Starting a business is an exciting venture but one that requires a significant amount of planning and investment. Raising capital for your startup can be challenging, especially if you're unsure how much you need to raise. Determining the right amount of funding can be tricky, as there are a lot of variables that can impact your startup costs. Aside from poor product-market fit, most businesses fail due to running out of money in the first two years.
This article will outline six easy steps for calculating how much your startup needs to raise to avoid cash flow shortfalls. We will use a case study of Entrepreneur X, who intends to launch a jewelry e-commerce business. While a few things may vary from business to business, the outlined steps below provide the basic guide for most startups.
Step 1: Determine Your One-off Startup Expenses
Determining your one-off startup costs is the first step in calculating how much funding you need to raise. You will incur these expenses once before you launch your business. One-off startup expenses include incorporation, research, professional consulting, and other legal and website or app development fees. Make a list of all the expenses you will need to incur before your business is up and running. Be as specific as possible. It's essential to be accurate when calculating your one-off expenses.
Underestimating your costs can lead to financial difficulties while overestimating your costs can make securing the funding you need to start challenging. Once you have a list of all your one-off expenses, you can move on to the next step. For instance, in our sample case study, an online jewelry business can account for the following as one-off startup costs.
Step 2: Estimate Your Startup Ongoing Expenses
Next, estimate your monthly expenses. You will incur these ongoing costs once your business is up and running. Determining your monthly expenses is crucial in managing your startup's finances. To estimate your monthly expenses, consider your fixed and variable costs. Fixed costs, such as rent or salaries, are expenses that do not change. Variable costs are expenses that fluctuate, such as inventory or marketing expenses.
Regularly reviewing and adjusting your budget will help you plan and budget more effectively and avoid overspending. This will help you stay on track to make informed decisions about your business's financial future and success.
In the case study example, this is what ongoing annual expenses look like for our jewelry e-commerce business:
Step 3: Project Your Revenue
The next step in calculating how much funding you need to raise is to project your revenue. This can be tricky if you are starting, as you may not have any historical data on which to base your projections.
Projections of revenue are crucial for any startup's success. Accurate revenue forecasting can help determine whether your business idea is viable. To project your revenue, start by researching your target market and competitors. Analyze industry trends and forecast potential growth rates to develop a realistic sales forecast.
You can forecast the revenue by reviewing income from similar companies in the same industry within the startup stage. Look at what similar businesses are charging for their products or services, and consider how much demand there is for what you are offering. Use this information to estimate how much revenue you can generate each month. The type of business you have will affect your revenue.
Lastly, consider your pricing strategy and the number of sales you need to break even. Track your actual revenue against your projections to adjust your strategy as needed. By projecting your revenue accurately, you can set achievable goals and maximize your startup's financial success.
Step 4: Determine Your Break-even Point
The break-even point is when your business's total revenue equals its total expenses, resulting in neither a profit nor a loss. Knowing your break-even point can help you set realistic sales targets and pricing strategies, secure funding, and help you decide how much you need to raise for your startup to avoid cash flow shortages.
To calculate the break-even point in sales, you follow these steps:
Determine the fixed costs.
Determine the variable costs per unit.
Calculate the contribution margin ratio: The contribution margin ratio is the difference between the selling price and the variable cost divided by the selling price. It represents the percentage of sales contributing to covering the fixed costs and generating profit.
Divide the total fixed costs by the contribution margin ratio: This calculation will give you the sales revenue needed to break even.
The formula for calculating the break-even point in sales: Break-even point in sales = Fixed costs ÷ Contribution margin ratio.
In our example of a jewelry e-commerce store, the break-even point would be: (based on previous assumptions)
Fixed Costs = $11,700
Variable Costs = $2,850
Contribution Margin = {(12,000 - 2,850/240)/12,000} = 0.765
Break-even point in sales/year = {11,700/0.765} = 15,294
Break-even point in sales/month = (15,294/12) = 1,274.5
Break-even point in units/month = (1,274.5/50) = 26
The above analysis indicates that the founder would have at least 26 units sold monthly in the case jewelry store study to break even. Lower sales would lead to a deficit. The startup funding raised should cover such deficits to avoid cash flow shortages. Therefore, you would need to deduct the estimated annual revenue from the annual break-even point in sales.
If there's a deficit, then the amount should be added to the total startup costs, to raise. In our case, the amount will be determined by: $12,000 - $15,294 = -$3,294.
Step 5: Determine the Costs of Other Assets
Assets refer to short-term and long-term investments in a business that generates income or profit over time. Here we want to calculate any other asset your business will require to operate efficiently. The asset classification system broadly categorizes assets into current, long-term, and intangible assets. They can include property, patents, machinery, equipment, and vehicles. Investors typically expect to earn a return on investment over time from these investments.
In our case, the list of unaccounted assets would be:
Step 6: Determine How Much Funding You Need to Raise
Once you have completed the first five steps, you should know how much funding you need to raise. These steps help you clarify the amount of capital to cover your expenses, but you don't want to overestimate and take on more debt than necessary.
To determine the exact amount, add your one-off startup expenses, the break-even deficit, if applicable, into the cash category, and the startup assets costs. You'll need to add a 10% contingency cost of all estimated startup costs should be added to add more cushion and cover any unanticipated costs.
In our case, the break-down of the startup costs would be as follows:
Determining how much funding you need to raise for your startup is a complex process that requires careful planning and analysis. By considering your goals, calculating your costs, determining your cash flow needs, and exploring funding options, you can create a detailed financial plan to help you achieve your business objectives and maximize your chances of success.
Following these six basic steps of startup funding, you can better understand your expenses, revenue projections, and cash flow, which will help you determine how much money you need to raise. With this information, you can approach investors and lenders with a solid plan and a realistic funding goal.
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