capital requirements in business plan

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Writing A Business Plan: Operations And Management

Feb 1, 1997

Generally, there are seven major components that make up a business plan. They are:

1. Executive summary

2. Business description

3. Market strategies

4. Competitive analysis

5. Design and development plans

6. Operations and management plans

7. Financial factors

The operations and management plan is designed to describe just how the business functions on a continuing basis. The operations plan will highlight the logistics of the organization such as the various responsibilities of the management team, the tasks assigned to each division within the company, and capital and expense requirements related to the operations of the business. In fact, within the operations plan you'll develop the next set of financial tables that will supply the foundation for the "Financial Components" section. The financial tables that you'll develop within the operations plan include:

*The operating expense table

*The capital requirements table

*The cost of goods table

There are two areas that need to be accounted for when planning the operations of your company. The first area is the organizational structure of the company, and the second is the expense and capital requirements associated with its operation.

Organizational Structure

The organizational structure of the company is an essential element within a business plan because it provides a basis from which to project operating expenses. This is critical to the formation of financial statements, which are heavily scrutinized by investors; therefore, the organizational structure has to be well-defined and based within a realistic framework given the parameters of the business.

Although every company will differ in its organizational structure, most can be divided into several broad areas that include:

*Marketing and sales (includes customer relations and service)

*Production (including quality assurance)

*Research and development

*Administration

These are very broad classifications and it is important to keep in mind that not every business can be divided in this manner. In fact, every business is different, and each one must be structured according to its own requirements and goals.

Terence P. McGarty in his book, Business Plans That Win Venture Capital , lists four stages for organizing a business:

1. Establish a list of the tasks using the broadest of classifications possible.

2. Organize these tasks into departments that produce an efficient line of communications between staff and management.

3. Determine the type of personnel required to perform each task.

4. Establish the function of each task and how it will relate to the generation of revenue within the company.

Once you have structured your business, however, you need to consider your overall goals and the number of personnel required to reach those goals.

In order to determine the number of employees you'll need to meet the goals you've set for your business, you'll need to apply the following equation to each department listed in your organizational structure:

In this equation, C represents the total number of customers, S represents the total number of customers that can be served by each employee, and P represents the personnel requirements. For instance, if the number of customers for first year sales is projected at 10,110 and one marketing employee is required for every 200 customers, you would need 51 employees within the marketing department.

10,110 ÷ 200 = 51

Once you calculate the number of employees that you'll need for your organization, you'll need to determine the labor expense. The factors that need to be considered when calculating labor expense (LE) are the personnel requirements (P) for each department multiplied by the employee salary level (SL). Therefore, the equation would be:

P × SL = LE

Using the marketing example from above, the labor expense for that department would be:

51 × $40,000 = $2,040,000

Once the organization's operations have been planned, the expenses associated with the operation of the business can be developed. These are usually referred to as overhead expenses. Overhead expenses refer to all non-labor expenses required to operate the business. Expenses can be divided into fixed -- those that must be paid, usually at the same rate, regardless of the volume of business -- and variable (or semivariable) -- those which change according to the amount of business.

Overhead expenses usually include the following:

*Maintenance and repair

*Equipment leases

*Advertising & promotion

*Packaging & shipping

*Payroll taxes and benefits

*Uncollectible receivables

*Professional services

*Loan payments

*Depreciation

In order to develop the overhead expenses for the expense table used in this portion of the business plan, you need to multiply the number of employees by the expenses associated with each employee. Therefore, if NE represents the number of employees and EE is the expense per employee, the following equation can be used to calculate the sum of each overhead (OH) expense:

OH = NE × EE

In addition to the expense table, you'll also need to develop a capital requirements table that depicts the amount of money necessary to purchase equipment you will use to establish and continue operations. It also illustrates the amount of depreciation your company will incur based on all equipment elements purchased with a lifetime of more than one year.

In order to generate the capital requirements table, you first have to establish the various elements within the business that will require capital investment. For service businesses, capital is usually tied to the various pieces of equipment used to service customers.

Capital for manufacturing companies, on the other hand, is based on the equipment required in order to produce the product. Manufacturing equipment usually falls into three categories: testing equipment, assembly equipment, and packaging equipment.

