Permanent link for Founders get this wrong on May 5, 2023

Starting a new business venture can be an exciting but challenging experience. Entrepreneurs are constantly looking for money to run their businesses, and most feel the pain of not having enough money.

I find myself frequently advising entrepreneurs to test their business ideas early and often—to fail fast—and one of the earliest and easiest ways to test a new idea is to prepare a plan with detailed financial projections. It's a cheap way to figure out what you need to start your business, and what you'll need to keep it running. In this and several following blog posts, we will explore how founders can determine how much money their startup needs to achieve success.

1. Conduct Market Research

The first step in determining how much money a startup needs is to conduct thorough market research, as we've explored in past blog posts. Understanding the market, competitors, and customer behavior will help you estimate the costs associated with acquiring customers, launching products or services, and running your business. Market research can also help you determine how much revenue you can expect to generate in the first year of operations.

2. Determine Startup Costs

Once you have conducted market research, you can start determining the costs associated with launching your business. These startup costs are what you will spend before you start selling and delivering your product or service. Startup costs can include expenses such as legal fees, permits, licenses, rent, equipment, supplies, inventory, and marketing expenses. They can also include capital expenses like real estate, manufacturing equipment, furniture, and computers.

3. Estimate Costs of Goods Sold

Costs of goods sold (COGS), sometimes known as production costs, are expenses that are directly related to the production or creation of your product. These costs can include raw materials, labor, shipping, and packaging, and will scale directly with your sales volume. When you sell twice as many items, your total COGS will be twice as much.

While the COGS are typically associated with manufacturing businesses, service-based businesses also have costs that are directly related to providing their services. These costs can include wages, supplies, and travel expenses directly associated with delivering a service.

4. Estimate Other Operating Costs

In addition to startup costs and COGS, you need to estimate the ongoing operating costs associated with running your business. Operating costs can include salaries, wages, benefits, rent, utilities, insurance, taxes, advertising and marketing, and maintenance costs. These costs will vary depending on the type of business you are starting and the location, and they do not typically scale with the amount of goods sold.

5. Calculate Cash Flow

Cash flow is the amount of money that flows in and out of your business each month. Understanding your cash flow is essential to determine how much money you need to have enough cash on hand to cover expenses and pay bills.

6. Determine Break-Even Point

The break-even point is the point at which your revenue covers your expenses. The break-even point will tell you how much revenue you need to generate to cover your costs.

7. Finish the Financial Plan

Once you have estimated your startup costs, operating costs, cash flow, and break-even point, you nearly have a complete financial plan for your startup. Add projected income (a.k.a. profit and loss) statements to calculate profit margins and balance sheets for the first year of operations, and you're done! A detailed financial plan can help you make informed decisions about how to allocate resources and manage cash flow.

So what do founders get wrong? Too often, when they make their ask for investment--whether from angels or VCs, or at a pitch competition, or just for a bank loan--they haven't done the work above to know how much they need and when they need to spend it. Haje Jan Kamps has some additional insights for you.

Categories: entrepreneurship funding management
Posted by Thomas Hopper on Permanent link for Founders get this wrong on May 5, 2023.