Have You Underestimated Your Working Capital Needs?

21/08/2009 by info.

It is thought that less than half of all start ups have any formal business plan, so it begs the question if they have no business plan, how do they know how much money they will need to run that business?

The fact is that they don’t! People starting business often overestimate their income and turnover and underestimate the amount of capital that is required to continue trading. This under capitalisation leads to business failures due to the owner not being able to invest money into that business.

How many times have you noticed new restaurants or retail shops open, only to close within a year, you can be almost certain that the owner fell into the category of not having a formal plan and being unjustly optimistic about their working capital needs.

The same scenario often happens with business purchases, often a business is sold on the basis that there is potential if only the owner could afford to invest, the buyer thinking they have a bargain underestimates the businesses working capital needs with the result that the new owner rather than the seller is the one who fails.

Maybe a business buyer should be staying clear of businesses sold “with potential in the right hands”, yes the owner could be incompetent without any business acumen and he might be a blithering fool. However the market (his potential customers) has already had experience of dealing with that business and has decided that they will NEVER return. So it might need a lot of money to turn this business around and persuade the market that things are now different.

So why not take this money you will need to invest turning around a business with potential and simply buy a more expensive business one that is generating profits and needs minimal investment.

If you don’t have the funds to do so, conceivably this is an indicator that you are under capitalised and will get into financial difficulties buying that business with potential.

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