Cash Flow
Let’s talk about cash! Money, dinero, dollars, yen, euros, and on and on. What we mean by this is let’s discuss cash flow, and most important, for people starting their own businesses, how much money do you need to start your own business? As you can guess, my next words are going to be…it depends.
But what I can teach you is how to calculate that number. As an overview, if you want to start a clothing store, you will need money for a lease/rent/buying a store, merchandise, display cases, shelves for storage, salaries, etc. But you may not need all this money at once. As we discussed earlier about liabilities, a lease might be for 2 years. So if the lease payment is $1000 a month, the total liability is $24,000, but to start, you may only need a security deposit and the first month, then you can sell clothes to make money for the second month’s rent.
Different industries have different needs for stock, physical items, store locations, etc. A lawyer doesn’t need to have a large inventory and may be able to work from home. A baker might be able to maintain very little in the way of ingredients, knowing they can quickly get more supplies as needed. But if you are an antique dealer, you might need to have some expensive pieces on hand right from the start. And while this stock is all considered an asset, it still changes the amount of money you need at the start.
Fair warning, we will be using Excel and math in this post, so get ready. I love math and business modeling, but I understand that most folks are not fans. You are getting into business because you love what you do, not because Excel excites you. But we really can’t do without it. For this exercise, I will use a clothing shop as the model. I’ll talk about the inputs, describe how you build your model, show formulas, and in the end, I’ll attach the model to this post so you can review it. Feel free to copy, edit, change, share, or whatever with the model attached.
So let’s hop in. I’ll be using totally made up numbers so understand they are just a placeholder. The concept is what we need. Let’s start with all the things we need to open a clothing shop. We need clothing to sell, counters to put cash registers on, a cash register, hangers, and display racks. In the back of the store, in the storeroom, we need shelves to keep inventory. We also need to build our store, put walls where we want them, paint the walls, and put in flooring –, those kinds of things. We need a lease and maybe an employee in case we want a day off or to get lunch.
So let’s put together the list:
So we need $39,250 to start, right? Nope, of course, it is not that easy.
Now we need to build our model of what your cash flow looks like. Our salaries are every month, but the lease is all upfront, even though it isn’t paid upfront. For the sake of ease, let’s say we owe a security deposit equal to one month and the first month’s rent at the beginning. So now, we subtract $22,000 from our total, and we get $17,250 so we’re good to go now, right?
As my Australian friend says, “Yeah, no.” Which if you speak Australian you know mean no. (Why don’t they just say no?)
There are three big issues with what we have. First, we need to take into account the vast majority of our variable costs like electricity, water, trash, etc. Second, did we buy any of this on credit? See, starting cash doesn’t always need to be starting cash. Sometimes it makes sense to spread it out to lessen the initial impact. Third, and most importantly, most businesses need to grow into themselves. Very few businesses are profitable from day one, so what do you need to grow your business? Let’s do some advertising, promotions, and maybe a little extra time for you and your employee to work?
OK, so let’s start building our model. Let’s say you put your displays and register/computer/printer on payments so instead of $6,000 initially you get to make payments over 3 years. That means you pay about $167 a month for those. That eases step in day a bit. But we have lots to add. So let’s go.
OK, the first month may look something like this:
So this is the first month before we open the store, which means no income. So we need at least that to start with, but as we mentioned, very few businesses start off profitable. That means we have more pain coming our way. But the great part is, so far, all we’ve looked at is liabilities. We haven’t looked at the fun part which is the income. But I’m here to break some bad news. With income comes more expenses.
Let’s say we sell $3000 of clothing. Guess what? We need to replace that stock. So we will now have to buy stock as we sell it. But we are hopefully selling it for more than we are buying it for. So let’s say we average a 20% markup. So if we sell stock for $3000, we actually sell it for $3600. No we didn’t just make $600, but that contributes to reducing our spending if that makes sense.
In month one we had a bunch of one-time expenses like building and buying the storeroom shelves. But we have a lot of ongoing expenses like electricity, payments on the displays and technology, and now paying for restocking our inventory. But we are selling things, so now we are off. Let’s look at what the first two months look like.
