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How Much Should You Spend on a Business?

Written by: Timur Sultanov

Article Overview: The aim of this article is to give you some basic thoughts to enable you to decide how much you should be prepared to invest in a business. There are two aspects that need to be covered: • Deciding how much it is right in your circumstances to consider investing. • Assessing how much of your own money will be needed to ensure your business venture is well funded.

How Much Should You Spend on a Business?

In order to give yourself the best chance of success, it is clearly vital to ensure that you are on a sound financial footing from day one.
There is nothing difficult about working out a sound structure for your finances - it is all down to common sense and, as long as you give this subject the time and thought it deserves, you should have no difficulty in avoiding arguably one of the biggest causes of business troubles: inadequate or inappropriate finance.

In business, as at home, there is nothing worse than forever struggling to make ends meet. You do not want to find yourself held back at critical times by lack of adequate funds. By ensuring that you are well funded, you can avoid the sort of situation where, for example, you know that more business is there for the taking, but you can't afford the extra stock; or where stock has to be run down because the rent is due.
It is important to be certain that not only is your business well funded, but also that your domestic financial resources are adequate at the same time. So often a good business, possibly soundly funded at the outset, runs into difficulty later because the owners have had to draw out too much money from the business to enable them to meet domestic commitments.

Assessing your own circumstances

Everybody's circumstances are different, so there is no magic formula. Nevertheless, the key issue is this. However carefully you may have investigated the business you eventually buy, you might find that there is not initially as much available cash to bring home as you had thought there would be.
There could be any number of reasons for this, not all bad ones. Maybe due to special circumstances there is a surge in trade and additional investment in stock is needed. Good news, but it might leave you short of cash for a while. On the other hand, you may take over at a bad time or at first you may not do as well as you could have done due to inexperience.
As already stated, it is vital to ensure that you are on a sound footing from day one. If you are short of financial resources right at the beginning things can only go from bad to worse, because somehow you will never recover, at least not for a long time. It is, therefore, essential to ensure that you have reserves in your domestic finances to enable you to survive in case of need without drawing on the business for a while.

How much do you need in reserve?

Again, there is no hard and fast rule, but enough to enable at least three months' domestic spending to be covered without drawing on the business at all is probably a sensible amount. Obviously you hope not to need to draw on it, but it will give you great peace of mind to know that this cash reserve is there. If your spouse/partner is working, that income (if secure) may reduce the reserve you consider to be necessary.

Assessing the needs of the business

As you will be aware, some of the funding for the business can be arranged via debt, but some of your own resources will be required.
How to arrange finance in detail is covered in a later chapter, but at this stage you have to consider how much of your own money is likely to be needed.
When you come to look at a specific business you must consider the financial needs in great detail, especially if it is a seasonal business where the needs are likely to vary greatly throughout the year. In such cases a detailed cash flow projection will be required and, if you are not experienced in accounting matters, professional assistance will be necessary. However, at this stage just work out a rule of thumb to enable you to know the price of business you are able to consider. The detailed workings can be done later when you have a particular business in mind.
As a rule of thumb, assume that, if it is a leasehold business, you will need to find a third of the total costs of buying the business and the stock from your own resources. If it is a freehold business assume twenty per cent, because you can normally use the freehold as security for borrowing, thus enabling you to obtain a higher percentage by way of loan.

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