More than ever, the last couple of years has shown business owners just how important it is to have sufficient cash reserves. The COVID-19 pandemic was something that no one expected to happen, and the toll that it has taken on businesses around the world has been truly tremendous. Having enough cash reserves could make the difference between being able to keep your business open during tough times and having to close your doors forever.
Suppose you are having a particularly difficult month. In that case, your cash reserves and capital can ensure that you are able to meet all of your important payment obligations, including loan repayments and salaries. But how much capital and reserves does a business in the UK really need to survive and thrive? Can you put a number on it?
In this article, we look at the importance of having sufficient cash reserves and capital, and how to accurately calculate the amount of capital and cash reserves that your business may need.
How much is enough when it comes to cash reserves?
There is no hard and fast rule when it comes to how much your business should have in its cash reserves. Of course, the more you have the better, but that is not always possible as funding a business can be very expensive.
A general rule of thumb says you should always have access to around three months’ worth of working capital in case you fall upon difficult times.
What is your working capital? Your working capital can be calculated by adding the short-term debts owed to and stock, minus any short-term liabilities that your business owes.
If that sounds confusing, think of it this way: How much would you need for your business to survive for three months if it was not generating any income? Add up your average monthly costs and times that by three. This number could look vastly different from business to business.
Let’s not forget about your personal expenses. As an individual, you should always try and keep around three months’ worth of expenses accessible to you so that you can pay your rent, buy groceries, etc. should your business not turn a profit.
How much capital is enough to start a business?
When it comes to starting a business, there is a large number of start-up costs involved, and you will need access to a certain amount of capital to get your business off the ground. But how much is enough to start a business?
Just like with cash reserves, there is no direct answer to this question. Each new business will have different start-up expenses based on the business venue, necessary assets, training, advertising, etc.
In the UK, the average startup has a budget of around £5,000 for their capital expenses.Having enough money to launch your business is often not enough. In order to survive long- term, you’ll need sufficient cash reserves to see you through hard times.
When calculating the amount of capital you’ll need to get your business going, it is often better to overestimate. Inflation can cause your original estimations to rise, and usually there are unexpected costs that you may have overlooked.
Having a detailed business plan in place and having a thorough understanding of how your business will run is the first step in estimating your required capital. The next step would be to start looking at the assets you’ll need to run your business, and whether or not you’ll require a brick-and-mortar premises.
What are cash reserves typically used for?
Building up your business’s cash reserves is very important. Cash reserves have various uses, including general working capital, paying various taxes, saving for big projects, covering unexpected expenses, and so much more.
Most businesses have a separate account in which they keep all of their cash reserves. In a way, cash reserves can be seen as your business’s savings. The money is there not for spending recklessly but to make calculated payments and help get you through unexpected financial hard times.
Ways you can raise capital
As you probably already know, starting a business can be very costly, usually requiring thousands of pounds. Most entrepreneurs don’t have this money just lying around. Once you have figured out the estimated amount that you’ll need for capital, you’re going to need to start looking for ways in which you can raise capital. Some common ways to do this include:
- Bank loan- Most major banks in the UK offer loans to new business owners, should they meet the bank’s requirements. But beware, these loans can have high interest rates attached to them.
- Startup loan- In certain instances, your startup may be eligible for a government-backed startup loan that comes with a fixed interest rate.
- Startup grants- There are various companies that offer start-up grants, and the details will differ greatly from business to business, but grants are available!
- Angel investor- You are able to offer equity in your business in exchange for a significant investment from an angel investor.
- Crowdfunding- These days there are many innovative ways to raise funds through crowdfunding platforms.
It is always helpful to have a detailed business plan and a good credit score when approaching both banks and private investors.
Any capital that you don’t use can be put away in your cash reserves.
Start-up expenses that you should know about
When starting a business, many new business owners overlook important start-up expenses, thus underestimating the amount they will need in terms of capital. Start-up expenses are usually once-off costs that you won’t get back, even if your business is successful.
So what are some of the start-up costs that you should take into consideration when calculating how much capital you’ll need to get your business off the ground?
- Marketing- Marketing is exceptionally important to any new business in this day and age. Competition is stiff, and you want to get your brand’s name out there. Quality marketing and branding can often be more expensive than you might think, but it is definitely worth investing in high-quality branding material, website, etc.
