When I was a pink-cheeked 16-year-old, I learnt my most important lesson in business: that cash is king.
My friend and I cut our teeth as entrepreneurs at school when we secured a supplier agreement with a sports supplement company to buy products at wholesale price to sell to our buddies.
We attended the UK’s leading sports school, so the demand was high and within a week we’d sold our stock and reordered our second batch three times the size of the first. I applied a discriminatory pricing tactic that later made me unpopular by setting the price depending on how rich their fathers were. My business studies teacher one day used my business as a case study, and when the class revealed I was making a 450 per cent markup I had some serious explaining to do.
With huge profit margins and a captured market we felt we had more money than Bill Gates, although one day we were left unable to pay our supplier, which pulled the handbrake on our business and neither of us had the wisdom to understand why.
So how does a profitable business have a cash flow problem? I’ve since learnt that profit and cash are two very different things, and while a lack in profit can eat away at your business like a slow cancer, a cash flow shortage will hit you like a heart attack.
With cash flow management if you fail to plan, then you’re planning to fail and what is worse is you won’t see it coming either.
So how do you make a plan? Well it’s important if you’re a new business to firstly project when you are likely to start breaking even on a monthly basis. At this point you stop taking cash from reserves and start paying from income. Once you are at this point, your expenditure will need to be aligned with your income. However, before you reach this point it’s vital that you start by creating a cash budget. To do this I first start with a simple time plan and strategy for setting up my business, as my cash flow payments will need to be scheduled in unison with this.
I then list every tiny expense I can by researching the prices and making calls to potential suppliers to get quotes. My aim is to get my expenses within 5 per cent accuracy and then add 10 per cent of the expenses as a contingency. What is key is to look at the timing of payments, as often there are grace periods or payment plans that breakdown the payments. You need to schedule these accordingly and include not just all expenses but all capital expenditure on assets, as these are also coming from your cash pool.
The next step is to project when you will start to make sales, how many you will make and at what average ticket price. This is the most subjective part of the process as none of us has a crystal ball, so as a rule of thumb, be conservative and allow more time than you expect and smaller number of sales to begin with. You will probably find that even when you are conservative that you wildly over-predict your success in the early stages, as often these things take time to grow.
Now you have a budget, it’s time to put your plan to work. You now have an itemised spending list for each month, so think of this like a things-to-do list because if you don’t spend this on schedule then you are delaying the project. One common mistake entrepreneurs make is to hoard cash and wait until the last moment before spending as they are overcautious. This stunts your business growth and if you’ve planned accordingly and ensured the cash reserves meet your outflow, then you must spend on schedule.
The most important part of any cash flow management is what you call your “buffer” or simply your cash reserve. Once you have started to break even on a monthly basis, you should always ensure that at minimum you have your next three months’ expenses in cash in your account. This will ensure that your expenses are always covered for a few months if your revenue drops and also leaves some for the inevitable unforeseen costs.
If I applied the above principals to my business venture at school, I would have avoided our cash flow problem. Thankfully we got through and continued to do well for two years. With more money than we knew what to do with, by the age of 18 I’d learnt another valuable lesson; that when you are cash- rich you need to resist the temptations that come with having money.
Paris Norriss is an entrepreneur and partner in Coba Education, which provides educators to schools and institutes