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2. Starting A Business
Say that you are the type who can operate a business of your own. You have given attention to the overall chances for success, and have chosen the business you wish to establish. What practical problems will you face in starting the business? How much money will you need? Where can you obtain it? What form of business organization will you have? Where should you locate the business?
The first question you want to answer is: How much money will I need? But this question can’t be answered until several other questions are answered and several decisions are made.
To decide how much money is needed to start a business, enter all of your potential income and all of your planned expenses on a work sheet or form.
Even though you may feel that this kind of planning is more than you need to start a simple small business it is useful to get started with this approach to management which puts figures down in black and white. You will find the same approach valuable in an established business.
First, estimate your sales volume. This will depend on the total amount of business in the area you are targeting (whether it be your county, state, country, or worldwide), the number and ability of competitors now sharing that business, and your own capability to compete for the consumer’s dollar. Obtain assistance in making your sales estimate from wholesalers, trade associations, your banker, and other business-people. Several business and statistical publications may be useful in making sales volume estimates.
In reaching your final estimate of sales do not be over-enthusiastic. A new business generally grows slowly at the start. If you overestimate sales you are likely to invest too much in equipment and initial inventory, and commit yourself to heavier operating expenses than your actual sales volume will justify. Since you are just starting up you might have no sales for the first few months. At any rate you can expect your first few months to be very low.
You must also determine what proportion of your sales will be cash and what proportion will be sold on credit. If you estimate that a certain portion of the sales will be on credit then you must figure when you are going to get the money for these sales. One month? Two months? More? Never? Be careful when providing credit and if you can, have your customers pay you upfront. If you are selling directly to consumers this should not be a problem.
Next, estimate how much cash will be paid out. Remember that in starting a business you may be purchasing equipment, paying fees and licenses, making deposits on lease, utilities and so on, several months before you open the door. Some of these expenses are easy to estimate. If you have decided to lease a building (more about that later) then you know what your deposits will be and how much you will have to pay out each month. You can probably get the cost of fees, licenses and utility deposits with a few telephone calls.
Other expense figures may take a little more work to get. One way is to obtain typical operating ratios for the kind of business in which you are interested. Among the sources for such ratios are Dun & Bradstreet, Inc., trade associations, publishers of trade magazines, specialized accounting firms, industrial companies, and colleges and universities. The typical ratios for your type of business multiplied by your estimated sales volume will serve as bench marks for estimating the various items of expense. However, do not rely exclusively on this method for estimating each expense item. Verify and modify these estimates through investigation and quotations in the particular market area where you plan to operate.
Don’t forget to pay yourself too. You may need money to live on if you have to quit your job. If your spouse is working and can support the family for a while you may not have to withdraw money from the business. The longer you can go without taking money out, the quicker you will build up a strong cash position. Now that you have estimated your cash receipts and expenses, write down the amount of cash you will put into the business to start. This goes on line 1 in the example below. Next, add lines 1 and 2 for the first month to get line 3. Then add up all of the expenses to get line 5. Subtract line 5 from line 3 to get line 6. This cash at the end of month 1 then goes to line 1 for the beginning of the next month, and so on.
If you continue this for the entire year, very soon you will find you have negative numbers or a negative cash flow. About this time you will also realize that you should be working on this form with a pencil that has a good eraser.
Let’s see what a simple forecast for a few months might look like:
|1) Cash on Hand||4000||1700||500||(200)|
|2) Cash Receipts||0||1000||1500||3000|
|3) Total Cash Available||4000||2700||2000||2800|
|4) Cash Paid Out |
|5) Total Cash Paid Out||2300||2200||2200||2200|
|6) Cash Position||1700||500||(200)||600|
In this overly-simplified illustration, you see that by the end of June you are minus $200 in cash. Two solutions can be tried – reduce your purchases in June by $200 or start with $200 more. You may not be able to reduce expenses (they will probably go up as your business starts). So you will have to put in $200 more to start with. If all you have is $4000 then the additional $200 you need is capital you must get from somewhere else.
Don’t be misled by this simple illustration. Many small businesses start with the $200, and try to get the $4000 from someplace else. Since a major reason for failure in the early stages of a business is under-capitalization, be very careful in your planning at this stage. You can almost always plan on some unexpected expenses and some delays in expected income.
Getting the Money
Now that you have computed your initial capital requirements, where will you get the money? The first source is your personal savings. Then relatives, friends, or other individuals may be found who are willing to “venture” their savings in your business. Before obtaining too large a share of money from outside sources, remember you should have personal control of enough to assure yourself ownership.
Once you can show that you have carefully worked out your financial requirements and can demonstrate experience and integrity, a lending institution may be willing to finance part of your operating needs. This may be done on a short term basis of from 60 days to as much as one year. Any institution that has money to lend is primarily concerned with security. The security may be a business asset, but when you’re just starting the best security is usually your home or some other personal asset.
