How much cash you need behind you to start a business

Almost everyone starting a business budgets the setup. The fit-out, the stock, the bond on the lease, the licences, the van, the advice. It is the visible cost, it comes with quotes attached, and it is the number people mean when they say what it cost them to open.

It is also, for most businesses, the smaller half of the answer. The larger half is the money the business loses while it is finding its feet, and that money is spent quietly, a few thousand at a time, in months when nothing appears to be going wrong.

What the money actually has to cover

There are four claims on your savings, and they arrive in a particular order. Most people plan for the first and are surprised by the other three.

The second and third of those are what turn a manageable setup budget into a number that stops people. They are also the two that a spreadsheet built around opening day will not show you, because they do not happen on opening day.

The number is the trough, not the setup

Picture the bank balance as a curve. It starts underwater by the setup spend. Every month after that it moves by whatever the business earned less what it cost to run and less what you took out to live on. Early months are negative, so the curve keeps falling. At some point the business turns and the curve starts climbing.

The lowest point on that curve is the reserve you need. Not the setup cost, and not the first month's loss. The deepest point, wherever it falls.

The setup cost was $180,000. The reserve required is $232,337, and the worst of it lands in month five, not month one. By month four the business is covering its own costs, which feels like the corner being turned, and the bank balance keeps falling for another month after that because the owner still has to eat.

The ramp is the assumption everything rests on

Every figure above depends on one guess: how long the business takes to reach the revenue it will settle at. Nobody knows this in advance. What can be known is how much the answer moves when the guess is wrong, and that is worth doing before you commit rather than after.

Three months of slower trading costs another $15,498 of reserve and pushes the payback out by a quarter. That is the honest sensitivity, and it is modest here because the margin is healthy. On a thinner margin the same three months costs a great deal more.

Run it both ways before you decide. If the business survives the slower version, you have a plan. If it only survives the version where everything goes right, you have a hope, and the difference between those two is usually the whole thing.

Your household is part of the arithmetic

Leaving your living costs out of the model is the most common way these numbers come out flattering, and it is easy to do without noticing. The business plan covers the business. The household sits in a different spreadsheet, or in no spreadsheet at all.

But the money comes from one pot. In the example above, the household draw is $7,500 a month, which across the fourteen months before the business covers it comes to a little over $100,000. Take it out of the model and the reserve looks like $130,000 rather than $232,000, and the business appears to turn two months earlier than it does.

If a partner's income covers the household for the first year, that is a genuine and enormous advantage, and it belongs in the model as such. What does not work is leaving the cost out and calling the difference optimism.

Borrowing it instead

The obvious question at this point is whether the reserve can be borrowed rather than saved. Sometimes, and the answer turns on something that has nothing to do with the quality of the idea.

Commercial lending is assessed on earnings history. A business that has not traded has none. There is nothing to rebuild into adjusted earnings, nothing to test a cover ratio against, and no pattern to read. That is not a judgement about the plan. It is that the standard assessment has no inputs.

So a startup that borrows generally does it against something else: equity in a property, a guarantee from someone with income, or an asset the money is buying that has resale value of its own. Equipment and vehicles are the straightforward case, because the financier can look at the machine rather than the trading record. Working capital and living costs are the hard case, because there is nothing to look at.

When the number comes back too big

Often it does, and the useful thing about working it out early is that there are only four levers, and you can see immediately which one is available to you.

• Open smaller. A shorter fit-out, less stock, second-hand plant, a smaller site. This attacks the setup, which is the half most people already control.
• Shorten the ramp. Pre-sell, open with contracts already signed, buy an existing book of customers. This is the highest-value lever and the hardest.
• Cut the monthly cost base. Every dollar off the fixed costs comes off the trough roughly month for month until the business turns.
• Fund the household elsewhere. Keeping one income for the first year changes the reserve more than almost anything else on this list.

What does not work is starting anyway and intending to be careful. The trough arrives on a schedule set by the arithmetic, not by resolve, and month five is a bad time to discover the number.

There is a fifth option, which is to buy a business that already trades instead of starting one. It costs more on day one and it comes with earnings history, customers and a cash curve that is already above water. Which of the two is right is a genuine question and not a rhetorical one.

What the file needs

If you do take a startup to a lender, or to anyone else whose money is involved, the pack that answers the questions before they are asked is short.

• A month by month cash forecast covering at least the first two years, showing the trough and when the business turns.
• The revenue assumption written down as an assumption, with what it is based on and what happens if it is three months late.
• Your household costs, stated, and how they are funded until the business covers them.
• Quotes for the setup spend rather than estimates, because this is the part that can be evidenced.
• Whatever the security is: the property, the guarantee, the asset being bought, with the current position on each.
• Any income continuing from elsewhere during the ramp, which is often the strongest single line in a startup file.

The forecast is the document that does the work. Not because anyone believes the numbers precisely, but because a forecast that names its own assumptions and shows what happens when they slip reads completely differently from one that only shows the good case.

The acronyms, in one place

What we can and cannot tell you

Andorra Advisory Group does not arrange credit and is not a credit representative. We build the analysis and the documents. Where a client wants the finance arranged as well, that is a referral to The Lending Lab Pty Ltd, a separate broking business, disclosed in writing at engagement. Our fee is fixed and payable regardless of whether finance is approved or what the analysis concludes.

So no lender is named here and no policy is quoted. Every threshold is a level commonly seen, and every lender sets its own. We give no taxation advice, no legal advice and no financial product advice. Tax positions belong with a registered tax agent and legal positions with your solicitor.

We also cannot tell you whether to start the business. What we can do is put a number on the hole you have to fund, show you how far it moves when the optimistic assumption slips, and let you make the decision with the arithmetic in front of you rather than behind you.

General information only. Not credit advice, not a credit assessment, and not an offer of finance. Lending decisions rest with the lender and depend on your circumstances and their criteria.