- Consulting fees- To get things done right, you may have to consult with various professionals, including accountants, lawyers, solicitors, and business consultants.
- Recruitment- Are you going to be hiring any employees? Think about the fees that you’ll need to pay for recruitment services and job advertising.
- Registration fees- Don’t forget about the various fees involved with registering your business.
Of course, there are dozens of other start-up costs involved with starting a business, including assets, renovating your premises, etc. By looking at your business model and understanding what your business needs to get off the ground, you’ll be able to accurately calculate the necessary capital you’ll need.
Start-up assets that you may need
Start-up assets are a bit different to start-up fees, as start-up assets hold value, and you would be able to sell them at a later stage should you need to.
One of the great things about assets is that certain assets allow you to deduct the cost amount from your profits before tax is calculated. This is according to HMRC’s annual investment income (AIA).
Some examples of various business assets include:
- Business vehicles
- Office furniture
- Any equipment that your business may require
- Technology such as cameras or laptops
- Certain security features
You are able to claim capital allowances on the costs of demolishing machinery, alterations to buildings (not repairs), integral features, certain fixtures, and items that you keep to use in your business.
Unfortunately, you can’t claim capital allowances on any things that you lease or that have been given to your business, such as cars, buildings, land and structures, or things used for business entertainment.
Remember that when buying assets for your business, it is important to invest in quality items. Any expensive assets should be covered by insurance to cover you in the case of loss, theft, or damage.
The different types of costs
When it comes to start-up expenses, there are many different types of costs, some of which we have already discussed. Understanding these costs will assist you in calculating the amounts you’ll need for working capital and cash reserves.
- Once-off costs- These are often ‘sunk’ costs, which are costs that your business won’t be able to recover easily. These types of costs include paying a professional to build your business website or buying equipment.
- Ongoing costs- Fixed costs are the costs that you’ll need to pay on an ongoing basis. They don’t fluctuate very often and include things like interest fees on loans, rent, etc. You can plan for these costs because they are the same every month.
- Variable costs- As their name suggests, variable costs are known to vary. They are often seasonal and can fluctuate depending on the demand for your business’s products or services.
- Essential costs- Essential costs are the costs that you just can’t get around. They are vital in order for your business to function and may pop up at any time. Examples include upgrading your tech, marketing, hiring a new staff member, etc.
- Optional cost- Don’t spend on optional costs unless you can really afford to. You may not need these things to function, but they will still add value to your business, such as new office furniture, website upgrades, etc.
How to keep your start-up costs low
It can be quite scary when you arrive at the amount that you need to cover your capital and cash reserves. But there are definitely ways in that you can reduce your start-up costs, as well as keep your running costs low. This means that you won’t have to raise quite as much when it comes to capital, and you’ll have some wriggle room should your business experience any financial hardships.
Any revenue that you are able to retain, you can put into your cash reserves or invest back into the business, so reducing costs is always a good idea. Consider the following few ways in which you can reduce costs.
Rent is often one of the biggest business expenses, and if you are able to create an office within your home property boundaries or work remotely, you will be saving yourself a huge amount each year. There are many affordable coworking spaces available in the UK. In many cases, renting an office is an unnecessary stress and expense.
Remember that your business does not always need the best of the best, especially if you are just starting out. If you have expensive taste, you may want to reel that in a bit. You can always opt to buy secondhand or refurbished furniture and equipment, saving you a significant amount in start-up costs.
Yes, many professionals are willing to barter. Offer your products or services in exchange for the items and services that you need to help get your business off the ground. You may be surprised to see how many people are willing to come to some sort of agreement.
Online marketing offers an incredible amount of free marketing initiatives. Educate yourself in this arena so that you are well-equipped to handle some of your own marketing in the initial stages of your business.
Finding the best deals, and the suppliers with the best prices, often requires a significant amount of research. By doing adequate research, and taking time before you sign leases and contracts, could help you discover some fantastic deals and save you money.
The amount of capital and cash reserves that you’ll need as a new business owner will entirely depend on the unique needs of your business. No one can predict the future, and that is why it is always better to overestimate when it comes to calculating these amounts. While it can feel overwhelming to assess these amounts, you have many options available to you, and there are many online resources to guide you through the process.