Q: When can you quit your day job when starting a small business?
A:When you are starting a business, your personal finances are inseparable from the business. So you need to factor your living expenses into all your financial calculations.
An exercise I use with my students is to have them calculate their “runway.” It is a simple calculation to determine how long they have before they and the business run out of money. How long before the business has to take off. How do you calculate your runway?
You begin by estimating the cash needs of the business. This includes investments in property, plant and equipment, lease improvements, inventory and all the other outflows of cash required to get a business off the ground. Don’t underestimate your monthly outflows.
You then need to estimate your living expenses by month. This includes all outflows, such as rent, car payments, insurance, mortgage payments, student loans, food, entertainment and all the rest of the bills you need to pay.
Total these two sets of expenses/outflows and you now have estimated the amount of cash you need to start your business by month. Now turn to the cash inflows.
You begin with savings and earnings. How much do you have saved (savings and investment accounts, 401(k), life insurance policies, etc.)? Next, turn to earnings from your current work. How much do you bring in a month? How long can you keep your job while building your business? How much does your significant other earn? Finally, estimate any cash you can take out of the business, even if it’s down the road. Now total these up by month. This is an estimate of your available cash. Net the monthly outflows from the available cash and you’ve estimated your monthly cash balance.
Your runway ends when your monthly cash balance turns negative. You have estimated the date you’ll be out of business. You extend your runway by working longer, saving more, or consulting, or you cut or delay outflows.
David Deeds is a professor of entrepreneurship at the University of St. Thomas Opus College of Business.
This article originally appeared in the Star Tribune on Mar. 29, 2019. Used by kind permission of the Star Tribune.