Estimating Home Based Businesses Start-Up Costs
Begin your home business financial planning by estimating your initial or start-up costs. Include all items of a nonrecurring nature such as fees, licenses, permits, franchise fees, insurance, telephone deposit, tools, equipment, office
supplies, fixtures, installation of fixtures and equipment, remodeling and decorating, funds for your opening promotional event if you plan to have one, signs, and, of course, professional fees for your attorney and accountant.
Depending on your type of operation, the amount of money you invest, and the energy you expect to put in (part-time to full-time) can determine how much working capital you will need. Many business experts say if you expect profit in six months, double that time and be ready to operate without profits for twelve months to give yourself a cushion in case of
unanticipated expenses or delays. Study the growth patterns of other
similar business and ask for advice from your accountant and attorney.
Next, estimate the "working" capital you will need to keep operating for six to twelve months. Operating expenses for work from home include salaries; expenses for telephone, light, heat, office supplies, and other supplies or materials; debt interest; advertising fees; maintenance costs; taxes; legal and accounting fees; insurance fees; business membership fees; and special services expenses, such as secretarial, copying, and delivery service.
It is a good idea to obtain typical operating ratios for the kind of business in which you are interested. Among the sources for such ratios are Robert Morris Associates, Dun & Bradstreet, Inc., the Accounting Corporation of America, trade associations, publishers of trade magazines, specialized accounting firms, industrial companies (for example, National Cash Register Co.), and colleges and universities. The typical ratios for your type of business combined with your estimated sales volume will serve as benchmarks for estimating the various items of expense. However, do not rely exclusively on this method for estimating each expense item. Modify these estimates through investigation and quotations in the particular market area where you plan to operate.
In addition to home businesses operating capital, you will need to plan for reserve capital to cover personal expenses. This estimate will include all your normal living expenses, such as food, household expenses, car payments, rent or mortgage, clothing, medical expenses, entertainment, and taxes for you and your family.
After you have estimated start-up costs, working or operating capital needed for six to twelve months, and personal expenses and obligations, you may see that you need more start-up capital than you thought. What will you do? Discuss this with your accountant, attorney, and trusted business associates and family. Entrepreneurs secure needed capital in a variety of ways. You can:
* Get loans or gifts from family members or friends. Make businesslike, written agreements and be sure to disclose fully the potential risk as well as the possible profit.
* Apply for a bank loan. For this you will need a comprehensive statement of your personal financial condition and a business plan with financial projections to present to the loan officer. If you need help in preparing your loan application, take a course for small business people at a local community college or visit your nearest SBA office to get assistance from a SCORE counselor.
* Apply for an SBA loan guarantee. The SBA is not a bank, but it does extend guarantees and may rarely participate in a loan when the bank is unable or unwilling to provide the entire financing itself. The SBA loan officer will ask you the same hard questions as a loan officer in a commercial bank and require the same carefully considered data on your personal finances, start-up costs, and business projections.
* Search for some sort of venture capital. For start-up entrepreneurs some prior managerial or entrepreneurial track record is usually necessary in order to get venture capital. The main disadvantage of venture capital is that you will probably have to give up between 50 to 90 percent ownership of the new business in return for the capital. A home business is extremely unlikely to attract venture capital.
Your Balance Sheet is a summary of the status of your business--i.e.., its assets, liabilities, and net worth--at an instant in time. By reviewing your Balance Sheet along with the Profit and Loss Statement and Cash-Flow Statement, you will be able to make informed financial and business planning decision.
The Balance Sheet is drawn up using the totals from the individual accounts kept in your General Ledger. It shows what you have left when you pay all your creditors. Assets less liabilities equal capital or net worth. The assets and liabilities sections must balance--hence the name Balance Sheet. It can be produced quarterly, semi-annually, or at the end of each calendar or fiscal year.
While your accountant will be most helpful in drawing up your Balance Sheet, it is you who must understand it. Current assets are anything of value you own such as cash, inventory, or property that the business owner can convert into cash within a year; fixed assets are things such as land and equipment. Liabilities are debts the business must pay. They may be current (such as amounts owed to suppliers or your accountant) or they may be long-term (such as notes owed to the bank). Capital (also called equity or net worth) is the excess of your assets over your liabilities.
Prepare a Balance Sheet for your new business during the planning phase to estimate its financial condition at that time and also a projected one for the first year of business. This will help you decide on the feasibility of your venture and make modifications to ensure profitability. You can also use these statements as part of the documentation in a loan application.
Understanding Home Businesses Profit and Loss Statement
Your Profit and Loss Statement is a detailed, month-by-month tally of the income from sales and the expenses incurred to generate the sales. It is a
good assessment tool because it shows the effect of your decision on profit. It is a good planning tool because you can "try out" decisions on paper before actually going ahead.
The Profit and Loss Statement includes four kinds of information:
* The Sales information lists the number of units sold and the total revenues generated by the sales.
* The Direct Expenses category includes the cost of labor, materials, and manufacturing overhead (but not normal overhead).
* Indirect Expenses are the costs you have even if the product is not produced or the service is not delivered. They include the fixed costs or normal overhead of salaries, rent, utilities, insurance, depreciation, office supplies, taxes, and professional fees for your lawyers and accountant.
* Income or Profit is the last category on the Profit and Loss Statement. It is shown both as pre-tax and after-tax or net income. The IRS will look at your pre-tax figure, whereas your loan officer and you are more concerned with your after-tax figure.
Your Profit and Loss Statement should be prepared at the very minimum once a year--and more often in the beginning or growth stages of your business. It is a key document from which the economic health of a business can be determined. Make certain you do it properly and understand its meaning.
Understanding Your Cash Flow Statement
Your business must have a healthy cash flow to survive. Cash flow is the amount of money available in your business at any given time. To keep tabs on cash flow, forecast the funds you expect to disburse and receive over a given period of time. Then you can predict deficiencies or surplus in cash and decide how to respond.
A cash flow projection serves one other very useful purpose in addition to planning. As the actual information becomes available to you, compare it to the monthly cash flow estimates you previously made to see how accurately you are estimating. As you do this, you will be giving your self on-the-spot business training in making more accurate estimates and plans for the coming months. As your ability to estimate improves, your financial control of the business will increase.
The creative business owner works with his or her accountant to use the information gleaned from all of these financial tools to make a variety of managerial decisions--decisions on buying supplies, expansion, when to hire more employees, how to get the best tax breaks, and many other important steps that will shape the future of the business.
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