7.01 – How Much Money Do You Need?
Understanding your financial needs is crucial when starting a business. Accurate estimates of your financial requirements can help ensure your business gets off the ground successfully. This lesson will guide you through the steps to determine how much money you need to start and sustain your business.
Estimating Start-Up Costs
Start-up costs include all the expenses incurred before your business starts generating revenue. These can be categorized into:
- One-Off Costs: Initial expenses such as purchasing equipment, initial stock, and legal fees.
- Fixed Costs: Ongoing expenses that remain constant regardless of sales volume, like rent, salaries, and insurance.
- Variable Costs: Expenses that fluctuate with your level of production or sales, such as raw materials, production costs, and shipping fees.
Creating a Cash-Flow Forecast
A cash-flow forecast is essential for managing your business finances. It helps you track the money coming in and going out of your business over a specific period. A cash-flow forecast should include:
- Revenue Projections: Estimate the income from sales.
- Expense Projections: List all expected expenses, both fixed and variable.
- Net Cash Flow: Calculate the difference between projected revenue and expenses to determine cash on hand or needed.
By regularly updating your cash-flow forecast, you can anticipate financial shortfalls and take proactive measures.
Key Steps to Ensure Accurate Financial Projections
- Believable Projections: Base your projections on facts, not conjecture. Demonstrate how you will achieve your sales targets.
- Main Assumptions: Clearly describe the assumptions underlying your projections.
- Effect of Assumptions: Explain the impact if your assumptions do not materialize. For example, what happens if you cannot recruit the planned number of salespeople?
- Best and Worst Outcomes: Prepare for different scenarios – best, worst, and most likely outcomes.
- Source Data: Always cite the sources of your data to support your projections.
- Seasonal Factors: Account for seasonal variations in sales.
- Economic Factors: Consider the broader economic environment, such as interest rates and employment rates.
- Specific Actions: Show the specific actions needed to achieve your projections.
- External Review: Have someone else check your figures to spot any flaws or blind spots.
Cash Flow Projections
Calculate cash flow by estimating how much cash you expect to receive and pay out each period. The difference between these figures gives you the cash on hand or the amount you need to raise to stay afloat.
- Receipts from Sales: These can vary based on your product range and customer payment terms.
- Projected Receipts: Total these for each month and for the year.
- Payments: Consider all types of expenses, including those that might be estimates.
A detailed cash-flow projection helps you see exactly how much cash you have or need at the end of each period.
Spotting Pitfalls
Be aware of potential pitfalls that can affect your cash flow:
- Delayed Sales: Sales may take longer to materialize than expected.
- Late Payments: Customers may not pay on time, affecting your cash flow.
- Unexpected Costs: Unanticipated costs, such as higher insurance rates, can disrupt your financial plans.
Credit reference agencies can help check the reliability of potential customers and suppliers.
Stress-Testing Your Business Plan
Stress-testing involves assessing the impact of adverse scenarios on your business. This helps you prepare for potential financial disruptions.
- Sales Reduction: Consider what happens if sales are significantly lower than expected.
- Cost Overruns: Assess the impact of increased costs on your cash flow.
- Worst-Case Scenarios: Test the resilience of your business plan against the worst possible outcomes.
For instance, if your initial cash flow forecast indicates you need £25,000 to start, a stress-test might show that you need £62,000 to withstand a 20% drop in sales and increased costs. on your business. This helps you prepare for potential financial disruptions.
