5 Step Venture eMentoring Program™
Module 3e: Uses and Sources of Funds
The Uses and Sources of Funds statement shows the initial investments needed to get a new venture started, and the expected source of these funds. It is a serious mistake to start the venture without making sure that you have both of these categories carefully covered. All too often, smaller businesses just start, without any consideration of what the start-up costs may be, and how they will pay for them. This places them behind the 8 Ball right from the start and may create such problems that the business never recovers.
Uses of Funds: Initial finding or start-up funding requirements are divided into four categories:
Initial Equipment: This is usually an easy category for most businesses. You need certain equipment to make whatever. For a part-time self-employment business, it is important to minimize investments in this category as they eventually must be paid for out of earned revenues. Even if you are using your own money, it is still important to consider whether the investment is necessary. If it is necessary, then proceed ahead - if not, then be cautious before you make increases in this area. If you are a service business, you should still look hard at investments such as a new computer, fancy cell phone, or any of numerous things that would be nice to have, but may not be essential.
Inventory and Supplies: Often this category is not so obvious, and a way for the business to find its cash resources challenged. If you are making items for sale, there is a gap between stocking inventory, manufacturing parts and supplies, and the eventual sale of the finished item. If you are selling through an intermediary, such as placing craft items on consignment in a retail store, you will need to finance the inventory before you start to see the revenues. If you are purchasing items for resale, you would typically need to have the items on-hand before you can start to sell them. Even a service business is likely to have supplies and may have other investment requirements that precede the receipt of revenues.
Negative Cash Flows: This tends to be a very difficult category for most businesses, large or small. The problem comes about because of breakeven. As long as the business is operating below breakeven, it will experience a negative cash flow - more cash will flow out of the business than flows in. Just about any business will experience this negative cash flow as it starts operations, simply because overhead such as rent, telephone, and other items must be paid even though the business is not fully up to speed. A second factor that impacts cash flow is the receipt of payments. Most part-time self-employment businesses should be on a cash basis, meaning that they get paid upon delivery of product or service. If there is a gap in this payment, such as invoicing a client and having them pay in 30 or more days, it will contribute to the negative cash flow. Look carefully at your business to see whether any of these factors will affect you. If so, plan accordingly.
Contingency Reserve: Things happen - especially unexpected things - and you need to be prepared for such occurrences. Your contingency reserve is an amount that you have saved aside to cover such unexpected events. There are numerous rules-of-thumb that help to determine how much this reserve should be. Your contingency reserve may be an amount equal to a typical month sales or equal to the initial negative cash flows. In any event, it is important to recognize that this is a possibility, and that you have a plan. Running out of cash is very finite, and the people that you owe money to are not likely to be overly sympathetic to your problems that keep you from paying them.
Sources of Funds: Identifying your funding options may be equally difficult - often even more difficult - than determining how and where they will be spent. Too often, even when people have a good idea of their initial funding requirements, they seem to hold out a wish that their Fairy Godmother will arrive at the right moment. Unfortunately, the Fairy Godmother is very unreliable, and so it is important to consider other alternatives. General options include the following:
Personal Funds: Funding from the individuals personal resources or help from the family represents the primary source of funding for most new businesses. These funds may come from personal savings, a liquidation of a 401K, or even a second mortgage on the family home. If you use all of your personal savings, you no longer have a cushion for a rainy day or any family emergencies. If you take an early disbursement from a 401K, you may experience early withdrawal penalties and back taxes that can take as much as a third of the funds. It is possible to convert a 401K to allow the use of funds for business purposes without penalties. If you take a second mortgage against the family home, you expose this critical resource to potential liquidation if the business doesn't work out as you hope. If you take funds from other family members, such as your parents, you may be putting their personal security at risk. These are all important considerations and should be carefully thought through.
Credit Cards: A great many small businesses have been started using credit card advances because of their easy availability. The problem here is that credit cards tend to carry a very high interest rate (often 30% or even more), and can begin to represent a very challenging cash flow demand to keep payments current. As convenient and attractive as this option may be, it should most certainly be reserved as a last resort.
Bank Loans: There is a popular myth that if your credit is good and you have always paid your bills, you can go down to your local bank and borrow the funds needed to start your new business. The reality here is that it is very unlikely that your friendly neighborhood bank (or any other one for that matter) will loan you the funds for this purpose. The reason is that new ventures are perceived as very risky by all banks, and unless you have considerable personal assets to back-up the loan, they are very reluctant to advance funds for such purposes. It is very wise to discuss your new venture with your local bank, help them to understand what you are doing, and so create a positive relationship that may make you eligible as a borrower 6 or 9 months after you get started. There is also a popular myth that you can go to the US Small Business Administration (SBA) and borrow the needed funds. The reality here is that the SBA does not loan funds - they guaranty loans made by banks to small businesses meeting certain criteria. Most start-up ventures do not qualify. There may be certain programs that you qualify for that have lower lending standards. Such programs may be available for minorities, women-owned businesses, veterans, or other categories. Your counselor, mentor, or bank may help you to understand about these programs, their requirements, and whether you qualify.
Program Funds: Programs such as Vocational Rehabilitation have special funding options to support client/customers meeting certain criteria in addressing business start-up, training, counseling and other cost categories. You should discuss these possibilities with your Vocational Rehabilitation counselor. There are many other specialized loan and grant programs available to help particular categories of individuals for various business and training support. You can find a listing of these programs in www.BUZGate.org, under "Free Help" and then "Financing."
Other: This category is included because there is no end of ingenuity individuals use to help launch their ventures. One good option is to consider leasing instead of purchasing. You may be able to set up a collaborative venture where some other business helps with the start-up costs if you provide certain products or services. You may have a special asset that you could sell such as an antique car. The list can be endless, and is limited only by your imagination.
As you plan the initial investment needed to start your new venture, think about each of the categories that will use your finds, and the possible sources where these funds will come from. The following form will help you to organize this information.