Running a small business: Cashflow planning is the vital key

WADE GLASS and GARETH HOOLE continue their series on how to start up and run your own business.



"In all things success is dependent on prior preparation"
- Abraham Lincoln

You have made the decision to follow your entrepreneurial instincts and venture out on your own; now there are some tough calls to make.

You have an idea of what the core business of your venture will be, what type of business you want and you will have decided on its legal form and ownership structure.

No one goes into a business intending it to fail, but the statistics reveal that about 75 per cent of new startup ventures in New Zealand do not last more than three years.

A large number of these businesses are undercapitalised from the start. Many fail and close, others experience difficulties and are swallowed by larger competitors.

Generally, most will survive the first year unless they are hopelessly undercapitalised from the outset or grossly mismanaged. Failure usually happens when the initial enthusiasm wears thin, the novelty value disappears, the bright, innovative ideas dry up and there is no more money to inject into the business.

Apart from poor management, the single biggest contributor to failure is poor cashflow planning and administration. Always remember the adage "Cash is king',' and if you are to succeed in your venture, get some solid planning done before you open your doors.

Do not let lack of planning be the downfall of your fledgling business, plan ahead.

Often new-business owners will have mortgaged their homes to provide capital for a new venture, so the implications of poor planning may be profound.

You would never think of undertaking a long journey without an idea of where you were going and how you were going to get there. Similarly, every business needs a plan which will act as a roadmap to success.

Your business plan should address, in detail, the four main business resource categories: strategy, products and marketing, human resources and finance.

It should ask probing questions along the way and provide succinct answers, focusing on the following: What is the business, what are the products and services and what is definition of the core business.

Are there barriers to entry - for instance, strong competitors who may reduce their prices and cause your new business to struggle?

Where are its target markets? Who will buy those products or services and how will you deliver them? What is the route to market?

Where will you source your supply from? Are the underlying raw materials and inputs required for the product or service freely available?

Who do you need to help you in delivering those products? Assessing the human resource need, do you need full or part-time staff and what is the prospect of outsourcing?

How will the product be marketed? Your plan needs to address in detail how your entrepreneurial ideas will convert to dollars in the bank.

Is the business a financially viable prospect? Will this business make enough money to warrant the efforts and risks associated with it? Will it provide enough return on the investment it requires to justify making that investment?

The business plan should contain carefully prepared budgets and forecasts which address both the revenue and expenditure aspects thoroughly. Too often businesses budget their expenses down to the last dollar and pay lip service to budgeting their revenue and, more importantly their cashflows.

A good financial forecast will consist of a budgeted profit and loss statement for the next 12 months, together with a budgeted balance sheet and forecast of cashflows, indicating how much cash will be received in each month, weighed up against the cash requirements of the business.

Many a business has failed despite being profitable by being unable to generate sufficient cash to meet its obligations as they fell due.

A properly prepared financial model will indicate the overall viability of the business, revealing the likely return on investment at the end of each month.

There are numerous models followed by accountants in determining this all-important data and the budding entrepreneur would be well advised to seek professional assistance in preparing this part of the business plan.

An important exercise you will need to perform is a break-even analysis. This will tell you the sales you must generate to cover all your fixed and variable costs. Any sales above this level will result in a profit.

Fixed expenses are those which remain the same to a large extent, despite the level of sales. Rent is a fixed expense because the cost of renting your premises will not change with fluctuations in the level of products sold or services you provide.

Variable expenses change in relation to sales. For instance, as the sales of a restaurant increase, the costs of food supplies increase to provide ingredients for the extra meals sold. Break-even point is determined by using a formula and making a variety of assumptions.

Your chartered accountant can assist in this regard and you will then be in a stronger position to assess the commercial viability of your planned venture.

By going into business for yourself, you will be facing risks not associated with paid employment. These are many and varied and the riskier the business, the more it will need to generate by way of return to justify taking those risks.

Consider what a risk-free investment will return to you. For example, opening a fixed-deposit account with a major bank. That is the starting point for determining your required rate of return.

Your required rate of return is expressed as a percentage, and represents the amount of return your business will need to generate to justify the extra risk you have undertaken with a business venture.

If you can earn 5 per cent on the bank deposit with little risk, then you will require a much greater return than this to entice you to enter any business venture.

As the risk of any venture increases, so will your required rate of return. You should perform a risk assessment for your business, addressing each of the risks that you will face.

For example, the risk of loss of supply, the risks of non-acceptance of your product, the risk that you will not achieve the required market penetration and thus not meet the break-even point.

Attribute points for each of those risks and then translate that into a required rate of return. The next step is to weigh up the likely cost of capital (to be dealt with in more detail in a future article) and assess whether the business is worth the risks and efforts.

If your answer is yes, then you will have justification to proceed down your chosen path of self-employment.

Another very useful chapter of your business plan is a "SWOT analysis", where you assess the Strengths, Weaknesses, Opportunities and Threats your new venture will face. Again, ask the probing questions and find the answers that will assist you in defining your strategy forward.

An example of a strength might be that the product or service is a guaranteed winner, while a weakness might be the entrepreneur's lack of specific experience.

An opportunity might be the lack of competition and an untapped market, while a threat could be low barriers to entry for potential competitors (in other words, Joe Competitor can set up shop doing the same thing you are doing, without too much hassle).

This might all seem like a daunting task but it is a very exciting opportunity for you to commit your ideas to paper, to perform a detailed analysis of those ideas and to emerge with a roadmap to success.

One final word on business planning: once you have drawn up the plan keep it alive and continually address it, making amendments as you go.

A business plan which has been committed to the bottom drawer is not worth the paper it's written on.

* Wade Glass (assistant manager) and Gareth Hoole (associate director) are chartered accountants in the Corporate Recovery Services unit of Staples Rodway, Auckland. The views expressed are their own and not necessarily those of Staples Rodway.

TOMORROW

The capital requirements of a new business and how they should be addressed.

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