Many entrepreneurs and small business owners have great business ideas and this is reflected in their products and services. These great business ideas are mostly sound but lack one very important element of good business strategy — Cash Flow. Many businesses fail not because their ideas are flawed but they just could not maintain their Cash Flow well.
Any good business plan must provide you with a reasonable forecast (or estimation) of the breakeven point. Even it may take time before breakeven point can be met you should at least ensure that you have available cash on hand to sustain the business throughout its life. Cash Flow must be maintained at a comfortable level at all times. By comfortable, I mean it should be at least more than 2 to 3 months of your total expenses and sales costs.
If you are coming from a finance background, this is definitely nothing new to you but if you are not, then here are some simple steps that you can take in order to start managing your Cash Flow with your business plan:
- Set a period of 24 months as your scope of planning. If you can not breakeven within 24 months, I would recommend you to really reconsider whether you want to proceed with the business idea.
- Forecast your monthly regular expenses with enough headroom for all unforeseeable items. You may just include an item called “Miscellaneous” if you do not have a clue for the time being.
- Forecast your monthly sales with a progressive growth rate. You need to be extremely conservative in order to ensure you are not over promising yourself the sales revenue before you have real data to support these forecasts. You can always revise it up and evaluate when the plan seems to be working or after running the business for a period of time. One thing to note is that even you have sales orders in each month; you may only receive payment after 30 days (or more) depending on credit terms you give to your customers. Accounts Payables always tests a company’s finances.
- Forecast your monthly sales cost in relation to the forecast sales. You have to bear in mind that sometimes higher sales volume means you have to increase labor; so labor costs or salaries have to rise proportionately.
- Calculate monthly profit (or loss) by totaling up sales and subtract expenses and sales costs. You will instantly see on which month you start making profits. The initial months will mostly be negative figures (i.e. losses) until total sales are higher than the sum of expenses and sales costs (including cost of goods).
After doing the above steps, you now can probably answer the most important question before you start any new business. That is, how much cash or capital should you invest in order keeping your business running until profit starts to build up? It is a relatively simple calculation as you just need to add all your losses in the initial months together plus two to three months of regular expenses (and sales costs) to make up the total capital required for your new business investment.
For example, you estimate it will take eight months before you can make a profit from your new business and the total loss is $700,000 during this period. You also calculate your monthly expenses and sales costs to total $100,000. Then your minimum cash required to invest at the beginning should be no less than $700,000 + ($100,000 x 3) or $1,000,000.
It may sound very simple but as others will tell you, business is very dynamic and no two companies will experience exactly the same conditions. What is certain though is that dynamics of the market are the same and so be prepared for uncertainties. Still, it is extremely useful to do such exercise in order to have a quick reality check of your business idea. This is the very reason why I did not start up my business early in the process as I could not shorten the loss period to minimize my investment risk!
I have prepared a sample of cash flow template and it can be downloaded from this link here: http://www.adamshk.com/download/SampleCashFlow.xls. You may have to adjust the key items to reflect the nature of your business but it should be intuitive enough to show you the idea.
Enjoy and be mindful with your Cash Flow!