When considering your start-up’s initial cash requirements, take note of how much everything costs because even small expenses can quickly add up and wreak havoc on your budget. To prevent your fledgling business from collapsing, Shatha Al Maskiry, managing director at Protiviti, a business consulting firm, advises entrepreneurs to allocate their funds wisely.
“Make sure there's a legitimate business reason for everything that you buy or spend money on, especially in the initial years, when cash is still tight,” she said. “In computing your initial cash requirement, factor all the start-up and operating costs for the next 12 months, at least.”
How to estimate initial cash requirements
Al Maskiry suggests a simple formula to determine how much you will need to get your start-up off the ground:
- List all spending on assets – Assets are the things you need to do your business. These varies depending on your start-up. If you’re running an online grocery delivery service, for example, you may need vehicles, refrigerators to keep goods fresh, computers with Internet access, and sufficient inventory levels to meet customers’ needs.
- List all spending on expenses – An expense is the cost incurred in running your business. These may include employee salaries, licensing fees, rent (for example, a warehouse where you can stock your inventory), insurance, utilities, and marketing.
- Add the costs of your starting assets and starting expenses – This will give you an idea of your initial cash requirement, which you can compare against your anticipated income. If your costs exceed your expected revenue, you may have to re-think your business plan and come up with ways to reduce costs or generate more income.
How to make a cash flow forecast
In addition to knowing your start-up costs, it would also serve you well to maintain a monthly cash flow forecast, preferably covering a three-year period, according to Alyson Baynes, director at Deloitte Corporate Finance Limited.
“Many business owners make the mistake of purely looking at sales and costs – how much will we be able to sell, what revenues will we generate, what is our cost of sales,” she said. “However, it is not profit, which underpins a company’s success, but the ability to generate cash and sustain cash flow.”
Making a cash flow forecast is somewhat similar to calculating start-up costs, but it is more detailed and it shines light on your company’s month-on-month liquidity position.
“In constructing the cash flow forecast, the SME owner needs to identify all the monthly cash inflows and outflows related to the business,” Baynes explained. “It is important to remember the focus here is cash – i.e. not when the sale is made, but when the cash is collected, and similarly not when the cost will be incurred but when the supplier is actually being paid.”
She added that only when a business is looked at from a cash-inflow-and-outflow perspective would it be possible to determine whether it is viable and how much upfront funding is required to carry it through to self-sufficiency.
To determine your cash inflows and outflows, Baynes gives the following examples:
- Cash inflows – These include customer receipts or payment for goods or services. Based on the sales profile, determine when the cash will be received (the sales date and any credit terms extended to the customer). And based on the timing of these cash flows, determine whether it will be necessary to request an upfront deposit and/or part payment to help ensure a more regular inflow of cash.
- Cash outflows – These include:
- Employee costs – Wage and salary payments
- Operating costs – Overheads such as utilities, rent and trade license, distribution costs and professional fees
- Capital expenditure – Plant and machinery, vehicles, office furniture and IT equipment
- Purchase of supplies and inventory – When purchasing supplies, the cost may only pass through your income statement when the goods are sold. However, from a cash perspective, the cash outflow happens at the point the supplier is paid.
- Debt servicing – Meeting interest payments and principal repayments is important to prevent going into default, which can have dire consequences for the business if the lender enforces their rights.
- Owner drawings – As a business owner, this is the amount you obtain from the company each month to finance your cost of living.
Baynes said that having identified and recorded all cash inflows and outflows, the aggregate in each month is the net monthly cash flow. So in months where the cash flow is negative – cash inflows such as customer receipts are insufficient to cover all cash outflows – funding is required to fill the gap.
“As unpalatable as the outcome may be, cash does not lie and whilst the SME owners may hope for the best, they must also adequately plan for the worst,” she concluded.
© Zawya SME 2021