How to Know If You’re Financially Ready to Start a Business

How to Know If You’re Financially Ready to Start a Business

Are you ready to start a business? If so, you aren’t alone. In the wake of mass layoffs and resignations, the U.S. saw the number of new business applications surge to more than 4 million. COVID-19 might have been the catalyst for these new ventures, but how many of them will make it long term? Unfortunately, the odds aren’t necessarily in their favor: A survey of pandemic entrepreneurs found that more than half believe their business will fail within the year without extra aid.

Pandemic aside, starting a business is a risky commitment. Even pre-pandemic data showed that 20% of startups shutter their operations within year one, and as many as 9 in 10 don’t make it past a decade. To make it work, you have to be prepared to make a lot of sacrifices. Are you ready to forgo a paycheck for months at a time? Are you at a point in your life where you can dedicate 60 hours a week to your business?

These are just a few things you need to consider before starting a business. To get all your ducks in a row and ensure you’re ready to jump into creating a new company, you need to craft a robust business plan that accounts for the myriad financial considerations of setting up a business.

The Importance of Writing a Business Plan

You wouldn’t show up at the airport without an idea of where you’re going. So why would you pour your time and money into a business without a clear vision of what you want to accomplish, the steps you’ll take to get there, and a way to track your progress? (And those are only some reasons you should create a business plan.) 

Several elements make up a robust business plan: 

  • Executive summary: Overall, what are you trying to accomplish? What’s your mission statement? How would you describe your product or service offering? Later in the plan, provide more specific information about your offering (e.g., suppliers, margins, and so forth).
  • Market analysis: What are the current trends in your industry? Who are your target customers? Be clear on how you’ll set your business apart in your industry.
  • Business organization: Who will manage operations? What are their responsibilities? How about their qualifications?
  • Marketing and sales strategy: How will you get in front of your target audience and promote your offering?
  • Business funding: How much funding will you need? How long will that amount last? And how do you plan on getting it? 

Funding is perhaps the most critical aspect of your plan. After all, without cash flow and a solid financial plan that includes costs and expenses, you won’t be able to get your business off the ground. 

Financial Considerations for Setting Up Your Business

Considering the No. 1 reason startups fail is that they run out of money, creating a financial plan for a new business is key. So before you dive headfirst into entrepreneurship, ask yourself these three questions to gauge your financial readiness:

1. Can I fund my business venture myself?

There’s something empowering about the idea of being able to fund a business venture all on your own. Who wants to go into debt, after all? Unfortunately, most entrepreneurs don’t have that kind of capital on hand.

If you don’t have the personal funds to get your business up and running, you’ll need to look at other sources to raise capital. If you have a preexisting relationship with a bank, start there. Your current bank will already know your creditworthiness. Loans from the U.S. Small Business Administration (e.g., 7(a) loans, 504 loans, or microloans) are another excellent option. 

Some aspiring entrepreneurs turn to friends and family members for startup money, but this route has pros and cons. For example, if a relative gives you an intrafamily loan, they’ll want to charge a minimum interest rate so it doesn’t count as a gift (which would trigger gift taxes). It can also lead to some sticky situations in your relationship with that relative, so proceed with caution. 

Remember that the more you use as leverage for loans, the bigger the risk. If you want to play it safe, use your own cash. It might take longer to build up the funds, but it can give you peace of mind not to owe to outside sources.

2. Do I have a good handle on my personal finances?

Are you currently earmarking 15% to 20% of your income for retirement? That’s a good indicator that you’re financially stable. But if you’re starting a business, then you generally won’t have income to put toward retirement at first. So to determine whether you’re financially stable, you’ll need to do a deep dive into your personal budget. 

You can do this via online resources like BrightPlan or Mint, or by printing out the past six months of statements from your bank accounts and credit card accounts. Either way, go through your bills and determine where you can cut personal expenses. The leaner your personal budget, the more resources you can put into your business, and the quicker it can grow.

Before you take the plunge, make sure you have at least a year’s worth of cash on hand for nondiscretionary expenses. It can take many months (if not years) before your business is profitable, and you want to ensure you can cover the essentials while you’re working on your startup.

3. What costs will be associated with my business? 

Some startup costs depend heavily on the type of business (e.g., brick and mortar, online, or service-based). Others, however, occur across business types and sizes. Consider working with a certified public accountant so you can better track your startup costs and separate them into expenses and assets.

You can deduct expenses from your taxes, but you must keep records of them. Divide your expenses into one-time (e.g., permits and licenses, website design, etc.) and ongoing (e.g., rent, utilities, etc.) categories so you’ll get a more reliable assessment of what it takes to run your company. Doing this also will help you identify ways to cut costs over time.

With so many people dipping their toes into entrepreneurship these days, you might be asking yourself: Am I ready to start a business? But you need to know what to consider before starting a business—and financial health should be the first priority. Trust me, creating a financial plan for your new business will put you in a better position to succeed.

Photo by Odua Images

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Sara Gelsheimer is a senior wealth manager at Plancorp, a full-service wealth management company serving families in 44 states. Sara came to Plancorp in 2013 with a strong financial background and an even stronger commitment to financial education — particularly for women. Sara’s passion for educating women about investing helped spur InspireHer: Plancorp’s Women’s Initiative, which empowers women to find their financial voice through a platform where they can connect with others, ask questions, and have their concerns addressed in a comfortable setting. In her free time, Sara volunteers as a mentor with Boys Hope Girls Hope and sponsors two young women in Uganda through Hearts & Hope for Uganda. She enjoys live music, hiking, biking and most of all, spending time with her husband and son.

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