Garage Entrepreneurs

by garage Tags: business development, business works, Cash, cash demands, Cash Flow, decisions, Entrepreneur, finance growth, lifeblood, Startup, success survival, Survival, website developer

Jun. 10^th 2009

Whether you realize it or not, cash is the lifeblood of your business. During the ‘prove it’ stage having no cash could be a godsend. Having little cash forces you to make tough decisions, and really think about how you spend every dollar. However, you must also ensure that you have enough money to cover the cash demands of the start-up phase: Can you pay your website developer on time? Can you repair your lawnmower to continue providing your lawn care services?

The next stage of business development is critical to your success: survival. At this point you’ve proven that your business works and that you have enough customers to keep providing your product/service – the key problem now shifts to the relationship between the money that you take in (revenues) and the money that you put out (expenses). Here you need to generate enough revenues to cover your expenses and finance growth (buying new equipment, hiring new employees).

Here is a critical lesson for entrepreneurs: A company can go bankrupt even if it is profitable. How? Allow me to explain.

Imagine for a moment that you operate a sheet metal company. Your company takes raw materials, flattens them into sheet metal, and ships them out to auto manufacturers. Picture a pile of raw steel that you’ve paid $15,000 for. You take the metal and flatten it into sheet metal, then ship it out to the auto manufacturer at a sale price of $25,000. Often times, customers don’t pay right away and in this instance the auto manufacturer says they’re going to pay you the $25,000 in 60 days. At the same time, you have to pay $5,000 in wages tomorrow and pay for another $15,000 load of steel to start making the next order. You’ve put out $15,000 today, and will be putting out another $20,000 tomorrow but you won’t be getting paid for another 59 days! You’ve got some issues.

In this example, your metal supplier may want payment before they drop off the delivery or they could refuse to supply you-and if you can’t pay for materials you won’t have any products to sell. In addition, if you can’t pay your employees they could quit and then you’ve got even bigger issues!

In order to survive even in the most simple business, you need to understand what your cash INFLOWS are. There are only three basic sources of cash in a typical business:

1. Your customers
2. People who loan you money
3. You (the owner).

You need to rely on these sources to survive so treat them with care. So, how can you improve the cash flow in a business?

Shorten Collections Period: In the above example, negotiate with your customer to reduce the 60-day payable period. Give a slight discount if they pay you in under 15 days and it could motivate them to pay faster.

Extend Payables Period: Negotiate with your suppliers to extend the period of time in which they want to get paid. Ideally you want to match your collections period (time that you get paid) with your payables period (time that you pay).

Raise Prices: Although this could lead to decreased sales, sometimes a slight price increase can create some extra cashflow for your business.

Reduce Costs: Are you paying yourself or an employee too much? Can you switch to basic internet instead of premium? Where can you cut some corners and operate your business more profitably?

Approach the Bank to Finance Shortfall: Sometimes a bank (or a friend) will lend you money to finance the gap between what you have coming in and what you need to pay out. Approaching a bank is a big step and requires quite a bit of preparation (to be provided in a later post).

To keep track of all this information, try creating a simple cash budget showing the following:

• A schedule of the expected timing of your cash coming in (sales made, sale of assets, loans)
• A schedule of priorities for paying debts (paying wages, purchase of new equipment, loan payments)
• Also try to factor in a bit of a cushion for unexpected changes in circumstances (drop in sales, etc.)

Remember that this budget will not be entirely accurate, and is not immune from changing circumstances; it is an ongoing process. When changes occur, revise the budget to determine the impact on your business.

Here are some more common mistakes that entrepreneurs make which strain cash flow:

1. Producing too much inventory to keep per unit costs low – If you started a design company, don’t purchase 50,000 blank business cards when you only need 5,000 just because the unit cost is lower.
2. Extending too much credit to risky customers – When you cut your Uncle Jim’s lawn, don’t tell him that he can pay you whenever he wants if he hasn’t paid you for the last five lawn cuttings.
3. Growing too fast without planning for increases in cash requirements – Like in the steel example above, realize that if you grow quickly, you’re going to have to put out a lot of money in order to make a lot of money. Plan for that GAP in what you make vs. what you owe.
4. Over estimating demand in business – When budgeting, be conservative. Don’t guess that business is going to grow 500% over the next year; do a high/low scenario showing an optimistic/pessimistic outlook. Can you still cover your cash needs if you don’t hit sales growth targets?
5. Borrowing too much – Don’t get stuck financing the GAP too much. What if Aunt Lisa has loaned you $500 to start your business and suddenly she wants it back next week; will you be able to continue?

Some of these concepts can be hard to grasp initially but they are incredibly important – if you have further questions please ask.

Now that you can manage some of that cash, how can you grow your business? See our next post in the series on Entrepreneurial Marketing.

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