Estimating Financial Funds Requirement

Most businesses, especially when they’re starting up or planning for expansion, face periods when they need to rely on outside resources to stay afloat. Whether the funds come from the owner’s pocket, accumulated business profits, or outside funding sources, they provide the lifeline that keeps the business going when expenses exceed revenue for a prolonged period. Use the information here to forecast how much money you need- and for how long.

1. Create a realistic forecast of your financial situation.

Follow the steps for preparing a pro forma or estimated statement of income, expenses, and profit, along with an estimated balance sheet and cash flow statement.

2. Estimate your funding need.

Use your financial forecasts, and especially your cash flow projection, to determine how long you anticipate expenses to exceed revenue and by how much. Doing so helps you get a handle on when you expect expenses to be incurred, when you expect revenues to roll in, and the amount of funding you need in order to cover the gap.

3. Create a funding time frame.

After you establish how much funding you need, create a schedule for how long you need the funding to last before your business needs to become self-sufficient. This schedule, called your time frame, should include dates by which you plan to meet revenue-generating milestones — for example, first customer, first major contract, first $10,000 in sales, and so on — that you can monitor as indicators that your business is on track to achieve profitability before funding runs out.

As you forecast how long your funding needs to last, be aware of these terms:

• Runway: The amount of time funding needs to last before your business becomes profitable and self-sufficient or until additional funding will be required
• Burn rate: The speed with which you expect to spend the funding you’ve raised in practical terms, the amount of cash required each month to cover the costs of staying in business

As every experienced entrepreneur knows, sales are only the result of a long line of business activities beginning with market research, manufacturing, inventory building, marketing, fulfillment and customer service. All this costs money, which is supposed to come from revenues earned in the previous year or from financing. Without the money, nothing happens, so the best place to start your financial projections is the money you have available.

1. Create a preliminary first-year budget based on your retained earnings and credit available from your bank. If you’re projecting startup financials and don’t have retained earnings or credit, use the amount of investment you can reasonably expect to raise, including investment by the founders. A conservative estimate is best because spending too much money too early can force you to cut back just as your business begins to pick up.
2. Estimate the cost of producing your product. You can skimp on administrative expenses and hire sales reps on commission only, but you must pay for any products or services you sell. You also need to balance your product inventory with customer demand. This takes careful study of your target market’s demographics, psychographics and buying habits, plus a modest estimation of what percentage of that market you’ll be able to capture. An established company is able to assign a reasonably accurate percentage with growth, but a startup must expect at least a quarter of virtually no sales.
3. Estimate your customer acquisition costs by establishing how you’ll market your product and then pricing out your marketing plan. A startup must develop its brand image and customer awareness during its first year, with sales demand appearing slowly during its second or third quarter; so, for a startup, marketing will carry a high priority. A mature company can estimate marketing costs with respect to its plans for market-share expansion or development of new revenue streams.
4. Adjust your production and marketing costs to fit your budget. The remainder is for administrative expenses. This gives you a figure of how much revenue will be required to offset your expenses. There may need to be some further adjustments once you reach this point. Add money to your marketing, figuring marketing costs at approximately 25 percent of total revenues. Marketing will produce your customers. Keep your production expenses efficient.

Tip

• Create a 12-month detailed projection and expand it into three to five years by estimating a year-over-year growth percentage. Doubling your results year-to-year isn’t realistic, so keep your growth estimates well under the 100 percent level. A startup’s second and third years might have higher growth than those of a mature company, but that’s because the first year is a year of experimentation and customer acquisition. If your growth strategy emphasizes a particular area, adjust your costs to reflect that. For example, if you plan to introduce more product lines, you might include R&D costs in your production. If you intend to expand your market share, marketing should receive more funds.

Warning

• Optimism is a quality of the entrepreneur. This is often seen in overly optimistic financial projections. Have an accountant, banker or experienced business owner review your projections with a critical and realistic eye. Negative feedback about overly optimistic projections is what you’re looking for, so pay full attention to any skeptical comments. Those comments may save your company from disaster.