How to Calculate the Amount of Cash It Takes to Start Your Business

June 4, 2016, 3:00 PM UTC
Shop keeper counting money in shop
Shop keeper counting money in shop
Photograph by Image Source — Getty Images

Cash is the lifeblood of a small business. Your goal is to actualize your business vision, but if you run out of cash, your company will go into cardiac arrest, and your operation will flatline. If you’re an entrepreneur looking to start a company, it’s good to have an idea of how much money you need to start it, run it, and where to go in case you need a cash transfusion.

So how much money do you need to start a business? These seven questions will help you get a pulse on your unique cash situation before you get started.

1. How much money do you need to start a business?

When you’re just starting, the simple answer is: as much as you can get! Cash is king and the more cash you have, the more nimble and reactive you can be. However, at some point, you’ll need to invest that cash into current and long-term assets, employees, and marketing—all the tools of business you will use to make more cash later.

Depending on what your business is and how it’s structured, you will have different cash requirements. For example, if you are into buying and flipping houses, you’ll need to create a business budget that includes large pools of cash on hand so you can be ready to buy that perfect money-making property if and when it hits the market. On the other hand, if your company is predictable, and you know well in advance the kinds of purchases and payments you will need to make, you can keep more of your cash invested, so it’s earning money for your business.

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2. Will you have enough money to pay your personal expenses AND the business expenses?

Many entrepreneurs fail to include their personal expenses when calculating their new business’s expenses. This can be a very costly error and lead to cash shortfalls.

Because running your own small business isn’t just a business decision, but a lifestyle decision, it’s important that you measure all aspects of your lifestyle to understand how your lifestyle could financially commingle with your business ventures. Consider your lifestyle now. Who depends on you to make an income, and what will happen if you need to cut back? What are you willing to sacrifice?

3. Are you able to project your cash flow?

When you write up your business plan, this should be one of the business factors you address. Where will your cash come from, and where does it flow to? Learn how to calculate projected cash flow so you don’t run into any surprises.

Note that I did not say sales revenue. Sales revenue is the gross amount of money coming into your company through sales of your product; it doesn’t track the money that is going out of your company. Cash flow can also refer to more than just sales, like sources of money that your company may have in other investments. Knowing this will help you understand what your operating cycle is, or when you’re going to have a lot of cash heading in or heading out. That will help you plan and hedge accordingly.

4. How much cash flow will your business need to keep the doors open?

Total up all your expected costs, both fixed and variable. Then consider what kind of emergency scenario could occur that would have you reaching for your wallet to fix it. Once you have a total, do you have enough to cover it? Will this emergency situation put you in a position where you can’t make payroll? If not, would it be cheaper to pay a smaller amount towards your small business insurance every month instead?

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5. How much will you have to pay in professional fees (e.g., attorneys, accountants, contractors)?

You may not have factored this in when you started totaling your costs, but you should allow for a certain amount of your budget to go toward professional fees and services. Simply put, many small business owners are just so busy they can’t do or learn everything needed to make their small businesses run.

Legal issues and questions about accounting and payroll programs can add up quickly unless you have the time to learn the subjects for yourself. Even then, you may still want a professional to check over your work and make sure you don’t commit costly compliance errors. If you’ve not budgeted for these expenses ahead of time, they can blindside you.

6. How long will you have to fund your business before it starts to make a profit?

Making revenue is not the same as making a profit. Profit is what you get to keep! Total up how many obligations you have and then project when you’ll be able to meet them. If it’s going to be a long while, you’ll need to keep more cash on hand for two reasons. First, if you have a large cash reserve, you could be more likely to get approved for a bank or SBA loan. Second, you will need liquid capital to cover some of the other expenses you may not have foreseen, like accounting and payroll, or professional fees.

7. How much money can you get?

Someone once told me, “It’s not about how much you can afford, it’s about how much you can borrow.” I don’t like that way of thinking. I’m not a big fan of being in debt. But, if you’re a small business owner, you’re probably going to experience debt at some point or another.

Buildings, equipment, and employees all cost money. Sometimes it isn’t about how much you can afford, but how much you can borrow to get those things and keep your business going, or simply get it off the ground. Business debt management and finding lenders can be difficult. It’s wise to know personal investors, friends, and family you might be able to talk to for short term loans.

Mike Kappel is the founder and CEO of Patriot Software Inc., and has over 30 years of entrepreneurial experience.

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