Finding the Money

 

Finding the Money

Setting up a business requires money – there is no getting away from that.  You have bills such as rent to pay, materials and equipment to purchase, and all before any income is received. Starting a business on the road to success involves ensuring that you have sufficient money to survive until the point where income continually exceeds expenditure.

Raising this initial money and the subsequent financial management of the business is therefore vital, and great care should be taken over it. Unfortunately, more businesses fail due to lack of sufficient day-to-day cash and financial management than for any other reason. This chapter helps you avoid common pitfalls and helps you find the right type of money for your business.

Assessing How Much Money You Need

You should work out from the outset how much money you will need to get your business off the ground. If your proposed venture needs more cash than you feel comfortable either putting up yourself or raising from others, then the sooner you know the better. Then you can start to revise your plans. The steps that lead to an accurate estimate of your financial needs start with the sales forecast, which you do as part of feasibility testing, detailed in Starting a Business For Dummies (Wiley), along with advice on estimating costs for initial expenditures such as retail or production space, equipment, staff, and so on.  Forecasting cash flow is the most reliable way to estimate the amount of money a business needs on a day-to-day basis.

Do’s and don’ts for making a cash flow forecast:

_ Do ensure your projections are believable. This means you need to show how your sales will be achieved.

_ Do base projections on facts, not conjecture.

_ Do describe the main assumptions that underpin your projections.  _ Do explain what the effect of these assumptions not happening to plan could be. For example, if your projections are based on recruiting three salespeople by month three, what would happen if you could only find two suitable people by that date?

_ Don’t use data to support projections without saying where it came from.  _ Don’t forget to allow for seasonal factors. At certain times of the year, most businesses are influenced by regular events. Sales of ice-cream are lower in winter than in summer, sales of toys peak in the lead up to Christmas, and business-to-business sales dip in the summer and Christmas holiday periods. So rather than taking your projected annual sales figure and dividing by twelve to get a monthly figure, you need to consider what effect seasonal factors might have.

_ Don’t ignore economic factors such as an expanding (or shrinking) economy, rising (or falling) interest rates and an unemployment rate that is so low that it may influence your ability to recruit at the wage rate you would like to pay.

_ Don’t make projections without showing the specific actions that will get those results.

_ Don’t forget to get someone else to check your figures out – you may be blind to your own mistakes but someone else is more likely to spot the mistakes/flaws in your projections.

Projecting receipts

Receipts from sales come in different ways, depending on the range of products and services on offer. And aside from money coming in from paying customers, the business owner may, and in many cases almost certainly will put in cash of their own. However not all the money will necessarily go in at the outset; you could budget so that £10,000 goes in at the start, followed by sums of £5,000 in months four, seven, and ten respectively.  There could be other sources of outside finance, say from a bank or investor, but these are best left out at this stage. In fact the point of the cash flow projection, as well as showing how much money the business needs, is to reveal the likely shortfall after the owner has put in what they can to the business and the customers have paid up.

You should total up the projected receipts for each month and for the year as a whole. You would be well advised to carry out this process using a spreadsheet program, which will save you the problems caused by faulty maths.  A sale made in one month may not result in any cash coming into the business bank account until the following month, if you are reasonably lucky, or much later if you are not.

Estimating expenses

Some expenses, such as rent, rates, and vehicle and equipment leases, you pay monthly. Others bills such as telephone, utilities, and bank charges come in quarterly.

If you haven’t yet had to pay utilities, for example, you put in your best guesstimate of how much you’ll spend and when. Marketing, promotion, travel, subsistence, and stationery are good examples of expenses you may have to estimate. You know you will have costs in these areas, but they may not be all that accurate as projections.

After you’ve been trading for a while, you can get a much a better handle on the true costs likely to be incurred.

Total up the payments for each month and for the year as a whole.

Working out the closing cash balances

This is crunch time when the real sums reveal the amount of money your great new business needs to get it off the ground. Working through the cash flow projections allows you to see exactly how much cash you have in hand, or in the bank, at the end of each month, or how much cash you need to raise. This is the closing cash balance for the month. It is also the opening cash balance for the following month as that is the position you are carrying forward.

The accounting convention is to show payments out and negative sums in brackets, rather than with minus signs in front.

Testing your assumptions

There is little that disturbs a financier more than a firm that has to go back cap-in-hand for more finance too soon after raising money, especially if the reason should have been seen and allowed for at the outset.  So in making projections you have to be ready for likely pitfalls and be prepared for the unexpected events that will knock your cash flow off target.  Forecasts and projections rarely go to plan, but the most common pitfalls can be anticipated and to some extent allowed for.

You can’t really protect yourself against freak disasters or unforeseen delays, which can hit large and small businesses alike. But some events are more likely than others to affect your cash flow, and it is against these that you need to guard by careful planning. Not all of the events listed here may be relevant to your business, but some, perhaps many, will at some stage be factors that could push you off course.

Getting the numbers wrong

It’s called estimating for a reason. You can’t know ahead of time how the future will pan out, so you have to guess, and sometimes you guess wrong.

