When cash flow problems emerge, the business owner probably didn’t accurately estimate anticipated revenue versus anticipated expenses. The estimate of startup costs was too conservative. Clients aren’t paying as quickly as they hoped or sales didn’t follow the anticipated trajectory.

There are several reasons business clients run into cash flow problems or just simply need more money in a hurry. It’s better to get in front of this problem sooner than later and as their accountant, you need to be able to ask the tough questions. Business owners, especially startups, can be excessively optimistic and not properly plan for the aforementioned scenarios. They are simply convinced their idea will take off.

Here are seven questions to ask clients in order to better understand their finance needs: 

1. Why is your business going to succeed? Answering this question requires a robust business plan. Ask your client the following questions:
2. How much money will you (realistically) need? This should be followed by “How did you arrive at that number?” You want them to walk you through their business plan. They often need exponentially more money as the business ramps up operations. Where will this money come from? Is it from product sales? How have they matched projected sales revenue with the more predictable outflow for expenses? Remind them of the timeless advice people are given when going on vacation: “Bring twice as much money as you think you will need.” That was back when people carried cash. Today the advice would be “Be prepared to spend twice as much as you anticipated in out-of-pocket costs.”
3. Are you prepared for contingencies? How will they be addressed? When you embark on a construction project such as building a new home, the architect typically builds in a cushion of 10 percent (or more) into the project budget. Why? Because they don’t know what problems they will encounter along the way. If construction is halted, rent still must be paid on equipment. The mortgage needs to be paid. When renovating an older home, contractors usually protect themselves by saying: “We don’t know what we'll find when we open up the walls.” Assume everything will not go according to plan. What cushion has the business owner built in?
4. Are you borrowing or taking on investors who will own equity? The answer might be “yes” to both options. If the client is borrowing, they'll need that robust business plan that will persuade the bank their venture is a good risk. If they are bringing on investors who will pay to own a slice of the equity, they need to be confident the projected return on investment is sufficient to balance the risk they are accepting. Their investment will likely be illiquid for a long time. What can they expect as a return on investment? When should they be starting to see a return? Regardless, if it’s a loan or equity, the client will need that good business plan.
5. How much equity are you prepared to give away? It’s been said early money is the most expensive money. If investors are willing to put money into a startup, they are buying into a vision and the business owner who promises to deliver. They are taking a major risk. They want to be adequately compensated. The client wants to retain control of their business, but they must be prepared to part with enough equity to make the risk worthwhile to the investor.
6. How much of your own money are you putting at risk? How much are immediate family members investing in the business? The client needs to understand that if a bank lends them money, they want to be lending alongside the client. They want them to have “skin in the game.” If a business runs into serious financial trouble, lenders have standing ahead of equity investors. They want the client to have a substantial amount of their own money at risk, so that they are motivated to see their business succeed.
7. How much are you prepared to pay to borrow money? The return on equity must far exceed the cost of borrowing money. Ask your client to imagine the following scenario: You are confident your business can return 20 percent, yet the only lender you can find wants 35 percent interest and your personal guarantee of the loan. In this scenario, the client shouldn’t be starting or expanding their business at this time. They need to bear in mind that there are costs besides the posted interest rate. Origination fees are a good example. The interest rate will likely be variable, which is dangerous in a rising interest rate environment.

Ideas can look great on paper. Things get complicated once loans are negotiated and your client signs documents. They need to be aware of the risks they are assuming along with costs and consequences.

This blog was originally published as a column on AccountingWeb and can be read in its entirety here.