The Acid Test, also known as the Quick Ratio, is derived from the Current Ratio.  Thus, we need to briefly discuss the Current Ratio first.  Anyone that is currently running a business or is in the planning or startup phase will want to be concerned with managing the cash flows of the business. 

The Current Ratio does just that.  It is simply the ratio of the firm’s current assets divided by the current liabilities.  The current assets are those that are the most liquid – namely cash, accounts receivable, and any inventory.  Current liabilities are those bills that are due within this year (the current term).  If your firm’s current liabilities begin to exceed the current assets, you run the risk of a cash shortage and could soon be facing liquidation just to meet your current obligations.  You don’t want to be forced to go deeper into debt just to pay your monthly bills as this only makes it harder for your business to continue to survive.

If you take the inventory out of the Current Ratio you are now left with the Acid Test.  This is basically a method used to determine the liquidity of the business, namely how much cash is on hand to pay the monthly bills.  The acid test is also an excellent gauge when used along side the Burn Rate, which is simply the amount of money being spent in a given period during the startup phase of the business (or a period of less income than expenses – this could be an off season, such as a homebuilder in Minnesota during the winter). 

If you know you’re burning through $3,000 per month and expect break even to be reached during the 7th month of operations, you know you need $18,000 to carry you over till you start to break even and turn an operating profit (6 months times $3,000). 

If your Acid Test ratio is less than 1.00 you know your cash is less than your current debt and you are going to face a cash crisis soon unless you can turn things around.  The Acid Test could be less than 1.00 because sales were not as high as expected (thus not as much cash in hand and you are holding more inventory – which as you know we do not include inventory in the Acid Test) or it could be that your business is taking on too much debt given the amount of money it’s bringing in (e.g. you owe $10,000 each month and only bring in $1,000 in sales).  We don’t include the inventory in the Acid Test because, well to be quite frank, you’ve obviously not sold it yet and if your company is struggling it could be that no one wants the product!  When a company has to be liquidated, it seems inventory is always sold pennies on the dollar.  This is the reality check part of the Acid Test. 

An Acid Test of 1.00 means your cash and debt levels are equal.  Please don’t think that equal means optimal!!!  The higher the ratio the better.  What if sales dropped off and you start burning through more cash?!  The ratio would quickly slip below 1.00.

One final note about Acid Tests, Current Ratios, and Burn Rates: these numbers are only representative of what is going on in the business today.  I would be much less concerned about a startup with an Acid Test ratio of 0.80 that just landed a huge contract with a Fortune 500 company than another entity that has an Acid Test ratio of 1.20 and is in the business of making typewriters, payphones, or door-to-door sales of encyclopedias.  I’m sure you all understand why that is.  If your business and its industry has a bright future, it’s understandable that you are taking on additional debt now to get your operations up and running.

To sum it up:  if you have an Acid Test ratio less than 1.00 your Burn Rate will be accelerating and you will see a more rapid depletion of cash in your business in the near future.  An Acid Test ratio greater than 1.00 will generally indicate more cash coming into your business (this could be from increasing sales and/or a reduction of current liabilities) and is a rough indication of growth or growth potential.

Here are five ways to help conserve cash during the start up phase.  Each method is discussed in more detail below the list.

1. Scale it down.
2. Add non-cash equity.
3. Ask suppliers for more favorable terms.
4. Consider generic instead of name brand and shop around.
5. Invite enthusiastic and early suppliers and customers to become investors/partners.

1.  Scale it down.  Instead of manufacturing 10,000 wigits in the first year could you get the business up and running by making 5,000 of them.  During this initial launch you could also be seeking out additional investors and demonstrating your new product to a select few customers.

2.  Add non-cash equity.  This option is great when you’re planning to go to the bank to ask for a loan, especially when you’re going to be offering an intangible product… namely some type of service.  In a service company (like a law firm, doctor’s office, etc.) you won’t have a tangible product for the bank to repossess if you default on your loan payments. 

Consider this: most people own a personal computer, some furniture, office supplies, a car, cell phones, printers, art work, digital camera, general purpose tools or tools of a certain trade, and so forth.  While banks won’t want to see a list of every item you own (the shirt off your back so to speak), if you are funding the business with all of the necessary office equipment and tools you’ll need the bank understands you won’t be rushing out to spend the bank’s money on furniture and computers at Office Depot.  Use what you already have at home, list it as a business asset when you go to apply for a loan and save your new start up the precious little cash the bank will require you to contribute to the loan in order for it to be approved.

