If you can afford to self-finance your business, then it is generally a great idea to do so. If you provide all of the start-up funding, then you will own 100% of the business, control all of the decisions, and reap all of the benefits of your hard work. High five! But. . .how do you know how much money you need?
You could use a rule of thumb. For example, it is commonly said that you should have enough cash on hand for six months’ worth of expenses. However, depending on the cash characteristics of your particular business, this estimate could be badly off. And, the stakes are high. Inc. magazine cites research from Xero stating, “65 percent of the entrepreneurs who cite a business issue (versus a personal issue) as a reason for failure blame financial mismanagement for their collapse” (Tabaka, 2018). So, don’t take a shortcut. Knuckle down and make a real financial plan.
You can never be absolutely certain how much money you need – there are many factors, and conditions are changing all of the time – but you can build a very strong estimate to give you confidence in your decision. Here are the steps:
- Create a vision of your future business a few years from now
- Choose a price, and estimate your revenue per customer per year
- Map out the process of delivering your product or service
- Estimate the direct costs of delivery per customer per year
- Calculate the annual capacity of your product or service
- Create a hiring plan for the next three years
- Map out the steps of your sales process
- Calculate your customer acquisition cost (CAC)
- Estimate your revenue by month for the next three years
- Estimate your remaining costs by month for the next three years
- Create a financial projection (income statement) for the next three years
- Estimate your funding need
If this list gives you a headache, then you understand why Forbes reports that more than a third of entrepreneurs don’t have a plan for their financial health (Derousseau, 2017). However, it really doesn’t take that long to work through these steps, especially if you get a hand from a business mentor or someone else with experience in entrepreneurial finance. Investing in your business knowledge now can keep you from getting your fingers burned later.
Tabaka, M. (2018, October 31). Research says 65 percent of entrepreneurs who fail admit to this avoidable mistake. Inc.
Derousseau, R. (2017, September 11). More than a third of entrepreneurs are making this big financial mistake. Fortune.