Some of the wrong guesses you can make about stock and costs are:

_ A flawed estimate: There is no doubt that forecasting sales are difficult.

The numbers of things that can and will go awry are many and varied.  In the first place, the entire premise on which the forecast is based may be flawed. Estimating the number of people who may come into a restaurant as passing trade, who will order from a catalog mailing, or what proportion of Internet site hits will turn into paying customers, depends on performance ratios. For example, a direct mailshot to a well-targeted list could produce anything from 0.5–3 percent response. If you build your sales forecast using the higher figure and actually achieve the lower figure then your sales income could be barely a sixth of the figure in your cash flow projection. You can’t avoid this problem, but you can allow for it by testing to destruction (see elsewhere in this checklist).  _ Carrying too much stock: If your sales projections are too high, you will experience the double whammy of having less cash coming in and more going out than shown in your forecast. That is because in all probability you will have bought in supplies to meet anticipated demand. Your suppliers offering discounts for bulk purchases may have exacerbated the situation if you took up their offers.

_ Missed or wrong cost: You may underestimate or completely leave out certain costs due to your inexperience. Business insurance and legal expenses are too often missed items. Even where a cost is not missed altogether it may be understated. So, for example, if you are including the cost of taking out a patent in your financing plan, it is safer to take it from the supplier’s Web site rather than from a friend who took out a patent a few years ago.  _ Testing to destruction: Even events that have not been anticipated can be allowed for when estimating financing needs. ‘What if’ analysis using a cash flow spreadsheet will allow you to identify worst-case scenarios that could knock you off-course. After this, you will end up with a realistic estimate of the financing requirements of the business or project.  _ Late deliveries: If your suppliers deliver late, you may, in turn, find you have nothing to sell. Apart from causing ill will with your customers, you may have to wait weeks or months for another opportunity to supply.  This problem can be minimized using online order tracking systems if your suppliers have them, but some late deliveries will occur. Increasing your stocks is one way to ensure against deficiencies in the supply chain, but that strategy to has an adverse impact on cash flow.

Settling on sales

Sales may be slow, pricing may be high – just two of the ways sales can make your projections look silly. More ways follow:

_ Slower than expected sales: Even if your forecasting premise is right, or nearly so, customers may take longer to make up their minds than you expect. A forecast may include an assumption that people will order within two weeks of receiving your mail-order catalog. But until you start trading you will not know how accurate that assumption is likely to be. Even if you have been in business for years, buying patterns may change.

_ Not being able to sell at list price: Selling price is an important factor in

estimating the amount of cash coming into a business and hence the amount of finance needed.

Often the only way a new or small business can win certain customers is by matching a competitor’s price. This may not be the price in your list, but it is the one you have to sell it.

Also, the mix of products or services you actually sell may be very different from your projection and this can affect average prices. For example, a restaurant owner has to forecast what wines his or her customers will buy. If the house wine is too good, then more customers might go for that rather than the more expensive and more profitable wines on the list.  _ Suppliers won’t give credit: Few suppliers are keen to give small and particularly new businesses any credit. So before you build in 30, 60, or even 90 days’ credit into your financial projections, you need to confirm that normal terms of trade will apply to what a supplier may view as an abnormal customer.

You need to remember that whilst taking extended credit may help your cash flow in the short term, it could sour relationships in the long term.  So in circumstances where a product is in short supply poor payers will be last on the list to get deliveries and the problems identified above may be further exacerbated.

Miscounting customers

Customers can confound your most well-thought-out projections. They pay late, they may rip you off, and they may not buy your goods as quickly as you’d like. Some of the ways customers can be to blame for throwing your estimates off are:

_ Paying slowly: Whilst you set the terms and conditions under which you plan to do business, customers are a law unto themselves. If they can take extra credit they will. Unless you are in a cash-only business, you can expect a proportion of your customers to be late payers. Whilst with good systems you will keep this to an acceptable figure, you will never get every bill paid on time. You need to allow for this lag in your cash flow projections.

_ Bad debts: Unfortunately late payers are not the only problem. Some customers never pay. Businesses fail each year and individuals go bankrupt, each leaving behind a trail of unpaid bills. You can take some steps to minimize this risk, but you can’t eliminate the risk. You can try to get a feel for the rate of non-payment in your sector and allow for it in your plans. For example, the building and restaurant industries have a relatively high incidence of bad debts, whilst business services have a lower rate.  _ Fraud and theft: Retailers claim they could knock 5 percent off everything they sell if they could eliminate theft. But despite their best endeavors with security guards and cameras, theft continues.

_ Repeat orders take longer to come in than expected: It is hard to know

exactly what a customer’s demand for your product or service is. The initial order may last them months, weeks, or days. For strategic reasons, they may want to divide up their business between a number of suppliers.  If, for example, they have three suppliers and they order a month’s worth at a time, it may be some time before they order from you again. If your customer sales are sluggish or seasonal, then that timeframe could extend further still. So even delighted customers may not come back for quite some time.