This will include both tangible assets (for example, equipment, inventory) and services (for example, remodeling, insurance). Then determine where you might purchase these goods or services. Research more than one vendor; i.e.: comparison shop. Do not look at price alone; terms of payment, delivery, reliability, and service are also important.
Contingencies
Add a reserve for contingencies. Be sure to explain in your narrative how you decided on the amount you are putting into this reserve.
Working Capital
You cannot open with an empty bank account. You need a cash cushion to meet expenses while the business gets going. Eventually you should do a 12-month cash flow projection. This is where you will work out your estimate of working capital needs. For now, either leave this line blank or put in your best rough guess. After you have done your cash flow, you can come back and enter the carefully researched figure.
Sources
Now that you have estimated how much capital will be needed to start, you should turn your attention to how you intend to fund your new business. What amount you will put in yourself, how much will be injected by partners or investors, and how much will be supplied by borrowing.
Collateral
If you're going to a bank to request a loan for a new small business, just make sure you take enough collateral to cover at least 80% of the loan. Unfortunately most banks want residential property that is owned by you and does not involve third parties. You have to understand that it seems that most recently, the Australian banks are the most astute at assessing risk, therefore you should take heed at their requests for so much collateral which is nothing more than saying "sure take the cash, good luck and don't forget don't pay and we've got your home in our sight". No wonder small business is so daunting.
As an employee if I make a bad decision ultimately, albeit maybe painful, my employer should not be put in a position of personal bankruptcy & liquidation of their personal assets. However, as a new small business owner, even a small incidental decision can have dire consequences not only you financially but also emotionally for you and those close to you.
Start ups are a massive risk and return on investment proposal. No matter how good the idea or product is, if you can not produce the product and distribute through channels that leave a profit large enough to allow reinvestment in infrastructure and systems then a business based on a good idea is going to suck your resources dry by the pulling at the bit growth the good idea is demanding.
The above can be, and usually is far more detrimental in the event of a collapse than the little guy who brought a heap of stock and sat in a shop that no one visited.
So a god idea or concept is nowhere near enough of a reason to o in to business.
There are millions of poor people with good ideas and millions of people who have made money with little knowledge or expertise in a particular industry selling products that have been around in the same form for hundreds of years.
What it comes down to is accepting business as a science, sure there are the unknown and unexpected, however fundamentally it all evolves around a simple equation, revenue in - expenses = Gross Profit - interest and tax = Nett Profit.
An interesting point to divert on here is what the owners does in terms of the day to day operations of a business. Although very broad and vague, generally a business (especially small business) is based on the amount of return received by the owner multiplied by a factor that relates to barrier of entry and longevity of leased premises etc.
Let's look at a small cafe. Owned by a husband and wife who both work full time in the business supported by a few casual staff over peak periods.
The businesses lets say returns $100,000 p/a to the owners who are quite happy with this amount.
Now they place the business on the market and after some research and deliberation decide to value the business based on a factor of 2.5 times there annual profit. After a quick smile at each other they decide to offer the business for sale at $225,000 just to get a quick sale.
Now fast forward 12 months and this couple are still working in their coffee shop. Although they have had numerous parties show various levels of interest nothing has eventuated further than a few visits by possible purchasers. They both look at each other, shrug their shoulders and blame the economic downturn scaring purchasers away.
However let's step away and look at things from a simple investment strategy.
Ok, quite simply the obvious problem here is the business generates a profit of $100,000 p/a based on two owners working full time. If I;m buying a business as an investment the fact I am completing a job in that business should be irrelevant. The duties I perform need to be done by someone in order to achieve the revenue taken, therefore the duties the owner performs should be looked at as a deductible expenses not profit.
Take the owners out of the above business and there would be at least another 80 hours per week in labour to replace them. At $25.00 ph there is $2000 that would then be paid to the employee, on top of that would be workcover and other charges relating to employing some one.
So now as an investor this business may be worth 2.5 times what it makes as it makes nothing.
This couple have brought themselves a job that doesn't provide annual leave, is far from flexible, has tons of responsibility and unless something dramatically changes is going to provide little if any capital growth. There is also a good chance that within a certain period they will face increased competition and most likely shrinking margins.
Hardly the stuff dreams are made off.
If you're in business or contemplating going in to business don't be a job buying sucker, get some good advice on how to be self employed as an investor, who may or may not work in the business.
Good luck & Happy Entrepreneuring
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