Definition: The condition that exists when a company doesn't have enough cash
to carry on its business and pay its creditors
When you're launching a business or starting out as the new
owner of an existing business, proper planning and research are
absolutely necessary. Undercapitalization can be a major problem,
one that may lead you right out of business.
You don't necessarily need piles of money to start a business.
Apple Computer was started in a garage by Steve Wozniak and Steven
Jobs. UPS (United Parcel Service) was started in 1907 when founder
Jim Casey borrowed $100 from a friend. Yahoo! was founded by a pair
of Stanford University graduate students, Jerry Yang and David
Filo, to help their fellow students locate cool Web sites. There's
nothing wrong with this approach if you're willing to invest a
great amount of time and energy into making the business work. But
keep in mind that undercapitalization is the number-one killer of
start-up businesses. Don't skimp on getting enough money to start
your business right.
To determine how much you'll need for start-up, account for all
opening expenses along with your initial operating expenses.
Although different businesses have different costs associated with
them, the main start-up costs include these:
Rent. Under many lease agreements, you'll be expected to
provide the first month's rent plus a security deposit. Many
leasors also require the last month's rent.
Phone and utilities. Some telephone and utility companies
require deposits, while others do not. A deposit may not be
required if you own real estate or have a previously established
payment record with the company. Telephone deposits are determined
by the number of phones and the type of service required. Unless
you need a large number of phones and lines, the deposit is likely
to range from $50 to $200. Deposits for gas and electricity (when
required) will vary according to your projected usage, so get
accurate information and carefully project your numbers.
Equipment. Equipment costs vary from one business to
another. At a minimum, most businesses need office equipment,
signage, and security systems. To determine your costs, list all
the equipment you must have to efficiently operate your business.
Next, price those items by obtaining quotes or bids from at least
three vendors. Use the quotes you receive to estimate your start-up
equipment costs.
Fixtures. This broad category includes partitions,
paneling, signage, storage cabinets, lighting, checkout counters,
and all shelves, table stands, wall systems, showcases, and related
hardware for product display. The cost of fixtures depends on your
business location, the size and condition of your facility, the
type of business you're in, what kind of image you want it to
project, and whether you're purchasing new or used fixtures.
Inventory. Like equipment, inventory requirements vary
from business to business. Some businesses, such as retail stores,
are inventory-intensive, whereas others, such as personal shopping
services, don't require any inventory at all except office
supplies.
Leasehold improvements. These nonremovable installations,
either original or the result of remodeling, include carpeting and
other floorings, insulation, electrical wiring and plumbing,
bathrooms, lighting, wall partitions, windows, ceiling tiles,
sprinkler systems, security systems, some elements of interior
design, and sometimes heating and/or air-conditioning systems.
Because the cost of improvements can vary tremendously, get several
estimates from reputable contractors.
Licenses and tax deposits. Most cities and counties
require business operators to obtain various licenses or permits to
show compliance with local regulations. Licensing costs vary from
business to business, depending on the requirements of your
particular location. In addition to these fees, you'll also need
start-up capital for tax deposits if yours is a retail business.
Many states require a deposit against future taxes to be
collected.
Marketing budgets. Most companies determine their first
year's advertising budget as a percentage of projected gross sales,
typically two to five percent.
Professional services. Before you officially open your
business, get help from a knowledgeable lawyer and accountant who
work with small business owners to make sure you meet your legal
and tax obligations. Their fees will range according to their
expertise, and the location and size of their practices.
Preopening payroll. If your business is going to be a
full-time venture, then set aside a salary for yourself in addition
to a three-month reserve, just to play it safe. This rule of thumb
also applies to any employees you might hire during this phase of
business start-up.
Insurance. Plan on allocating the first two quarters'
cost of insurance to get your business rolling.
A word of caution when estimating these costs: If there's ever a
time to be conservative, it's now. Err on the high side when you
project expenses, and on the low side when you project revenue. And
don't forget to add a "rainy day" or contingency fund to cover the
costs of unforeseen expenses--somewhere around five percent of your
budget is a typical amount to set aside. This financial cushion
will help you--and your investors--avoid panic in case you're faced
with an expense you hadn't budgeted for.