With these capital elements in mind, you need to determine the number of units or customers, in terms of sales, that each equipment item can adequately handle. This is important because capital requirements are a product of income, which is produced through unit sales. In order to meet sales projections, a business usually has to invest money to increase production or supply better service. In the business plan, capital requirements are tied to projected sales as illustrated in the revenue model shown earlier in this chapter.

For instance, if the capital equipment required is capable of handling the needs of 10,000 customers at an average sale of $10 each, that would be $100,000 in sales, at which point additional capital will be required in order to purchase more equipment should the company grow beyond this point. This leads us to another factor within the capital requirements equation, and that is equipment cost. If you multiply the cost of equipment by the number of customers it can support in terms of sales, it would result in the capital requirements for that particular equipment element. Therefore, you can use an equation in which capital requirements (CR) equals sales (S) divided by number of customers (NC) supported by each equipment element, multiplied by the average sale (AS), which is then multiplied by the capital cost (CC) of the equipment element. Given these parameters, your equation would look like the following:

CR = [(S &3247; NC) × AS] × CC

The capital requirements table is formed by adding all your equipment elements to generate the total new capital for that year. During the first year, total new capital is also the total capital required. For each successive year thereafter, total capital (TC) required is the sum of total new capital (NC) plus total capital (PC) from the previous year, less depreciation (D), once again, from the previous year. Therefore, your equation to arrive at total capital for each year portrayed in the capital requirements model would be:

TC = NC + PC - D

Keep in mind that depreciation is an expense that shows the decrease in value of the equipment throughout its effective lifetime. For many businesses, depreciation is based upon schedules that are tied to the lifetime of the equipment. Be careful when choosing the schedule that best fits your business. Depreciation is also the basis for a tax deduction as well as the flow of money for new capital. You may need to seek consultation from an expert in this area.

The last table that needs to be generated in the operations and management section of your business plan is the cost of goods table. This table is used only for businesses where the product is placed into inventory. For a retail or wholesale business, cost of goods sold , or cost of sales , refers to the purchase of products for resale -- the inventory. The products that are sold are logged into cost of goods as an expense of the sale, while those that aren't sold remain in inventory.

For a manufacturing firm, cost of goods is the cost incurred by the company to manufacture its product. This usually consists of three elements:

1. Material

3. Overhead

As in retail, the merchandise that is sold is expensed as a cost of goods, while merchandise that isn't sold is placed in inventory. Cost of goods has to be accounted for in the operations of a business. It is an important yardstick for measuring the firm's profitability for the cash-flow statement and income statement.

In the income statement, the last stage of the manufacturing process is the item expensed as cost of goods, but it is important to document the inventory still in various stages of the manufacturing process because it represents assets to the company. This is important to determining cash flow and to generating the balance sheet.

That is what the cost of goods table does. It is one of the most complicated tables you'll have to develop for your business plan, but it is an integral part of portraying the flow of inventory through your operations, the placement of assets within the company, and the rate at which your inventory turns.

In order to generate the cost of goods table, you need a little more information in addition to what your labor and material cost is per unit. You also need to know the total number of units sold for the year, the percentage of units which will be fully assembled, the percentage which will be partially assembled, and the percentage which will be in unassembled inventory. Much of these figures will depend on the capacity of your equipment as well as on the inventory control system you develop. Along with these factors, you also need to know at what stage the majority of labor is performed.

Part six of seven. Tomorrow, we'll cover the financial factors that go into your plan. Tips are updated daily at 8:30am PST or 11:30 EDT.

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As a business owner, there are many things that need to be prepared to run a company. One of the most important considerations is a full understanding of capital. Capital is essential to keep a business running and growing.

Understanding Capital

In short, capital is cash or liquid assets that each company secures to pay for their expenditures. It is both a measurement of wealth and a resource that one could utilize to increase company wealth through different investments. The financial assets that a company has in deposit accounts and funds that it received from other financing sources are considered to be its capital.

Capital can be held through financial assets, or be can procured from debt or selling company stock to investors, otherwise known as equity financing .

A firm’s capital is the core of the business. The company needs this to run and finance all the assets that require significant amounts of money. There are three types of business capital that every business needs to prepare: working capital, debt capital, and equity capital.

