Determining Your Cash Needs

One of the major challenges of starting a business is finding the capital to get the doors open. What is equally important—and often overlooked—is the need for sufficient cash reserves to operate the business until it begins generating revenue on its own. Opening your doors with no money in the bank could mean you won't stay open for long.

But how much money do you need?

To find out, you must do cash flow projections. This is the exercise that helps you determine how much money you need to operate until your business begins generating income. It will show you whether or not you can truly afford to start the business you’ve planned. Effective cash budgeting often makes the difference between staying in business and being forced into bankruptcy.

Your cash flow projections are more than an internal worksheet. Lenders and investors will want to see strong, realistic cash flow projections before giving you any money. Bankers, for example, will want to see evidence that you can cover your costs, pay yourself a livable wage (unless you have a separate income), and still meet your repayment obligations. Investors look for similar proof, depending on the details of their arrangement with you.

However, don’t confuse a cash flow projection with a profit and loss projection. The issue of cash needs has virtually nothing to do with profitability—it’s simply tracking and managing the money coming in and going out. Profitability and liquidity do not necessarily go hand-in-hand.

Though cash flow statements are a critical management tool, they do not necessarily measure operating results. In fact, you may be on a strong, positive growth track, but could run into trouble because of insufficient cash.

Calculating your cash flow needs
Sound cash flow projections should include anticipated seasonal fluctuations, both in income and expenses, and consider the amounts and timing of cash receipts and disbursements. Include every known expense in your cash flow projection, and then allow 20 percent for the unexpected. When forecasting your income, don’t indulge in excessive optimism.

If you are buying a franchise, the franchisor will be able to help with this forecast. If you are purchasing an existing business, you’ll have some history to consider. But if you’re starting from scratch, you’ll need to develop your own numbers.

Your initial cash flow projection should cover whatever period of time you expect to operate before you begin seeing enough income to cover your expenses. This could be a few months or longer, depending on the nature of your business.

Though you need to know how much money you’ll need for this period, it is not essential to have that amount of money in your checking account when you open. In fact, it's smarter not to. If you have the cash on hand, put it in an account where it can work for you until you need it. If you are using borrowed funds, set up a line of credit you can draw on as you need it, so you are not paying interest on money you aren't using.

The rule to follow is this: You need enough cash on hand to meet immediate needs, but not so much that you sacrifice profitability. Do not allow excess cash to remain idle in your cash account; transfer it to earning assets until you need to spend it.

Do it again
Though your first cash flow statement should be prepared before you start your business, this is not a one-time task. It’s an ongoing exercise you’ll be doing for the life of your business. In fact, your cash flow statement should be your most frequently prepared financial statement. Most businesses do their cash flow projections by the month, but you may want to do yours more often.

Remember, your business may be built on a great product, but its lifeblood is cash. Sound cash management will help you stay on course as you take your company from concept to profitability.