Show me the money
In the third of our four part series on cash flow, we look at what to do if you need more cash in your business and working out how much cash you need.
You may need an injection of capital if your cash flow dries up, if you are planning to expand or to help you survive a seasonal downturn. When you decide which finance option is right for your business, you need to ask yourself:
- Is the timing of your cash flow seasonal or are your sales relatively consistent?
- What plans do you have for your business? Are you thinking of expansion?
- Is your business a high or low risk operation when talking about cash flow?
- Are you prepared to share the ownership of your company?
Now you can start to think about what sort of financial solution would most suits your business.
There are two major options, debt financing – borrowing that involves repayment in cash, and equity finance – selling a stake in your business.
Finance option | Money required for | Timing | Features |
| Debt financing |  |  |  |
| Bank overdrafts | Daily trading or short term financial shortfalls. | Short | Operates as a line of credit attached to your existing cheque facility. Interest usually calculated on a daily basis. |
| Commercial bills | Seasonal funding needs. | Short | Usually cheaper than a fully drawn advance or an overdraft facility |
| Debtor finance or 'factoring' | For high-growth companies. | Short | Firm buys debt of a business for a percentage of their face value. The loan is repaid when the debtor pays the invoice. |
| Term loans | Useful when trying to structure loan repayments to correspond with income produced from equipment purchased or sales of new products. | Medium | Loan is paid back over an agreed period with principal and interest usually paid off in monthly instalments. |
| Personal loans | Can be used when it's not possible to source a business loan. | Medium | Can be contributed as equity or a loan to the business. |
| Leasing | Commonly used when purchasing motor vehicles and plant and equipment. | Medium | Leased asset owned by financier who leases it to you for a regular rental payment. |
| Long term finance | Fund assets which contribute to profit over a number of years, e.g. land, buildings or the business itself. | Long | Provides a funding mechanism to acquire large or substantial assets |
| Equity finance |  |  |  |
| Business angels or 'private investor financiers | For businesses seeking funds up to $500,000 and who are happy to receive managerial input. | Medium | Private investors provide finance in return for equity, but also offer management experience and expertise. |
| Venture capital | Investment for high-risk situations. Usually for unlisted businesses. | Medium - Long | Venture capital managed funds invest in businesses that offer higher expected rates of return than more traditional asset situations. |
| Pooled development funds | Investment for new equity in SMEs with total assets of less than $50 million. | Medium | Private companies regulated by the Pooled Development Fund Registration Board. They become part owners of the business. |
The impact of growth on cash flow
Growth will generally impact your cash flow and, in most cases, it will have a negative impact in the short term. It's not uncommon for a business to run out of cash when it is growing.
As you grow a number of things are likely to happen: - You need more stock;
- You have more debtors;
- Perhaps you need larger premises; or
- You have to employ more staff.
All of this means the money is going out before it comes back in through your increased sales. In fact, you can be growing and making more profits but seemingly in a worse cash position. Often this can provide mixed messages to both you and the people your business deals with.
So if you are planning to grow, here are a few tips: 1. Calculate what extra costs you will incur in order to grow
2. Work out how much extra money will be tied up in your debtors and stock
3. Complete a new cash flow projection and see if you have enough money, including a reasonable buffer level
4. If you don't have enough cash, make the necessary arrangements before you head down the growth path
5. Keep a very close eye on your budgets and cash flow during a growth period. This means you should be reviewing them at least a monthly.
How much cash does my business need?
A great question and a very important one. Unfortunately there is no one answer that is right for everyone.
The amount of cash your business needs will be depend on a range of factors such as: - Its size
- Rate of growth
- The amount of working capital required
- The actual infrastructure of the business – things like plant & equipment, vehicles etc.
You can generally break down your capital needs into two broad categories – your start up capital and your working capital. Most businesses are readily able to identify their start up capital requirements although it is easy to overlook something.
Work through this checklist to see if you have captured all your likely start up requirements.
Start up capital requirements:
- Setting up your business structure (partnership, company, trust etc.)
- Plant and equipment
- Vehicles
- Initial rent and security bond on premises
- Office/shop/factory fit out
- Connection fees and security deposits for telephone, electricity and gas
- Insurances and workers compensation
- Licences and registrations
- Professional advisers fees
- Initial stock holding
- Printing and stationery
- Signage
These represent some of the typical costs you will incur before you open for business.
And then there is your working capital. Working capital is the money you need to run your business. It is the amount of cash required to cover your operating expenses and to smooth out the time periods involved in collecting money from your sales, paying your suppliers and carrying the levels of stock required at different times of the year.
Again, the amount of working capital required will vary from business to business. If you carry debtors and stock then typically you will need more working capital than a service business that requires little or no stock and sells everything for cash.
You can estimate your working capital requirements by:
- Knowing, on average, how long your customers will take to pay you
- Calculating how much stock you need to carry
- Calculating your monthly operating expenses
A lot of businesses get into trouble because they don't have enough working capital. It's a good idea to try and leave yourself with a buffer. It will help to overcome any surprises in your cash flow cycle.
And remember, when you are calculating your monthly expenses don't forget about how much money you need to pay yourself and meet your tax liabilities. These are easy to overlook, particularly your tax payments. Forget about these, and you will find yourself in trouble fairly quickly.
