Undercapitalization and overcapitalization as some of the primary reasons small businesses collapse. Over capitalization is having too much cash in the reserves, and undercapitalization is holding insufficient cash in the reserves. When you have too much cash reserves, you will spend it unnecessarily, such as undertaking unprofitable projects, buying expensive equipment, moving to larger offices, hiring more staff, among others. Inadequate cash reserves will hinder the company from getting enough resources such as staff, equipment, and failure to complete projects, and so on. For you to know how much cash you serve your business needs, you should consider the following factors. Click here for more info.
Analyze the cash flow report of your business and note the cash received from sales and the cash the company spent. The net between the two is "net burn rate". "Gross burn rate" takes into consideration expenditures only because it does assume no sales were made. Analyze the historical spending patterns of the company using the "gross burn rate" and make appropriate future spending plans.
When deciding on how much cash the company should spend, determine the projected monthly cash flow for the next 12-15 months from the monthly budget. Your company does not have a monthly budget; you can use a financial forecast. A startup should use its business plan. Analyze the sales and expenses separately. Expenses are more predictable than revenue because most of the expenses are relatively fixed, for example, rent and payroll. Separate one-time upfront costs from the required costs before you analyze the operating expenses of the business is a startup.
You should consider the stage of your business. If your company is a small business, the past expenses may not necessarily predict the future needs of the company because there are many uncertainties. As a small business that is planning to grow or make huge purchases, you should hold more cash in the reserves. An established business should be more conservative when setting cash flow needs because it has more experience to handle uncertainties than a startup business. Accounts receivables and inventory of a small business may expand to support the sales as they increase. You may need to spend money to generate sales from customers before the customers remit cash. Read more on this blog about economics.
The duration it will take for the business to get more cash and when the cash will be needed for expenses matters. Understand the cash needs of the business for the next 12-15months. It takes a short time to finance the business with personal resources like savings or selling personal assets. A bank loan may take longer because of the paperwork and other complications in the procedure. You also need a convincing business plan and maintain a good relationship with the bank, and both take time. After determining the amount of cash the business has been spending, how much is needed to be spent and how long it will take to get it, you can establish the appropriate amount of money the business should reserve.
Establish if the business has other sources of cash before you approach a bank or other investors. Request suppliers to give you supplies on credit to you or extend the periods of payment for the credit they offer to you. Offer incentives to customers or request them to pay you in a shorter time frame. Increase your credit card balances, take a home equity loan, borrow from friends and family, use your savings and retirement account, and please equipment instead of purchasing them, and so on. These alternatives to save you from increasing debts for businesses that arise from getting loans from banks. The alternatives will help the business not hold excess cash or inadequate cash in the reserves.
Determine the appropriate time to look for more cash. Look for cash at a time when the business does not need it because that will give enough time to compare terms of payment and interest rates and negotiate the best deals. When you look for more cash for the business at a time when it needs the car should be desperate and end up taking a loan that may be too expensive for the business to pay. Read more here: https://en.wikipedia.org/wiki/Finance.