Capital Assets

Another term that needs to be discussed is capital assets. These are assets of the business that may be part of the current or long-term portion of the balance sheet. These can either be in cash, cash equivalents, and marketable securities. It may also include the company’s production and storage facilities and their manufacturing equipment.

Capital is vital for the business to grow. All companies must be careful about how they finance their working capital, which is for daily expenses, and how they invest the money that they obtained. If done well, the company’s return on investment would be guaranteed. The business’s net worth would depend on the total capital and capital assets that the company holds.

The company will use the capital to pay for everything that it needs to manufacture the products that they will sell to the market, which will create profit. Most companies also use this to invest in all sorts of things that could be beneficial to the business. They mostly allocate their capital for expansions both in labor and buildings or facilities. Doing so directs money towards investments that would bring in more money than the cost of the capital.

As time passes by, the firm must carefully assess the capital thresholds, capital needs for investments, and all its other capital assets. This can be done by reviewing and analyzing the balance sheet.

What are Capital Requirements?

Capital requirement is the total amount of funds that the firm will need for the business to achieve its goal of raising profit. The way to calculate this is by adding the founding and start-up expenses and investments. Afterwhich, one can subtract their equity capital from their capital requirements to know how much external capital they will need.

When making the business plan, the management and executives must also specify the capital requirements because there are follow-up costs that need to be considered. Remember to calculate the capital requirements as accurate as possible. However, it is also important not to plan too conservatively in case the company will face unforeseen financial problems in the future.

On the other hand, if one calculates too generously, the funds are much more flexible, but that would be much more expensive. Take note that one must prioritize liquidity over profitability. Meaning it is much better to have too much credit and return it, then subsequently finance funds.

Start-Up Capital Requirements

One of the most challenging tasks for anyone that wants to start their own business is preparing the right amount of start-up capital they will need. Start-Up capital is the money that one will need to keep the business running until it will break-even (positive cash flow). If business owners cannot calculate enough capital to sustain the company until the break-even point, the business will go bankrupt and fail.

To create a budget, one must include all the expenses from recurring costs (lease, electricity, taxes, payroll, etc.) and income. Also, take note of one-time expenditures, such as business licenses, building signs, and incorporation costs. To calculate an accurate budget, list everything down on a spreadsheet, including:

Initial Costs

Fixed costs, capital intensive start-ups.

Managing capital-intensive startups is tricky. Most investors and debt lenders have an aversion to capital-intensive business models and industries like biotech, medical devices, cleantech and semiconductors.

Carrying considerable staff, receivables, inventory, research and development costs, and even buildings, as a more capital-intensive startup takes a special kind of focus, patience and partnership with investors, management and employees.

Unlike software, bootstrapping a capital intensive company is not a long-term option. These industries are far too risky for debt financing, too.

You will need equity financing to run operations like R&D, labs, highly compensated research professionals, and, as you get closer to commercial viability, clinical trials and regulatory approvals.

Business Capital Structure

A balance sheet analysis must be done to review and assess the business capital, which will eventually lead to profitable returns. There are several types of capital that make-up the business capital structure, and those are:

Debt Capital

A company can acquire funds by getting a loan either from private or government sources or from the owner’s friends or family. However, to obtain this, one must have an active credit history and excellent credit rating. Companies must also remember that this option requires regular payment of the amount borrowed plus interest, which will depend on the capital that was obtained and the borrower’s credit history.

Equity Capital

This can come in three distinctions, namely private equity, public equity, and real estate equity. The first two are usually in the form of shares. Public equity capital will be received if the owner lists their company on a market exchange that is open for all people to invest in and become a shareholder. On the other hand, private equity capital comes from the owners or selected investors.

Working Capital

A business will need its most liquid capital assets to cover all of the daily expenses that the company will incur. This must be calculated regularly. This measures the company’s ability to pay for the debts and accounts payable within a year.

Trading Capital

This refers to the total amount of money available for people to buy and sell different securities. Investors or traders can increase their trading capital by utilizing various trade optimization methods.

• Start-Up Capital
• Capital Intensive Startups
• Capital Structure

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