Small business owners and entrepreneurs are an important and dynamic part of the economy, you and I both know that, but one of the realities is that most new businesses do not succeed. Depending on the specific report you look at the exact percentages may vary, but it is safe to say many new small business fail within the first three- to five-year period, and finances play a large role in these failures.
Fortunately, and a result of the vast amount of information that is now available, most new entrepreneurs are aware of these risks and take action to address them. Working with CPAs and other financial professionals, it is definitely possible to put together a plan and strategy to make sure you have enough capital to start and grow your business.
Millennials, who make up a plurality (and depending on the workplace, a majority) of the workforce, are especially aware of the importance to finance new business ideas. Even with all of this information, including articles on crowdfunding, small business loans, and economic development groups, there is one aspect of finance and capital raising that is often overlooked. Just like, if you were training for a marathon, you have to consistently exercise over time, small business finances are not a one-off affair.
Even after putting together a plan to raise startup capital, attract potential investors, and get the business off the ground, there is still more work to do. Below, I am going to break down these two broad categories of capital, but it is always important to remember that every business is different. You know your business better than anyone else, and frankly, are the most interested person in making sure it is successful. That said, this should give you a starting point to think about making sure your business is in good financial shape.
1. Permanent capital
Think of this as money that you really, really, really do not ever want to spend or use up, but you have just in case. Without getting too much in the accounting details, think of this capital as your owner's equity (remember accounting 101?). This can be as simple as reallocating a certain percentage of all incoming funds into a separate account, and this permanent capital is what is often used as collateral for business loans, mortgages, etc. Funds dedicated to this area also, in addition to helping your obtain credit, also give you a cushion in case of unexpected events. Remember you never want to be looking for credit when you really need it -- this is your businesses rainy day fund.
2. Working capital
You work hard in your business, and the dollars you raise and earn should also work hard! All kidding aside, this type of money is where some entrepreneurs get themselves into hot water. After raising capital, setting aside some for a rainy day, and getting up and running, finance is put on autopilot -- that is a potentially devastating mistake. What working capital represents are the dollars and funds you have access to on a day-to-day basis to help you run the business, pay bills, and purchase supplies, all of which are obviously very important. This may sound like an abstract or obvious idea, but think of this. If you give your customers 45 days to pay, but you need to reorder inventory or supplies every 30 days, this creates a hole in your finances. Borrowing funds, or working with your vendors to extend your own credit terms are stopgap measures that ultimately distract you from running and growing your business.
Running a small business, and being an entrepreneur is already difficult enough, so the specter of running out of money, rightly so, keeps many an entrepreneur awake at night. Making this even slightly more complicated is the fact that raising capital is not just a onetime event that happens as your start your business. Understanding the differences between the different types of business finance can help your stay more focused on what you do best -- delivering value and service to your customers.