Profitability Assessment

One of the most common reasons small businesses fail is that the owners underestimate how much money they will need to start the business. It always seems to cost more than they thought. Have you ever heard the old adage about planning a trip from the U.S. to Europe: Plan what you should wear and how much it will cost, then halve the clothes and double the money. Perhaps we need a similar adage about starting a small business.

In the Business Tools area is a checklist of everything you'll need to consider when figuring out how much money you'll need to start a new business.

The lesson to be learned from the many small business failures is that you need to be extremely careful when determining how much money you need to start your new business. Don't fall into the "rosy forecast" trap in which the new owner over-optimistically predicts robust sales in the first year and, as a result, doesn't have enough money on hand when the cash flow dries up.

Work Smart When you estimate how much you'll need, either build in some cushion by padding the numbers or go back and change your estimates every time something costs more than you thought. For example, a lot of small business owners who limit their advertising to the Yellow Pages will estimate their advertising costs as the cost of placing an ad. But when they actually take out the ad, they'll decide instead to place it under three categories rather than one. Although the difference may only be $30 to $40 a month, the numbers really add up and the planning gets completely skewed when the owner decides to make similar changes in several different areas.

For a complete picture of how you can determine what it will cost you to start a new business, consider the following:

• Making a family budget— a look at your family's fixed and variable living expenses. It's important to know the amount of personal costs that you'll have to cover during the startup phase of your business.
• Costs of setting up the business— a look at the costs associated with forming the new business, including a complete rundown of everything you need to consider before you start your business.
• Costs of running the business— a look at the costs associated with operating the business, including some advice on how to estimate how much you'll need to keep your business going.
• Cash flow peaks and valleys— a look at the costs associated with uneven cash flows and seasonal businesses and how to plan for them.
• Wearing the parachute— a look at some ways to limit your costs, and to cushion your fall if things don't go as well as expected.