The second thing the lender will want to see is some sort of business plan. If you complete a business plan – which includes a cash flow forecast – the lender will see that you have done some serious and realistic thinking about your business and be more likely to consider your request.
Become acquainted with your banker. In selecting a banker consider progressiveness, attitude toward your business, credit services offered, and the size and management policies of the bank. Is the bank progressive? The physical appearance of the bank may give you some indication. When the employees are reasonably young, interested in your problems and active in civic affairs the bank is likely to be progressive. The character of the bank’s advertising may also be a clue to its progressiveness.
To be effective the banker should be interested in helping you to become a better manager, and build a continuing relationship that will mean profitable business for you and the bank over the years.
Will the bank offer you the kind of credit you need? For example, if seasonal accumulations of inventory become a problem will the bank make a loan against public or field warehouse receipts? If your capital is tied up in accounts receivable during your heavy selling season, will the bank take these receivables as security for a loan? Will the bank consider a term loan?
Finally, know the size and management policies of the bank. Will your maximum requirements fall well within the bank’s “legal limit”? If you plan to do some export business, does it have a foreign exchange department? If you or your dealers sell on installment terms does the bank have facilities for handling installment paper? How deeply is the bank concerned with the growth and prosperity of your local community?
When you deal with your banker, sell yourself. Whether or not you need a bank loan, make it a practice to visit your banker at least once a year. Openly discuss your plans and difficulties. It is the bank’s business not to betray a confidence. If you need financial assistance carefully prepare, in written form, complete information that will present a thorough understanding of your entire proposition. Many business-people or prospective business operators destroy their chances of obtaining financial help by failing to present their proposition properly. Remember, before a banker will make a loan he/she must have satisfactory answers to questions such as these”
What sort of person are you?
What will you do with the money?
When and how do you plan to pay it back?
Does the amount requested allow for unexpected developments?
What is the outlook for you, for your line of business, and for business in general?
Trade creditor or equipment manufacturer, Companies from which you buy equipment or merchandise may also furnish capital to you in the form of extended credit. Manufacturers of store fixtures, cash registers, and industrial machinery frequently have financing plans under which you may buy on an installment basis and pay out of future income. You need not pay for the goods at once. If goods are for resale, no security other than repossession rights of the unsold goods is involved. However, too extended a use of credit may prove expensive. Usually cash discounts are quoted if a bill is paid within 10, 30, or 60 days. For example, a term of sale quoted as “2-10; net 30 days” means that a cash discount of 2 percent will be granted if the bill is paid within 10 days. If not paid in 10 days, the entire amount is due in 30 days. If you do not take advantage of the cash discount, you are paying 2 percent to use money for 20 days, or 36 percent per year. This is high interest. Avoid it.
One of the principal causes of failures among businesses is inadequate financing. If you do go into business, remember it is your responsibility to provide, or obtain from others, sufficient money to supply a firm foundation for your enterprise.
Sharing Ownership With Others
Now that you have decided what business to start and about how much capital will be required, you may find it necessary to join with one or more associates to launch the enterprise.
If you lack certain technical or management skills which are of major importance to your chosen business a partner with these skills may prove a most satisfactory way to cover the deficiency. If you are very skilled in your special area but lack management training and skills, you might look for a partner with a background in management. If you may need more start-up money, sharing the ownership of the business is one way to obtain it. Great care should be taken in deciding upon a partner. Personality and character, as well as ability to render technical or financial assistance, affect the success of a partnership.
A partnership can be a mixed blessing. A partner who puts in time or money has a right to expect a share in running the business.
In a partnership the liability for the debts of the firm is unlimited, just as it is in a single proprietorship. This means the owners are personally responsible for the firm’s debts, even in excess of the amount they have invested in the business. In a corporation the liability of the owner is limited to the amount they pay for their shares of stock. A partnership, like a single proprietorship, lacks continuity. This means the business terminates upon the death of the owner or a partner, or upon the withdrawal of a partner.
The corporation is a legal entity whose continuity is unaffected by death or transfer of stock shares by any or all of its owners. Even with no partners, you may decide a corporation with minor stockholders is better than a single proprietorship primarily because of the corporation’s limited liability.
Since partnership agreements and incorporation papers should be prepared by a lawyer, consultation with a lawyer will help you determine the best type of organization for you.
Selecting a Location
Once you have decided what type of business you want to start and the investment requirements, you are ready to select a location. The number of competitive businesses already in the area should influence your choice of location. Some areas are overloaded with service stations or certain types of restaurants. Check on the number of your kind of business in Census figures, the yellow pages, or by personally checking out the location.
Factors other than the potential market, availability of employees and number of competitive businesses must be considered in selecting a location. For instance, how adequate are utilities – sewer, water, power, gas? Parking facilities? Police and fire protection? What about housing and environmental factors such as schools, cultural and community activities for employees? What is the average cost of the location in taxes and rents? Check on zoning regulations. Evaluate the enterprise of the local business-people, the aggressiveness of civic organizations. In short, what is the town spirit? Such factors should give you a clue to the city or town’s future.