So if we follow this through, in month one, we had no sales, and paid a bunch of upfront expenses, and we spent $10,967. In the second month, we didn’t have a few of those expenses, but we added a restocking expense, and we spent $7,717. But now we have income of $3,600 to offset some of that. So we still lost money, $4,117, for the month and if we add this to the money we paid out in month 1, we have a total loss of $15,083.
Now is when our model gets interesting. As we mentioned, we are advertising, so people know we are around; people who bought from us tell their friends, and word gets out, so sales increase. Let’s say we grow 20% a month. That means that now our sales have increased 20%, but our restocking expense also grows 20% a month. Let’s run 6 months, including our growth.
At the end of 6 months, our monthly expenses are $10, 937 and our income is $7,465. So we are still losing money every month but the amount we lose is less. But this is starting to be where we need to be. If we take the initial spend before we opened of $10,967 and add the loss from the six months we’ve been open, our total loss since inception is $30,085.
If we continue to run this out, we see that we don’t actually turn a monthly profit until 14 months in and then we only turn $633. You can download the Excel to see it; once it gets this large a picture doesn’t make sense anymore. Now, if we look at the total loss, we look for the low point, which came in the last month we turned a monthly loss; so in this case, month 13. The total loss there is $43,818. So this is the total funding we need to start our business. Basically think of it as the low point financially.
But this model can change. On the Excel you’ll see two green cells that you can change that will change the model. What if we change the profit margin from 20% to 40%? Then we make our first monthly profit in month 10 and our lowest financial point is only $28, 901 in month 9. What if we keep our 20% profit margin, but we grow at 30% a month? Then we coincidentally also turn our first monthly profit in month 10, but our low point financially is $34,385.
Besides knowing the low point financially, this also demonstrates other concepts, like having a higher profit margin is better than driving growth. You can also look at things like monthly sales and see if they make sense. In our original model, in month 14, when we turn profitable, our sales are $32,098 a month. If we break this down to days, that is a little over $1000 a day in sales. Think to yourself, does this seem reasonable? If so, great. If not, that doesn’t mean give up. That means maybe you need to change some more inputs.
I’ve also made salaries and lease editable (green). If we find a cheaper store, say one that is only $12,000 for a two-year lease, then our lease payment becomes $500. With our 20% growth and 20% profit margin, we are profitable in only 13 months, and our low point is $37,560. Or if we keep the original lease, but cut salaries to $2000 a month, we only have a $2 loss in month 12, turning our first profit in month 13 again, but our low point is $31,560.
So as you can see, modeling can be a powerful tool for not just understanding how much money you need, but to understand what are the key numbers that really drive the financials. One of these weeks I’ll show you how to create a tornado diagram that really calls out clearly what variables matter so you know where to focus your energy.
So since we talked about breaking, let’s talk about hammers, or as we often refer to them in my house as persuaders. We’ve talked before that everyone should own a 16 or 20 ounce hammer as just a general tool of getting things done. The hammer most of us know is the claw hammer. Very similar to this is a framing hammer, it is usually longer and has a texture to the face that sets it apart from a claw hammer, but unless you do a lot of framing, the claw hammer works just fine.
But there are other hammers as well. I also own and use, very often, my 3 lbs hammer. This is great for getting things moving. They can either resemble a very small sledge hammer or one side can be tapered. I have the tapered kind like this (northerntool.com/shop/tools/product_200344797_200344797). I work on a lot of older, crappy cars, and having a 3 lbs hammer can be helpful to get parts unstuck. I can use a breaker bar to take the nut off, but the two parts of the bolt still need to come out. A 3 lbs hammer is often helpful for this.
But that is for crappy car parts. What if you need to get two things together or separate but don’t want to mar them? Well, then you either need a rubber hammer or a dead blow hammer. A rubber hammer is just what you think it is. It’s a big mallet made of rubber so it doesn’t scratch or dent like a metal hammer does. A dead blow hammer is used when you don’t want the hammer to bounce and you want to distribute the impact. Here is a great comparison: thetoolsmag.com/dead-blow-hammer-vs-rubber-mallet. Some say 4 hammers is a lot, but the right tool for the right job is often the way to go. Plus, I have way more than just 4 hammers so I shouldn’t talk