How Much to Cushion in a Startup Business?
Running out of money before reaching sustainable profits is a concern of any start-up business. No two businesses are alike, even when they sell the same service or product, and so no standard amount of financial cushion a business must aim for realistically exists. However, using a business plan as a foundation for figuring start-up and operational costs can help pinpoint an appropriate cushion.
The process to accurately figure start-up funds begins with a detailed business plan. A business plan is an outline of what the business does and how it operates. Start-up and operational costs are derived once the business has written out their version of the six essential parts of the business plan -- the executive summary; market analysis; description of the company and its objectives; organization and management structures; marketing and sales strategies; and the description of the service or product being offered.
Start-up costs can be broken into two separate areas: pre-opening and organizational. Pre-opening expenses include administrative costs to begin a legal business along with advertising and marketing expenses. Organizational costs include leasing office space and equipment and establishing needed processes to begin manufacturing or purchasing a product or supplying a service. Once initial costs are incurred, they are not typically repeated. For instance, purchasing equipment may require a down payment and a certain number of payments; leasing may require a one-time deposit; and legally establishing a business may require an initial incorporation fee to the state and the cost of legal advice.
Operational costs are the day-to-day and month-to-month costs of running the business. These expenses include rent and utilities, insurance, salaries and materials required to produce a product or supply a service. Creating a monthly budget can help a business understand its operational costs. To arrive at an accurate figure, all costs must be included in the monthly budget. For instance, businesses requiring a fleet of vehicles must figure fuel, insurance, employee training and vehicle repairs in its budget. Service oriented businesses might include employee training expenses and fees for criminal background checks in its monthly budget.
Ideally, a start-up needs enough cushion to support itself until the business becomes profitable. Figuring out when profitability might occur is not an exact science. Even though careful planning may create a picture of profitability occurring during a specific span of time, there are many variables that can dictate the actual outcome. Unforeseen costs can crop up due to changes in government requirements, a down turn in demand, price fluctuations for materials or because of an oversight in budgeting. Most business experts recommend a cushion of three to six months of operating costs. Seeking the advice of a CPA who has worked with like or similar businesses can help a start-up gain a better idea regarding the cushion it needs and the possible pitfalls it may have overlooked.
Obtaining a Cushion
A monetary cushion can occur through lines of credit with banks and vendors, investment capital or pre-orders. Lines of credit may allow the business to pay salaries and overhead costs or continue to purchase materials during a slump. A portion of investment capital can be placed in a separate account to cover unforeseen expenses. Pre-orders are contracts promising to purchase goods or services by a certain date -- pre-orders can be obtained before the business is in full operation. Pre-orders that can cover six to 12 months of operating expenses provide an excellent monetary cushion allowing the business to seek new contracts and build relationships with new customers.
Alex Burke holds a degree in environmental design and a Master of Arts in information management. She's worked as a licensed interior designer, artist, database administrator and nightclub manager. A perpetual student, Burke writes Web content on a variety of topics, including art, interior design, database design, culture, health and business.