Determining Capital in Business

For those planning to be entrepreneurs, one of the most important questions is how much capital you will need to start a business. Assuming that the type of business has been decided and that you do not intend to get a franchise, I have listed below the basic factors that determine the minimum amount necessary. Using these as a guide, you can better approximate what you will need to begin the business you want:

Legal requirements. For some businesses, there are laws that set the minimum paid-up capital. Some of the largest, if not the biggest, requirements are those for banks that may run to hundreds of millions of pesos because their stability is critical to our economy. However, even small businesses like money lending may be subject to rules. In the case of money lending, the minimum capital is presently set at one million pesos.

Income needs and expectations. If a person is already earning a hundred thousand pesos a month, then he/she may not be satisfied if the venture’s income is only P50,000—especially if they have a lot of financial commitments. To match substantial needs, the sales and profit goals will have to be set higher; and to support this level of activity, there will be a greater need for additional funds. In the case of a retail outlet, there needs to be more inventory and larger outlet size. A lot of sound ventures have gone under not because they were unprofitable but only because the owner was taking too big a salary for living expenses.

Location of business. A business situated in Metro Manila, especially in the commercial centers or malls, will, of course, be more expensive than a similar one situated in the provinces. Almost everything costs far more in the metropolis than in other areas. Not only are prices higher but the standards are also more stringent. A low-cost renovation, for example, may be acceptable in most provinces, but in Metro Manila it may get buried in the stylishness of its competitors.

Necessary capital expenditures. Capital expenditure is the cash outlay for non-consumable items like equipment, facilities and rental deposits. Due to insufficient studies, there are many essential capital expenditures that are often not factored in. Our experience in putting up a printing press serves as a good example. We thought that the majority of the capital expenses will be in the cost of the printing press. It turned out that we also had to buy a cutter and other support equipment that, in total, cost almost as much as the printing press. To top it off, we had to spend over P200,000 to get a three-phase electrical connection and to rewire all electrical connections to accommodate the large machinery. Such additional costs are easy to overlook since they are secondary to the main machine.

Operating capital needed. Also called OPEX, these are expenses incurred in the daily operations of the business. Examples of this type of expense include wages, rental and electricity. This is what beginners in business often fail to compute accurately. The most common blunder is an overly optimistic projection. Sometimes a business may take a year or two to begin making profit, and those lacking in capital may run out of cash just before they begin earning.

Trade credit. This is when your supplier is willing to sell you their goods for future payment, usually for around 30 days, but eventually this may be much longer. There are certain lines of business that run mostly on trade credit. Be warned though that in the present situation, vendors rarely give credit lines at once; and even after you are given a credit line, the amount is usually limited. Others may be willing but only if you give collateral. Still, it may be possible to lessen your capital requirements if you could find a supplier that will trust you.

Strong nearby competitors. Even if you are in the provinces, you may still be forced to increase your capitalization if you are up against strong competition. This will entail not only additional investment in equipment and facilities to match their quality and capacity, but also a greater marketing budget.

Uneven demand. A highly uneven cash flow could destroy your budget. For example, if you are selling one million a month from January to November and then suddenly in December the demand is four million pesos, your reserves may be depleted. This situation may force you to have a higher level of capital than is normally needed.

Profit margins. When the margins are high, there is usually a better chance to avoid heavy investment. This is because you could afford to outsource needed functions or buy from a wholesaler. If the mark-up is low, it would not be possible to have a profit if you do not make it inhouse.

Economies of scale. There are businesses that need a certain volume of operations to be viable. An example of this is the taxi business. You may be able to afford one taxi but the cost of maintenance will be too much since you would not be able to afford your own mechanic, equipment and garage. In this case, you would need around 10 vehicles to be feasible.

The capital you will need to start a business is dependent on many factors. In some ventures, the amount is easy to estimate. However, there are also those that entail you to spend time and effort to gain a good estimate. Even after careful study, it would be best to keep some cash in reserve because there will always be unexpected expenses.

*Originally published by the Manila Bulletin. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.