Experience has shown that many small business owners lack an understanding of basic accounting principles. Knowing the fundamentals will help entrepreneurs better manage cash flow. In fact, poor management can be a predicator for business failure and for many new entrepreneurs; especially those without a financial background, cash management can be considered a major stumbling block. To be competitive, small business owners must prepare for all future events and market changes. One of the most important aspects of such preparation is cash flow planning. Failure to properly plan cash flow is one of the leading causes for small business failures.
Cash flow refers to the movement of cash into and out of a business. Monitoring the cash inflows and outflows is one of the most pressing management tasks for any business. The outflow of cash includes checks for salaries, suppliers, and creditors. The inflow includes cash receive from customers, lenders, and investors. If cash inflow exceeds the outflow, a company has a positive cash flow. A positive cash flow is a good sign of financial health, but is by no means the only one. If cash outflow exceeds the inflow, a company has a negative cash flow. Reasons for negative cash flow include too much or obsolete inventory and poor collections on accounts receivable.
Cash flow analysis can let you know if inflows and outflows from your operation combine to result in a positive cash flow or in a net drain. An understanding of cash flow will lead to better control of your cash flows and will allow adequate time to plan and prepare for the growth of your business. It is important to note that it is best to have enough cash on hand each month to pay the cash obligations. A monthly cash-flow projection helps to identify and eliminate deficiencies or surpluses in cash and to compare actual figures to past months. When cash-flow deficiencies are found, business financial plans must be altered to provide more cash. When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested. The objective is to develop a plan that will provide a well-balanced cash flow.
The Components of Cash Flow
Operating Cash Flow Operating cash flow (working capital) is the cash flow generated from internal operations. It comes from sales of the product or service of your business.
Investing Cash Flow Investing cash flow is generated internally from non-operating activities. This includes investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or other sources and uses of cash outside of normal operations.
Financing Cash Flow Financing cash flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock, and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.
Good cash management involves:
1. Knowing when, where, and how your cash needs will occur
2. Knowing the best sources for meeting additional cash needs
3. Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors
The starting point for good cash flow management is developing a cash flow projection. It is important to develop both short-term cash flow projections to help manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help develop the necessary capital strategy to meet the business’ needs. It is also necessary to prepare and use historical cash flow statements to understand how the business used money in the past.
Planning a Positive Cash Flow
Businesses can increase cash reserves in a number of ways:
• Collecting receivables: Actively managing accounts receivable and quickly collecting overdue accounts.
• Tightening credit requirements: As credit and terms become more stringent, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing uncorrectable accounts.
• Adjusting the price of products: Many small businesses fail to make a profit because they erroneously price their products or services. Pricing is the critical element in achieving a profit and maintaining positive cash flow. Before setting your prices, you must understand your product's market, distribution costs and competition.
• Taking out short-term loans: Loans from various financial institutions are often necessary for covering cash-flow problems. Revolving credit lines and equity loans are common types of credit used in this situation.
• Increasing your sales: Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Therefore it becomes critical to collect outstanding accounts quickly.
• Managing your expenses: Watch your expenses carefully. However, beware of penalties for late payment and the potential impact on your credit rating. You should monitor your expenses to make certain they are necessary and reasonable in amount.
Wednesday, June 30, 2010
Bootstrap Your Way into Business
Bootstrapping can be defined as “a collection of methods used to minimize the amount of outside debt and equity financing needed from banks and investors”. While bootstrapping involves a risk for the founders, the absence of any other stakeholder gives the founders more freedom to develop the company. In essence, bbootstrapping is getting a lot done on very little cash. For most start-ups, bootstrapping is an essential first stage because it:
• Demonstrates the entrepreneur's commitment and determination.
• Keeps the company focused.
• Allows the business concept to mature more into a product or service.
• Gives the concept a chance to be investigated by the market.
Bootstrapping means behaving very smartly at every cost point, given there is no external investment in the business. It means entrepreneurs consume business essentials only and are constantly looking for innovative means to substitute costs out of operations. It means resourcefulness. Bootstrapping can be beneficial because if the business fails to take off as planned, it is less painful to exit as the cash burn rate will have been low, so there are no significant losers. However, if the business takes off the rewards are not dispersed to third parties.
Bootstrapping Ideas
• Cash from savings.
• Borrowing against assets, such as your home.
• The careful use of selected credit cards.
• Keeping your day job, while starting the business in off-hours.
• Living off your spouse's wages while starting the company.
