Undercapitalization is the single biggest reason new businesses fail. So how much capital is enough? Many tools for measuring needed capital are out there, but here’s one that works particularly well for many small service and retail businesses.
Using this model, you’ll need to begin with enough capital for a full year of operations. That’s a common enough benchmark, but managing that initial capital is the real trick.
Very important: once you open shop, keep your initial capital entirely separate from your income. Your capital will pay all your bills for that whole year, while you bank the income.
Save every penny of gross income for the entire year. Then, once the year is up, take your income from that period, and use that for operating income for as long as it will last. Again, bank every penny that comes in the door during this period. Once the new pool of operating-expense capital is depleted, use the gross income from that period for your next operating-expense capital pool, and so on.
Chances are, these new operating budgets will last for fewer and fewer months as you cycle through the exercise. But by the time that period is close to zero, you should have positive cash flow if your business is really a winner.
“I was skeptical,” reports one small retailer who tried this system. “And it was not an easy thing to make a thousand dollars in a day and then keep myself from taking out a couple o hundred to pay for an extra little bill that popped up that day. But I kept on and the discipline helped me keep from spending more than I had planned for at the outset.”
This start-up had about eight months worth of new capital to employ once the first year was over, and after that first cycle, about six months worth.
Then a wonderful thing happened. During the third cycle, after about two years in business, more capital was left in the bank at the end of the cycle than the business had started with. That meant positive cash-flow.
“It was really something,” the owner recalls. “That’s when we knew that after two years, it was really a business, not just an experiment.”
