Start at the bottom to see realities
Received wisdom says that you should hand wash your car from the top to bottom. You start by rinsing your car and loosening off the dirt. Then you get a sponge, dip it into a bucket of warm water containing that special car shampoo and start to wash the top of the car and work your way down. The problem with this method is that at the end of the whole process you can see where you missed with the sponge by the scattering of dirty patches around the car. It’s infuriating.
Much the best way to hand wash your car is to start washing it from the bottom to the top of the car. You can see exactly where you have washed or not and you don’t get fooled by by your soap suds dripping over patches of dirty bodywork making them look as though you have cleaned them. It seems odd and I have had occasional mocking rebukes from friends saying I am talking rubbish. But it works.
So, what the heck has this got to do with cash flow?
Anyone who has ever run a business will know that cash flow is one of the most important aspects of financial planning to get right to enable your business to survive. Get your cash flow wrong and your business dies. You might have orders in the pipeline, purchase orders and sales coming in. But, if the cash is not coming in and cash is going out faster than it comes in then a business that looks profitable on paper will go bust quickly. (If you want an example of a near miss for a business that could have gone bust then read my earlier article about a small business I know that could have easily gone bust).
When you put together a cash flow forecast on a spreadsheet, received wisdom will, generally, tell you to start at the top of the spreadsheet with your sales and other income each month for the first year. You might even forecast your sales or the first few months on week by week basis . Then you are told to write out your variable costs (those costs which increase depending on the number of sales of your product or service that you sell) into the cash flow forecast for each month. And, then you add in your fixed costs for each month such as your rent, broadband costs, and salaries, for example.
At the bottom of the spreadsheet, using some simple formulas, you subtract your fixed and variable costs for each month from your monthly forecasted sales income. This then gives you a figure of how much cash will come in and out of your business bank account each month. It shows you how much money you need to fund your business at the start-up stage. It is likely that your cash flow will show that more money will go out in the first few months of your business than will come in. This is very important to understand.
But it is wrong.
By starting at the top with your sales income, you start the whole process of building your cash flow forecast on a false premise. A fantasy. Forecasting your sales income is the most difficult thing to do and starting at the top of the spreadsheet is a massive mistake. You will fall into the trap of entering sales income figures which look right rather than those that are possible. And when you finish putting together your cash flow forecast, you sit back and feel good because your spreadsheet shows that you have a great business idea which is going to make you lots of profits. You start your business full of cheer and six months later you wonder what happened to your great business idea as it collapses around you.
You can avoid this trap. You avoid it by putting together a cash flow forecast from the bottom up in the spreadsheet. Costs to your business are definite. Sales income is a ghost at this stage. You can find out exactly how much everything will cost you down to the last penny. Find a sense of interest and intrigue in discovering your costs to your business each month that others will find baffling. Because finding certainty in your costs is the only sure thing which you can do for your business finances at this stage.
When you have done this and used your simple formulas to work out your fixed costs and the costs you will incur when you do sell a product, which will be your variable costs, you can begin to work out what you need to sell and when you need the cash to come in to cover your costs. When you know this, you can work out how you will get your sales. This is sales strategy. You can research your potential customers. You can ask them if they would buy your product. You can work out if your product or service is too expensive or too cheap. You can work out what else you will need to do to sell and market your product or service.
When you know these highly important details, you will know whether your business idea is not just a good idea but something which you will be able to sell profitably. You will save yourself a lot of trouble and money too.
And why should you believe me? Because I started a business with a cash flow forecast at the top of the spreadsheet and completely overestimated how much I could sell and underestimated when the cash would come in. The business went bust. It was painful but it taught me the right way to plan a business and its cash flow forecast.
So, when you are next planning to start a business and you are planning your cash flow, take a few moments out and hand wash your car. But do it from the bottom to the top. You won’t miss anything then and you will see that the received wisdom of hand washing cars the other way round is wrong. And then go back inside and do the same with your cash flow forecast.
Tags:
bankers,
business,
car wash,
cash-flow,
credit crunch,
Finance,
marketing,
sales,
small business,
strategy
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