• Doing consulting work to provide start-up cash for the business and for living expenses.
• Rushing an early product to market to provide for early revenues and earnings.
• Running extremely frugal operations, allowing the company to grow on internally generated cash earned on the sales of products.
These are some tactics to stretch your bootstrapped cash runway:
• Lease or borrow the equipment you need to acquire new, such as computers.
• Buy fixed assets such as furniture used.
• Go as long as possible without paying yourself.
• Compensate advisers and consultants with equity, good will, and in-kind services.
• Call in past favors and rely on personal relationships to get things done for free.
• Use lawyers and accountants to help you with judgment issues, not basic education issues.
• Be frugal everywhere-drive instead of flying, choose cheap hotels, and use your personal computer and printer.
• Spend money on marketing only if you must.
Continue bootstrapping as long as possible, but know when it's time to seek investors.
Dangers of bootstrapping
While certain aspects of bootstrapping are clearly useful, it is important not to overstep the line. There needs to be some reasonable amount of cash available. Excessive thrift can be counterproductive and can send out the wrong signals to staff, customers and prospects alike. The objective is not to become compulsive in managing the costs or to expect a company to successfully develop on nothing. As always it is a question of balance. You do not want to lose credibility by being noticeably focused on bootstrapping, but you do want to manage your cash position to move the company forward.
Summary
Bootstrapping is an increasingly popular way to start a business, regardless of the economic conditions. Once the idea you are bootstrapping gains traction and revenue begins to increase, you may then need to switch out of bootstrapping mode. At this point it may be appropriate to seek external funding from the likes of VCs. However once you have proven the concept, the risk for investors reduces a little and hence you should capture more of the upside as you need to give away less equity. In short, the aim of bootstrapping is to keep a low cost base to ensure you can gain a foothold in some market and to generate a sufficient return so you can then assess how best to proceed.
• Demonstrates the entrepreneur's commitment and determination.
• Keeps the company focused.
• Allows the business concept to mature more into a product or service.
• Gives the concept a chance to be investigated by the market.
Bootstrapping means behaving very smartly at every cost point, given there is no external investment in the business. It means entrepreneurs consume business essentials only and are constantly looking for innovative means to substitute costs out of operations. It means resourcefulness. Bootstrapping can be beneficial because if the business fails to take off as planned, it is less painful to exit as the cash burn rate will have been low, so there are no significant losers. However, if the business takes off the rewards are not dispersed to third parties.
Bootstrapping Ideas
• Cash from savings.
• Borrowing against assets, such as your home.
• The careful use of selected credit cards.
• Keeping your day job, while starting the business in off-hours.
• Living off your spouse's wages while starting the company.
• Doing consulting work to provide start-up cash for the business and for living expenses.
• Rushing an early product to market to provide for early revenues and earnings.
• Running extremely frugal operations, allowing the company to grow on internally generated cash earned on the sales of products.
These are some tactics to stretch your bootstrapped cash runway:
• Lease or borrow the equipment you need to acquire new, such as computers.
• Buy fixed assets such as furniture used.
• Go as long as possible without paying yourself.
• Compensate advisers and consultants with equity, good will, and in-kind services.
• Call in past favors and rely on personal relationships to get things done for free.
• Use lawyers and accountants to help you with judgment issues, not basic education issues.
• Be frugal everywhere-drive instead of flying, choose cheap hotels, and use your personal computer and printer.
• Spend money on marketing only if you must.
Continue bootstrapping as long as possible, but know when it's time to seek investors.
Dangers of bootstrapping
While certain aspects of bootstrapping are clearly useful, it is important not to overstep the line. There needs to be some reasonable amount of cash available. Excessive thrift can be counterproductive and can send out the wrong signals to staff, customers and prospects alike. The objective is not to become compulsive in managing the costs or to expect a company to successfully develop on nothing. As always it is a question of balance. You do not want to lose credibility by being noticeably focused on bootstrapping, but you do want to manage your cash position to move the company forward.
Summary
Bootstrapping is an increasingly popular way to start a business, regardless of the economic conditions. Once the idea you are bootstrapping gains traction and revenue begins to increase, you may then need to switch out of bootstrapping mode. At this point it may be appropriate to seek external funding from the likes of VCs. However once you have proven the concept, the risk for investors reduces a little and hence you should capture more of the upside as you need to give away less equity. In short, the aim of bootstrapping is to keep a low cost base to ensure you can gain a foothold in some market and to generate a sufficient return so you can then assess how best to proceed.
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