3.  Ask suppliers for more favorable terms.  There’s a couple of old mottos: “it never hurts to ask” and “the worst they can say is no“.  This could not be more true than in dealing with those suppliers for your business.  Remember, YOU are their customer.  If you’re starting out and don’t have much cash, ask for more time to pay. 

A lot of companies want payment 2/10 net 30, meaning you get a 2% discount for paying in the first 10 days and if you don’t pay in the first 10 days the full amount is due within 30 days.  Other companies, especially larger suppliers, may try to push their own credit program on you – for instance if you go to any of the big box stores or office supply stores they will want you to sign up for a business account or store credit card.  

Let them know right up front when you order that you are a new business and you need to stretch your dollar as far as possible.  Ask if it’s possible to pay over 60 days instead of 30.  If they balk at that suggest 45 days.  Always start with the higher number.  Let them know that within the year you hope to be taking advantage of any discounts for paying early (once your venture starts bringing in revenues as opposed to burning through cash at the start).

4.  Consider generic instead of name brand and shop around.  By this we don’t simply mean buying the store brand, single-ply TP for the office or the refurbished ink cartridges.  When building your wigit, is there a part or component that could be made cheaper by someone else and added to the final product, or can a piece be substituted for another (making them interchangable and therefore reusable).  The easier it is to swap parts, replace parts, and interchange them, the easier it will be to make your product cheaper and at a lower cost to you. 

If you are offering a service rather than a product, this means buying the store brand pens that dry up faster… no, just kidding, you can still shop around for lower prices on things you use to bring your service to market or that add value to your service.  These value added features will of course depend upon your service or possibly a particular customer’s needs.

5.  Invite enthusiastic and early suppliers and customers to become investors or partners.  You will find out early on that there is no one who wants you to succeed more than your suppliers.  They like for their customers to grow as that helps them grow in return.  If a particular supplier is eager to help you get up and running, and to sell you more supplies, perhaps this supplier would be willing to take an equity stake to help get your venture up and running. 

It could be as easy as providing a set amount of supplies for free, giving you a discount, an extended amount of time to pay, or could be actually taking an equity stake in return for some capital.  Likewise some customers early on may like your product so much that they want to ensure it will be there to meet their needs down the road.  These customers have a vested interest in seeing your business becoming successful and sustained.  At the very least these early suppliers and customers represent a good resource that can help your business grow.   These groups also represent excellent sources for advisory panels, board of directors positions, and by making them more involved in your business will help forge more loyalty and drive growth.  If you go to a bank looking for a loan it will also look better in the bank’s eyes that you take such an interest in your customers and suppliers and value their feedback and input.

There are many more ways to help get your business up and running without having a truck load of money to get started.  This article is meant to stimulate your thoughts on what you can do in your own unique situation to think outside the box with regard to funding your venture.  Please feel free to share any alternatives to cash investment that you think might work or even those that you have tried that don’t work and why they didn’t work. 

• Advisory Capitalists
• Liquidation
• Startup Strategy
• Characteristics of an Entrepreneur (Please don’t let these discourage you!)
• Selecting a Venture Capital Firm
• When to Raise Capital
• Entrepreneur’s Pitch
• Term Sheets
• Success Stories

Read the full article: 75 Blog Posts to Read Before Talking to a Venture Capitalist

While more than half of the approximately 600 business owners surveyed said it would have been easier to start their companies had more money been available, start-up financing was not the only challenge they identified.

Forty-nine percent of respondents said advice from other business owners also would have made their start-up days easier, while 39% said a better understanding of financial management would have helped.

Additional statistics:

• 73% of start-ups were primarily funded by the owner’s personal savings
• 37% of start-ups were funded in part by loans and lines of credit
• Only 31% of small business owners surveyed started with business plans

Story on Inc.com: Most Entrepreneurs Start with Limited Funds, No Business Plan

Fund Isabella is the firm’s flagship offering, which is targeted towards early stage, women-led companies or those operating in the women’s market. Isabella believes that female-led entrepreneurial ventures are an untapped market in the venture capital industry, and hopes to find and fund start-ups that help promote minority leadership and entrepreneurship.

Here are some of the criteria for the fund:

• Industries targeted: Information technology, health care, retail/consumer products, communications
• Company size: $500,000 or more in annualized revenues
• Investment size: $250,000 to $1 million per company dispersed in multiple rounds
• Investment type: Equity or equity-linked investments, typically in the form of convertible preferred stock

Isabella’s current porfolio:

• Club Mom, Inc.
• Digital Scout
• Experience
• Gentra
• MarketMax
• Healthy Advice Networks
• ViaCell
• Wisdom Tools