- Explain the ways in which a new business gets start-up cash.
- Identify approaches used by existing companies to finance operations and growth.
So far, we’ve focused our attention on the financial environment in which U.S. businesses operate. Now let’s focus on the role that finance plays within an organization. In Chapter 1 “The Foundations of Business”, we defined finance as all the activities involved in planning for, obtaining, and managing a company’s funds. We also explained that a financial manager determines how much money the company needs, how and where it will get the necessary funds, and how and when it will repay the money that it has borrowed. The financial manager also decides what the company should do with its funds—what investments should be made in plant and equipment, how much should be spent on research and development, and how excess funds should be invested.
Financing a New Company
Because new businesses usually need to borrow money in order to get off the ground, good financial management is particularly important to start-ups. Let’s suppose that you’re about to start up a company that you intend to run from your dorm room. You thought of the idea while rummaging through a pile of previously worn clothes to find something that wasn’t about to get up and walk to the laundry all by itself. “Wouldn’t it be great,” you thought, “if there was an on-campus laundry service that would come and pick up my dirty clothes and bring them back to me washed and folded.” Because you were also in the habit of running out of cash at inopportune times, you were highly motivated to start some sort of money-making enterprise, and the laundry service seemed to fit the bill (even though washing and folding clothes wasn’t among your favorite activities—or skills).
Developing a Financial Plan
Because you didn’t want your business to be so small that it stayed under the radar of fellow students and potential customers, you knew that you’d need to raise funds to get started. So what are your cash needs? To answer this question, you need to draw up a financial plan—a document that performs two functions:
- Calculating the amount of funds that a company needs for a specified period
- Detailing a strategy for getting those funds
Fortunately, you can draw on your newly acquired accounting skills to prepare the first section—the one in which you’ll specify the amount of cash you need. You start by estimating your sales (or, in your case, revenue from laundering clothes) for your first year of operations. This is the most important estimate you’ll make: without a realistic sales estimate, you can’t accurately calculate equipment needs and other costs. To predict sales, you’ll need to estimate two figures:
- The number of loads of laundry that you’ll handle
- The price that you’ll charge per load
You calculate as follows: You estimate that 5 percent of the ten thousand students on campus will use the service. These five hundred students will have one large load of laundry for each of the thirty-five weeks that they’re on campus. Therefore, you’ll do 17,500 loads (500 × 35 = 17,500 loads). You decide to price each load at $10. At first, this seemed high, but when you consider that you’ll have to pick up, wash, dry, fold, and return large loads, it seems reasonable.
Perhaps more important, when you projected your costs—including salaries (for some student workers), rent, utilities, depreciation on equipment and a truck, supplies, maintenance, insurance, and advertising—you found that each load would cost $8, leaving a profit of $2 per load and earning you $35,000 for your first year (which is worth your time, though not enough to make you rich).
What things will you have to buy in order to get started? Using your estimate of sales, you’ve determined that you’d need the following:
- Five washers and five dryers
- A truck to pick up and deliver the clothes (a used truck will do for now)
- An inventory of laundry detergent and other supplies, such as laundry baskets
- Rental space in a nearby building (which will need some work to accommodate a laundry)
And, you’ll need cash—cash to carry you over while the business gets going and cash with which to pay your bills. Finally, you’d better have some extra money for contingencies—things you don’t expect, such as a machine overflowing and damaging the floor. You’re mildly surprised to find that your cash needs total $33,000. Your next task is to find out where you can get $33,000. In the next section, we’ll look at some options.