Chambers of Commerce and nearby universities usually have made or are familiar with local surveys which can provide answers to these questions and the many other questions which will occur to you.
Next you must decide in what part of town to locate. If the town is very small and you are establishing a retail or service business, there will probably be little choice. Only one shopping area exists. Cities have outlying shopping centers in addition to the central shopping area, and stores spring up along principal thoroughfares and neighborhood streets.
Consider the shopping center. It is different from other locations. The shopping center building is pre-planned as a merchandising unit. The site has been deliberately selected by a developer. On-site parking is a common feature. Customers may drive in, park and do their shopping in relative safety and speed. Some centers provide weather protection. Such conveniences make the shopping center an advantageous location.
There are also some limitations you should know about. As a tenant, you become part of a merchant team and must pay your pro rata share of the budget. You must keep store hours, light your windows, and place your signs according to established rules. Many communities have restrictions on signs and the center management may have further limitations. Moreover, if you are considering a shopping center for your first store you may have an additional problem. Developers and owners of shopping centers look for successful retailers.
The kind and variety of merchandise you carry helps determine the type of shopping area you choose. For example, clothing stores, jewelry stores and department stores are more likely to be successful in shopping districts. On the other hand, grocery stores, drug stores, filling stations, and bakeries usually do better on principal thoroughfares and neighborhood streets outside the shopping districts. Some kinds of stores customarily pay a low rent per square foot, while others pay a high rent. In the “low” category are furniture, grocery and hardware stores. In the “high” are cigar, drug, women’s furnishings, and department stores. There is no hard and fast rule, but it is helpful to observe in what type of area a store like yours most often appears to flourish.
After determining an area best suited to your type of business, obtain as many facts as you can about it. Check the competition. How many similar businesses are located nearby? What does their sales volume appear to be? If you are establishing a store or service trade, how far do people come to trade in the area? Are the traffic patterns favorable? If most of your customers will be local inhabitants, study the population trends of the area. Is population increasing, stationary or declining? Are the people native-born, mixed or chiefly foreign? Are new ethnic groups coming in? Are they predominantly laborers, clerks, executives or retired persons? Are they all ages or principally retired, middle aged, or young? Judge buying power by checking average home rental, average real estate taxes, number of telephones, number of automobiles and, if the figure is available, per capita income. Larger shopping centers have this type of information available, and will make it available to serious potential tenants.
Zoning ordinances, parking availability, transportation facilities and natural barriers – such as hills and bridges – are all important considerations in locating any kinds of business. Possible sources for this information are Chambers of Commerce, trade associations, real estate companies, local newspapers, banks, city officials, local merchants and personal observation. If the Bureau of the Census has developed census tract information for the particular area in which you are interested you will find this especially helpful. A census tract is a small, permanently established, geographical area within a large city and its environs. The Census Bureau provides population and housing characteristics for each tract. This information can be valuable in measuring your market or service potential.
Choosing the actual site within an area may well be taking what you can get. Not too many buildings or plants will be suitable and at the same time, available. If you do have a choice, be sure to weigh the possibilities carefully.
For a manufacturing plant, consider the condition and suitability of the building, transportation, parking facilities, and the type of lease. For a store or service establishment, check on the nearest competition, traffic flow, parking facilities, street location, physical aspects of the building, type of lease and cost, and the speed, cost and quality of transportation. Also investigate the history of the site. Find answers to such questions as: Has the building remained vacant for any length of time? Why? Have various types of stores occupied it for short periods? It may have proved unprofitable for them. Sites on which many enterprises have failed should be avoided. Vacant buildings don’t bring traffic and are generally regarded as bad neighbors, so check on nearby unoccupied buildings.
Use a Score Sheet
To help choose your location use some type of “score sheet” in evaluating different sites. See the following suggested score sheet. Depending upon your kind of business and situation some factors will have more importance than others. You may wish to eliminate some factors listed in the sample and add others. But some sort of score sheet is essential to choosing your business location wisely.
Time and effort devoted to the selection of (a) the town or city, (b) the area within the town or city, and (c) the particular site for the location of your business can well mean the difference between success and failure.
Score Sheet on Sites
Grade each factor: “A” for excellent, “B” for good, “C” for fair, and “D” for poor.
Centrally located to reach my market
Physical suitability of building
Type and cost of lease
Provision for future expansion
Overall estimate of quality of site in 10 years
Adequacy of utilities (sewer, water, power, gas)
Transportation availability and rates
Nearby competition situation
Quali ty of police and fire protection
Environmental factors (schools, cultural, community activities, enterprise of business people
Quantity of available employees
Prevailing rates of employee pay
Housing availability for employees
Merchandise or raw materials readily available