There is little doubt that many new businesses fail in their first year, plus quite a high percentage will fail in the subsequent 4 years. I say “little doubt" because there is not much agreement on actual statistics. But I am sure few people would dispute the fact that the failure rate of new small businesses is high.
That failure rate is not surprising. Starting your own business is very tough; and keeping it going beyond even the first year is even more tough. Taking that same business through the fifth year barrier is quite an achievement.
There are many reasons for business failure, but they mostly revolve around poor management skills, poor marketing skills, lack of planning, and . . . . . . . MONEY. To be a successful business owner, you certainly need to understand finance, and the impact it has on your future business. A business plan, covering funding, cash flow forecasting, and details of your market and products or services, is a minimum starting point.
The Roots of Financial Failure in a New Small Business
The finances of a business cannot be isolated from its management and market. The business owner needs to know and understand how these three facets inter-relate. However, for the purpose of this article, we will concentrate on the financial aspects of a business, most particularly the initial capital with which you need to start the business, and provide enough working capital to keep the business going, and to guide it into a profitable business that will provide for you and your dependants.
The initial capital you need is not a figure you should clutch from the air. Your decision on the amount should be based on a business plan, which includes financial projections for the first 5 years. The first year is especially important and should be more detailed; as the first year passes, you will be able to monitor results against the plan, and see what adjustments you need to make to keep the new business heading towards profitability and financial strength.
Making the 5 year plan can be the source of your required capital, at least so far as the required amount is concerned. The first year of the plan should have a monthly breakdown. If you make out the cash flow forecast, a key part of the business plan, on the basis of zero capital investment, then the negative figures in the cash balance will give you an idea of how much finance you need to get started and maintain working capital.
As an example, let us assume your initial cash flow forecast shows your bank balance in negative territory for the first six months, and then becomes positive. The total of those 6 months negatives is the absolute minimum you need in terms of initial capital. If you set out the figures on a spreadsheet, then you can simply add the total of those six months negatives into the initial cash balance spot, which was previously set at zero. You will see that your cash balance never then goes below zero.
That, of course, is far too simplistic, and it is dangerous not to include some wide margins of error. Your cash flow plan will be wrong; that is a certainty. Once you have everything on a spreadsheet, you can then play around with your assumptions, such as sales, product costs, materials costs and so on. After doing many variations, in a process that some call sensitivity analysis, decide on an initial capital figure you feel comfortable and confident about
When putting your plan together, be aware that many people are over optimistic about their sales volume, and also the price the market will bear. Do a worst case scenario with your spreadsheet, and then you can use that as a basis for your initial capital requirement. Remember, as the first year progresses, you will be able to monitor everything in your plan, learn the reality of your marketplace in the raw, and refine your plan accordingly. If you are not able to put the plan together yourself, then it is advisable to get professional help.
Business Start Up Loans and Other Forms of Business Credit
Once you have a capital figure in mind to start your business, you then need to work out how to fund the initial capital needed to get the business off the ground, and safely into profit, without resorting to further borrowing.
You then have to decide how to raise the money you need for that starting capital. Assuming that you cannot input the required capital from savings, then there are many options. However, bear in mind that debt charges will affect your bottom line, and must therefore be built into your business plan. Not only will you pay interest, though, you may find the debt an additional pressure in the early days of the business. Lenders can quickly apply pressure if you seem to be running into trouble. For that reason, it may be better to finance your initial capital yourself if you can, and then add debt at a later date when you are confident the business is running smoothly and profitable, and you feel comfortable and competent with the financial management.
Here are some of the options for raising the initial capital, either in whole or in part:
1. Business start up loan from a bank, or bank overdraft. To obtain such finance, you will normally need a good, professionally prepared business plan.
2. A business “angel", an experienced businessman who has money to invest and likes to speculate on new business. The angel's input can be more than money; they may have valuable advice too. However, much will depend on personalities; it is for you to judge whether the two of you will get on, and if he or she will be more of a help than a hindrance.
3. Business credit may an option for some of your funding, if you can find suppliers that will give you terms. It can be very difficult, though, to get suppliers to give you credit immediately, so in many cases you will need to build business credit confidence slowly. This can mean buying on a cash basis, and then asking for credit later when your business is established.
4. Government grants are sometimes an option, but will depend entirely on your circumstances, country, the type of business and other factors.
5. Credit cards are an option some people resort to for starting a business, but this can be a short sighted, and short lasting, option if used as a main source of finance. Interest rates can be high by comparison to other sources, and repayment pressures can quickly mount.
There are other ways to raise finance, but those mentioned are some of the most common. Starting a business from debt is feasible, and is often done, but always bear in mind the pressures of making a business succeed can be great, and pressure from creditors can only add to that. If you want to avoid personal debt problems, and avoid additional pressure, then you may prefer to at least get started with your own capital.
This small business credit and finance article was written by Roy Thomsitt, owner author of the Eliminate credit Card Debt Now web site and former finance professional. Also on the website you will find articles on personal debt problems and building business credit