This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
Presumably this question will have been answered before the financial plan was formulated; that is to say, the amount of capital that would be required was first of all estimated and the financial plan was made to fit this estimate. Right here is a frequent source of serious error. The capital required is often not estimated at its proper amount. It is easy enough, usually, to calculate what will be needed for plant and machinery, road-bed and equipment, office furniture, or whatever the fixed assets of the business may be. In addition, however, there are two requirements of uncertain amount - for working capital and development expenses.
Sufficient working capital must be provided in order to take care of the normal process of purchasing raw materials and supplies, turning out finished products, selling the products, and waiting for payments to be made. If the original estimates of working capital are insufficient, some emergency measures must be resorted to or the business will come to a dead stop.
The losses and expenses of development are generally underestimated. Every new organization must be in part an experiment. Men will be employed who are unsuited for their positions; methods of production and of sale will be tried that must be discarded; machinery will be installed that proves worthless; advertisements and sales booklets will be written that do harm rather than good. If the enterprise is basically sound, all these expensive losses may properly be charged as a part of the initial expense of getting the business on its feet. The experience of generations has proved that mistakes of this kind are unavoidable and they should be provided for in the original estimates of capital expenditures.
These remarks apply - though with somewhat less force - to the planning of extensions and betterments for which fresh capital is raised. It is an every-day occurrence for a manufacturer to plan to put up a new building and install new machinery that will increase his capacity, let us say, 50%, and to overlook entirely the necessity for a corresponding 50% increase in his working capital. Also, he frequently overlooks the probability of experiments and losses in construction of the plant and in developing the sales and administrative organization which will take care of the increased output.