Cash Flow or No Go – When Is the Right Time To Start a New Business?
How much cash should you have on hand in order to successfully start a business? That is the age-old question any new business owner must answer in order to make a ‘Go or No Go’ decision.
How Much Cash On Hand Does Your New Business Need?
The short answer is “it depends.” There are a number of factors to consider when dealing with the cash on hand considerations that should be addressed as you develop your business plan and financial projections for any new business venture. Each of these financial considerations should be carefully reviewed before moving forward.
Most new businesses that fail within the first 2–3 years do so for two primary reasons – lack of resources (time, people and capital) and lack of sales. In most instances access to cash is what ultimately leads to success or failure. To address this issue, I recommend clients have 12–18 months of cash on hand to sustain the business. When I mentioned this on a recent podcast, I got some push back from listeners.
Sources of Cash On Hand
So, let me give you a more detailed explanation of what “cash on hand” includes so we are all on the same page. Cash on hand by my definition includes cash and cash equivalents that can be converted to cash in 90 days or less, and available to you to fund the business. This includes the following:
- Savings and checking account balances.
- Projected sales revenues (be conservative).
- Credit card balances.
- Bank loans and/or Line of Credit.
- IRA, 401K + Retirement Accounts.
- Stocks, bonds, CDs + Treasury Notes.
When you add up all of these sources for cash available to you, do they provide the working capital required to offset your projected expenses for the initial 12–18 months? In order to answer this question, you need to calculate what your average monthly expenses will be to determine the “burn rate” for this same period.
Liquidity = Scalability = Sustainability
In general terms, the burn rate is normally defined as the rate in which a new business spends its available capital before generating positive cash flow. It’s also important in determining the liquidity of the business. Why is liquidity important? Because liquidity is a key measurement in determining the financial health of any business. Now, after you have calculated the projected total monthly expenses, subtract this amount from your cash on hand.
Based on the burn rate calculations, is there a projected cash balance at the end of the first 12–18 months, or will you be operating at a deficit? If there is a projected deficit, then you are at a critical decision point. Should you move forward in a loss position, or adjust your launch plans? Once you have considered all of the important decision criteria, the extent of the deficit should help you make the final determination.
New Business Launch: Full Speed Ahead or Part-Time?
If you decide to move ahead, how long will it take to get access to more cash when it’s needed, and what sources for additional capital are available to you? Most bank loans generally take up to two months and if the angel investor is a path you want to pursue, then the timeline for access to seed capital from potential investors will be much longer.
Another viable option, of course, would be to get the new business up and running part-time while remaining employed, until it is able to generate positive cash flow. At that point, you can then make the decision whether to move full speed ahead as a full-time entrepreneur, or not.
Be Objective in Your Financial Review
Consider all of the options and your current financial position carefully before deciding to move forward. This will put you in an optimal position to make a ‘Go or No Go’ decision and achieve future success.
Share your new business launch story with us in the comments below!