In the course I teach about introductory business finance, one of the topics is evaluating business projects, either stand alone or additions to an existing business portfolio.  The framework is to compare initial investment in a project with the discounted future cash flows that we expect from the project.  For example, we buy a new piece of machinery to make noodles.  Then, we project net cash inflows from making noodles over the life of the machine, and we discount the projected after tax cash flows, using the rate of return that we want or need to earn on our initial investment.

One of the things that my students often have trouble with is what constitutes the initial investment, and I realize that not only my students have trouble with this but also many people who start a business, which I am made even more aware of as I watch literally hundreds of people go in and out of business, in my neighborhood, in China.  It is easy for most to understand that some sort of capital investment is necessary, for example, buying a noodle making machine to be in the noodle making business or remodeling a space for a store or restaurant.  However, some do not even figure out, properly, how much that part of the investment will be.  For example, there was a space being built out, in my neighborhood for a hamburger bar, and the person did not even have the money to finish building out the space, so, a new person took over and turned it into an Indian Restaurant, which was in business only for a few months.  Lately, it is being ripped apart and built out again (why did they even have to do that?) for its third potential business in about a year.  Indeed, there are quite a few tall office and apartment buildings, in Guangzhou, which have been only partially finished for as much as ten years or more. 

If some people do not even plan for the obvious long-term capital investment that is required for business startup, many totally miss the short-term, working capital part of the equation.  Working capital (WC) is the short-term, less than one year, part of the balance sheet: current assets (CA) and current liabilities (CL; NWC = net working capital = CA - CL).  In that regard, if you are going to start a dress shop, you will need to make a long-term capital investment, consisting of: fitting out a space and buying fixtures.  However, you will also need to make an initial invest in inventory ( a CA in WC) as part of startup costs, or you will have nothing to sell.  If you plan on selling partly on credit, you will also have to set aside seed-money for accounts receivable (A/R), which will also need to be part of your initial investment.  For example, if you expect to sell $100,000 per month in dresses (ignoring profits to make it simple), and you will sell 25% on credit (due in one month), then, you will need, not only $100,000 initial investment, in inventory, but also $25,000 initial investment for future A/R.  Otherwise, after one month, you will have sold $100,000 in dresses, but your cash inflow will be only $75,000, so you could only buy $75,000 in dresses to sell in the second month.  By thinking to put aside the extra $25,000 for initial investment startup costs for A/R, you will be able to buy $100,000 in dresses the second month.  By the end of the second month, your credit customers from month one will have paid you, and for the third month and thereafter, you will have $100,000 to buy dress inventory.

Those are the things that people must think about when they are starting a business.  Those are the broad strokes.  The fine points of startup include considering all of the components of the larger classes of short-term and long-term asset startup costs.  For example, purchase of equipment will include purchase, transportation, insurance and installation of equipment.  If you expect sales to grow each year, you might also have to plan for further investments in WC, in future years.  You can also subtract from initial investment, if you expect to be able to buy materials for the business on credit (A/P).  Then, you could make a subtraction from the funds that you will need for your total initial startup costs.

After that, you can toy with the future side of the equation.  First, for a new small business, you might also want to set aside some extra money as a cushion to pay expenses for 6 months or more until you get discovered.  You might look at the future cash flows using different required rates of return (called a present value profile.  You could look at sales and costs under various good and bad future scenarios.

I realize that it is the dream of many a person to have their own business, but don't romanticize and fantasize, understand the game, and then play.  The theoretical idea in finance for this problem is to look at the discounted value of the future cash flows, which means that the money you get from the investment, totaled and accounting for an annual return on investment as percent per year on initial investment.  Then, that amount should be larger than your initial investment total.  In other words, you pay less, in terms of what you initially pay for the investment project, than it is worth in expected discounted future after tax cash flows from the business investment project.  If it works out as predicted and you included all of the money you really need to start the business, in the first place, you will make the return on investment that you used to value the business.

In that manner, business, itself, becomes a sort of long-term arbitrage, albeit not riskless.  Consider borrowing all of the initial startup costs for interest rate, B, and having the implied annual rate of return on investment (formally, called the internal rate of return of the investment, which is analogous to the yield-to-maturity, YTM, on a bond), ROI, greater than B.  Then, with an initial capital outlay of zero dollars, you make a return, equal to ROI - B.  An analogy from bond investment is convertible arbitrage, wherein one buys convertible bonds (convertible at a certain number of shares of stock per bond after or on a given future date in the bond indenture), and short sells stock against the long bond position.  Moreover, for a broker dealer, the required capital outlay on the position is only 10% of the value of the bonds (note quite zero, but close).

In the end, whatever you invest in, invest thoughtfully and wisely.  By doing only that much, you will already be light years ahead of the pack.

Note: Discounted cash flow is a technique from finance that talks about the time value of money.  A dollar that you get a year from now is not worth the same as a dollar, now, because, if you had a dollar, now, you could invest it, in a bank account or elsewhere, and have more that a dollar, a year from now.