As an entrepreneur, there are many facets to your business idea to consider. First and foremost is coming up with a killer idea for a product or service you will sell. However, just as important is knowing the financial side of your new enterprise. While it’s easy to get caught up in the excitement of launching a business, here are five financial questions to ask before you pull the trigger. Without answers to these questions, you may face an uphill battle.
1. How Much Money Do I Have to Start My Business?
A big part of being an entrepreneur is putting yourself into your business idea. While you don’t have to be rich to start a company, you should be willing to invest at least some of your own money into the enterprise. Not only can these funds help you get off the ground faster, but they can signal to others (like banks and investors) that you believe in your idea.
One thing we should point out is that you don’t necessarily want to put your new business on credit. Going into debt to start a company can add extra pressure and stress, which could put your enterprise on unstable footing. Realistically, you should only use personal credit cards or a revolving line of credit as a last resort.
It’s also worth noting that you shouldn’t sacrifice too much of your personal finances to start your business. Since it’s relatively easy to secure funding from other sources, there’s no reason to put yourself in financial jeopardy to get your company off the ground. Start with any disposal income or savings you have that you don’t need (at least for a while). Then, if you have to dip into other funds, be sure to weigh the pros and cons of each option before pulling the trigger.
2. How Much Funding Do I Need to Start My Business?
Knowing how much money you have already is a great start, but you also need to know how much is necessary to launch your new enterprise. The amount of funding you’ll need depends greatly on the type of business you’re starting. Here’s a breakdown of various elements that can have a cost attached.
●Business Paperwork – You’ll have to form a business entity (more on that in the next section) and get a business license in your state. You may also need other permits and licenses, such as a reseller’s permit, liquor license, contractor license, etc. Each of these documents costs money, and most of them have annual renewal fees.
●Inventory – If you’re selling physical products, will you store and sell them yourself or have a supplier do it for you? For example, print-on-demand products are highly popular as you can design all kinds of items without maintaining inventory. Even if you’re planning on making your own products from scratch, you need to source raw materials.
●Infrastructure – Will you need an office space for your business? What if you plan to hire employees? Do you need a brick-and-mortar retail or storage location? Does your business depend on foot traffic for sales or online traffic? If it’s the latter, you need to find a suitable location to ensure swift sales but nothing so expensive that your overhead will eat into your profit margin.
●Equipment – Do you need specialized equipment to run your business? Will you need vehicles to transport people or products from one location to the next? For example, if you’re running a restaurant, what kind of kitchen equipment do you need, and does it have to be brand-new or will used machinery work?
●Payroll – Sometimes, you can launch your business as the only employee. In other cases, you must hire workers to help you get your new enterprise off the ground. Consider which positions you must hire and their salary ranges. Also, consider whether it’s better to pay more for a high-quality worker than it is to pay less and have to contend with high turnover rates.
●Marketing – While organic marketing can help your business grow and expand, you’ll likely have to invest in various materials and advertising channels. For example, if you run a brick-and-mortar store, you may have to buy signage or direct mailers to boost sales. If your business exists online, you might have to invest in PPC ads and other digital marketing techniques.
As you run through your list, put both dollar amounts and create a timeline. For example, you may need money for business paperwork immediately, but you won’t need money for marketing or payroll until your business is officially launched.
3. How Will My Business Get Taxed?
There are four primary types of business entities you can create, and each one gets taxed a little differently. Here’s a quick overview of each type.
●Sole Proprietorship – In this case, there is no dividing line between your personal and business income. While you can create merchant accounts and manage business expenses separately, everything is taxed as personal income with the IRS.
●Partnership – To form this kind of entity, you must create a partnership agreement. This agreement outlines who owns the business, how much of the company they own (i.e., 50/50), and their responsibilities within the business. As with a sole proprietorship, all income “passes through” the business to each partner. So, each owner is liable for income taxes and other debts.
●Limited Liability Company (LLC) – You can form an LLC as a sole proprietor or with other owners. LLCs are very flexible with their organization, and it’s much easier to add or remove partners from the business. Also, as the name implies, you have limited liability for business debts and income. However, your company revenue will likely “pass through” as personal income if you don’t have a corporate structure.
●Corporation (S-Corp or C-Corp) – Corporations have strict hierarchies, such as a CEO, CFO, President, and Board of Directors. C-corporations have to pay corporate taxes on profits. Additionally, employees of the corporation have to pay income taxes. So, you have to pay taxes twice. S-corporations offer “pass-through” earnings, but you must meet specific requirements.
Generally speaking, forming an LLC is the best option because you have more flexibility with how you run your business. As you grow and expand, you can hire employees, reorganize your company structure, and maintain a strict separation between your personal and business finances. Alongside that, it is important to know that an LLC setup can cost a few hundred dollars, and therefore, it is recommended to weigh the potential financial pros and cons before deciding upon a preferred business structure.
4. What is My Profit Margin Going to Be?
One mistake that many entrepreneurs make is spending too much compared to their earnings. While it can take a while for a new business to turn a profit, you must also ensure you can sustain yourself long enough to reach that point. For example, if you’re losing thousands of dollars per month, how long can you keep that up before your company has to be financially solvent?
With some business models, the profit margin is relatively easy to calculate. If you sell physical products, you can determine your profit for each item. To do this, simply take the sale amount and subtract the inventory cost. For example, if you bought an item for $5 and sold it for $10, your profit margin is $5.
However, you must also consider other operational costs, such as rent, utilities, marketing, and taxes. Most businesses add sales tax as a separate charge, so it’s easier for accounting purposes. However, if you’re not adding sales tax to each transaction (i.e., if you’re selling products online), you must subtract it from the total price. For example, if you sell a product for $10 and the sales tax is five percent, you have to deduct $.50 for the tax.
When calculating your business profit margin, you must look at total sales, not individual transactions. For example, let’s say your operating costs are $5,000 per month, and your gross sales are $10,000. However, you must subtract sales tax and inventory costs from that number to get your net earnings. If each product sells for $10 and costs $5.50, your total net earnings are only $4,500 for the month, so you’ll lose $500.
Overall, it’s imperative to consider all costs when measuring your earnings compared to your expenses. Understanding cash flow can help you sustain your business over the long term.
5. What Is My Growth Potential for the Next Five Years?
When developing your business plan, you should pay close attention to how your market share will change over six months, one year, and five years. Realistically, you may have a small market share initially, which will increase steadily over time. However, you must also make sure there’s room for growth.
For example, if you’re starting a business in a growing industry, you may be able to compete with other, more established brands. However, if the industry is on the decline, you’ll be competing for a smaller sales percentage over time.
Also, consider how you may expand your business and which opportunities may become likely. For example, can you branch out into other cities or states? Can you expand to other countries with online sales? What about selling new products or services? There are multiple ways to ensure consistent financial growth, but you must plan for it now so you know where your business is heading in the future.
Overall, starting a business can be exciting, but it also takes a lot of planning and hard work. By answering these financial questions, you’ll be able to set yourself up for success long before you even launch your new enterprise.
