How to Be Financially Ready to Start a Small Business
When you reach the financial planning stage of starting a business, things start to get real. This is where your vision meets some hard truths. If you’ve come this far, you’re clearly serious about your venture — now it’s time to get yourself financially ready for the future.
Calculate your startup costs
Before you dive into the complexities of variable day to day costs, start out with your fixed startup costs. These are the expenses you’ll need to cover during the process of building your new business from scratch. No two businesses are the same, but there are some startups costs that pretty much all owners will need to find the money for:
- Location (renting or buying, decorating and fitting out)
- Professional equipment and supplies
- Employee wages and training
- Marketing & advertising (including website development)
When we surveyed 1,000 small business owners in the U.S., these were the largest startup costs they found themselves covering:
- 53%: inventory/supplies/raw materials
- 48%: lease/purchase of space
- 46%: office equipment
- 42%: marketing & advertising
- 39%: professional equipment
Create a pricing strategy
There are a number of pricing strategies that might be a good idea for your business. Some are more permanent, whilst others are designed for use during a set period of time.
- Economy pricing: setting a low price to attract the most thrifty customers.
- Penetration: setting a low price to boost initial sales and market share, before then raising prices over time.
- Premium: setting a high price to show the exclusivity and quality of your products.
- Milking: setting a high price before gradually lowering it to make your products available to more markets in stages.
- Competition: strategically setting your price in line with competitors
- Psychological: setting prices to psychologically influence the consumer, like charging £0.99 instead of £1.
- Bundle: bulk reducing the price of a group of products.
Key to setting your costs is knowing what your customers are willing to pay, as well as how much revenue you absolutely need to make to achieve positive cash flow. Sometimes these will be hard to align, but if you can achieve the balance, you’ve found a good price point.
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Set your budget
This hopefully feels like a familiar process, albeit on a larger scale than you’ve been used to in your day to day budgeting. This budget is the framework for you to plan towards your break-even and profit points. As well as a tool for internal use, it’s a necessary resource for any lenders that you plan to approach.
Your budget should include your startup costs, as well as the ongoing expenditures that must be covered month to month for the coming year. It should include:
- The cost of opening: your startup costs from above
- Monthly fixed expenses: outgoings that are unlikely to fluctuate, such as rent and insurance.
- Monthly variable expenses: outgoings that are likely to fluctuate, such as stock and staff wages
- Monthly personal expenses: both fixed and variable outgoings relating to your own personal costs, like mortgage payments
- Monthly revenue: the money you estimate you’ll make
Healthy cash flow is essential to a healthy young business, meaning that the combined total of the first four expenses should be less than your monthly revenue — or the same as, at the very least. This means having money left over at the end of each month to cover any unexpected costs (like repairs) or to use for long-term growth.
In the likely event that your initial workings out highlight a lack of funds to cover all your costs, you can then look into which costs can be lowered, how and by how much.
You can expect things to be tight at least for the first few years of opening a new venture, and your focus will often fall continually on how to maintain positive cash flow. This was something that concerned nearly half of the business owners that we surveyed, who found themselves making some big decisions about how to reduce their expected outgoings. The top three strategic choices made to reduce costs within their budget were:
- Delaying the purchase of certain items, or doing without altogether
- Choosing an alternative location at a lower price
- Limiting the scope of products or services for duration
To begin the cost-cutting process, work through all your expenses and do further research on each to see if you can bring them down. Be sure to analyse each option for its downsides. For example, using cheaper and, consequently, lower quality ingredients in a restaurant could potentially impact customers’ experience of the food they order and have a negative effect on your business.
If the negative impact of cost-cutting seems too risky, or if there are expenses you simply can’t reduce, it’s time to revisit your pricing strategy with the aim of increasing cash flow that way.
Prepare financial documents
There are a number of documents you can create which will help you project the financial viability of your business. And it will feel great to get all the numbers down in writing, instead of storing them in your head. The three documents below can be used to support your business plan, and will play an ongoing role in managing your business’s operations.
A break-even analysis helps determine fixed costs and variable costs so you can correctly set your prices and predict when your business will become profitable.
Profit & Loss Statement
The Profit & Loss Statement (or “Income Statement”) projects your business’s cash flow and performance in its first year by working out your future profit potential and the tax you’ll have to pay.
The balance sheet or” statement of financial position” reveals your business’s assets, liabilities and shareholder equity at a specific point in time. It’s a quick snapshot of your business’s financial position.
You can find out more about some of these financial documents and others in our article onthe essential components of a financial analysis.
Whilst some individuals may find it possible to “bootstrap” their new business — that is to fund it independently — external capital is needed in most cases. There’s a wealth of choice available, with some of the most viable including:
- Angel investment
- Government grants and loans
- Seed Enterprise Investment Scheme
- Enterprise Investment Scheme
Bank loans are notoriously hard to secure, which is why we didn’t include them here. This is not to say that you shouldn’t apply for one, but be aware that only a handful of businesses are successful in their application.
This article is intended to offer helpful guidance and does not constitute qualified financial advice. Please consult an accountant or financial advisor if you have any questions.
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