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Capital growth for a new venture

Capital growth for a new venture

This article was written by Ed Hatton for the column the Start up Coach and published by the South African edition of Entrepreneur magazine in June 2011 and is posted here by their kind permission.

All start-up entrepreneurs should understand their business finances before they launch

By Ed Hatton

 

Challenge:

An entrepreneur is planning to start cattle farming, but has very little economic or entrepreneurial background as he works in the medicine field. He wants to know what the growth in capital ia that is needed by a business during its first year to sustain further development and growth.

Solution

This is question all start-up entrepreneurs should ask themselves. The focus is usually on the initial capital needed to start operations, but sustaining the business past the first year is equally important.

To answer the question we need to take a step back to the business plan for the new venture. This should start with how much the entrepreneur wants from the venture as a monthly income and / or capital gain. That will tell him how many calves he will have to sell each year if he makes assumptions of the sale price and cost of breeding, rearing and sale. The estimated yield will tell him how many breeding cows he will need. The size of the breeding herd and the capacity of the land to produce grazing and fodder will tell him how much land, labour and infrastructure he needs. These factors will determine his start up capital needs Then he needs to do the cash conversion cycle (from when cash is laid out to produce stock to the time cash is paid as a result of sales) and work out the operating cost of running the business during that period to establish his working capital needs.

This is a business like any other. The entrepreneur has to identify his target market and see what it needs, decide how to compete, then get the right product (breed and quantity) and distribution channel to sell his breeding stock, find the right production facility (land and infrastructure) and identify the right labour and management to handle the required volume.

Managing risk

As a part of the planning he needs to find ways to manage the risks of the business.  In farming these include fires, droughts, stock theft, epidemics and many others. There is a cost for risk management and this must be in the budget. He may need to spend on veterinary fees, security or insurance, or take greater rewards from the business to balance the risks he takes. Risk management is ignored by many entrepreneurs, and this may be a significant part of the failure rate of new businesses.  Don’t let that happen to your start up.

So now that all the planning has been done we can look at the question – how much does he need to grow his capital to give sustainability and growth prospects?  His income must pay himself and all the operating expenses, interest, loan repayments, maintenance and depreciation. He must have sufficient funds to replace stock losses, and cater for inflation. If the farm income covered all these factors then theoretically he could draw and spend any surplus to these amounts and continue farming indefinitely without any reinvestment. Sadly many businesses attempt to operate like this, investing no new capital, and they put themselves at risk of becoming part of the dreaded start up failure ratio.

Ensure sustainability

To continue to operate with no new investment, the entrepreneur would need all the factors that affected the year’s profit to be the same or better every year in the future. This is impractical, so he should invest in his business from year one in order to ensure sustainability. The farmer would invest in better breeding stock to increase his yield and the quality of his stud, in care for his land to improve grazing, in reduce calf mortality and in mechanisation and training to improve operating  efficiencies. This is no different to a manufacturer investing in better machines and raw materials, reducing scrap and training his workers to be more productive.

There is no single right answer to what the percentage this investment should be, other than it should be greater than the inflation rate and less than the percentage that would not give the entrepreneur sufficient income to pay his bills. The more that is re-invested the less risky and more profitable the venture becomes, so investing steadily in the first few years is desirable. Between 8% and 12% of turnover should be possible for this farmer.

© copyright Entrepreneur Media SA (Pty) Ltd. All rights reserved. No part of this article may be reproduced, stored in a retrieval system or transmitted in any form without prior permission of Entrepreneur Media (Pty) Ltd.  Permission is only deemed valid if approval is in writing.

 

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