Posts Tagged cash flow
I often see bankers trying to lure small business owners into letting them help manage their cash flows. Although managing cash flows is critical for the small business owner, I question the value of going to a banker for help. In my experience, many bankers only have banking experience and little other tangible business experience. Banks concern themselves with cash flows mainly to ensure customers produce enough funds to pay the bank back. Is this approach enough to create enough cash to run your business?
Banks do not provide services without some form of compensation and may charge fees for managing cash flows. Banks often have no understanding of your business and what it takes to increase cash because all they understand is that you must sell more without understanding the tactics it takes to make more sales. Many times banks simply focus on cutting costs without considering new ways to raise revenues. Is this the approach you need?
My advice to the small business owner is to look at your own cash flows daily. Looking at your own cash flows will help understand where to increase revenues and where to cut costs. The business owner is the person who needs to decide how to increase cash and how to cut it not some outside party with little experience in your business. A business owner can look at the environment in which the company works and do some scanning to see what best fits the company’s model.
A company that does need help should employ a coach or an analyst to help design a procedure for the owner to make his own daily evaluation of cash flows. A coach or an analyst can also help the small business owner asked the right questions about what to add to improve revenues and what to cut to decrease costs. Experience and education are key ingredients in deciding what revenues to improve and what costs to cut. A good consultant is worth his or her weight in gold in helping the small business understand how to produce enough cash flows to keep a profitable business.
In my view, a good coach or consultant is there to guide you and help you develop the experience you need to make intelligent cash flow decisions. Yes a good coach or consultant comes with a cost, but the cost pays for itself because the small business owner benefits from learning how to manage his or her own cash flow. Do you want to learn more? Do you think you can get the same service from your banker?
Entrepreneurs do not spend too much time planning, but often consider opportunities arising from uncertain conditions as they deal with original ideas. As new opportunities come into focus original ideas can garner new value not considered when the entrepreneur acted on an original opportunity.
Larger companies use net present value, internal rate of return, payback period, and many other sophisticated methods to evaluate cash streams from capital investments. Often these companies do not consider the “real options.” Capital budgeting involves understanding time value of money and probability analysis, which many entrepreneurs may not have learned about. The idea involves evaluating projects like a game of chance using the time value of money and probability analysis.
For example, the idea is similar to a card game in a casino and playing the odds. The player finding the project with the best odds usually wins. The concept of “real options” evaluates cash flow using net present value and the odds for each alternative to decide if the project has future value. If the expected value in a project turns negative the player can cut bait to minimize losses. On the other hand, continued investing may give the player an option to chase a project with a dubious future value.
Sometimes early losses can reverse and turn profitable. Without committing to an investment in a project, the entrepreneur may not see any prospect for net present value turning positive and not invest in the project. Thus the entrepreneur may find a project is worth investing in because the chances are good the net cash streams will turn positive sometime in the future.
“Real options” offer the entrepreneur a call option to help decide when to cut bait or to continue with a project. Without a sense of what lies ahead the entrepreneur may overlook good projects and exit too soon leaving the prize for someone else to discover.
What alternatives do you consider when deciding to invest in projects for your business?
The biggest problem I hear most entrepreneurs have in starting their business is how to raise the funds they need. The truth is 91% of entrepreneurs start their businesses by using debt, while only 7% use their own equity (Lam, 2010). This statistic is almost perfectly correlated with the failure rate. The high failure rate associated with the use of debt is no coincidence.
Many small business consultants offer services to develop a business plan to find financing. I suggest avoiding borrowing as much as you can. Bankers and other lenders are not your friend, but the enemy. Entrepreneurs pay dearly on borrowed money leading to high failure rates. How do you expect to earn a return high enough to cover the double-digit cost of capital when first starting out?
I find finances work better for a small business entrepreneur who can manage his or her own finances. An entrepreneur can control his or her own destiny by following this simple advice. Bootstrapping will set you free and make you independent of the loan sharks. What is bootstrapping? Quite simply, bootstrapping is “using other people’s money.” Moreover, bootstrapping is a continuing course of action, not a onetime affair. A savvy entrepreneur will learn how to use bootstrapping to lessen the need to borrow (Lam, 2010).
Some ways an entrepreneur can use bootstrapping include working out of your house, leasing rather than buying equipment, buying second-hand equipment, taking advantage of trade credit, hiring inexpensive labor, and employing family members in the business. An entrepreneur can also develop a savings club to raise capital for start-up (Lam, 2010). Using these techniques avoids the need for external financing and reduces the financing gap. A good entrepreneur balances the cost of funding with the returns the business can earn. A good entrepreneur manages the gap between immediate demand and the firm’s funding needs.
By using bootstrapping the small business entrepreneur shows the ability to manage capital in an efficient way. The small business entrepreneur does not need to give up control to find external financing and can highlight his or her management ability. Bootstrapping shows the small business entrepreneur has the ability to manage relations with others including family, customers, supply-chain partners, banks, and suppliers.
The small business entrepreneur who employs this strategy shows financiers the ability to manage capital so these financiers are more likely to want to offer external financing. The best time to find financing is when the business least needs it. Showing this ability allows the small business entrepreneur to find external financing at more desirable rates without sacrificing ownership and control.
Please let me know why you need financing to start your business by leaving a comment. Do you want to learn more about how to attract financing to your business using this proven forumula?
Lam, W. (2010). Funding gap, what funding gap? Financial bootstrapping: Supply, demand and creation of entrepreneurial finance. International Journal of Entrepreneurial Behaviour & Research, 16(4), 268-295. doi: 10.1108/13552551011054480
I had a conversation with a friend of mine the other day about what sets apart a person who wants to start a new business. My friend told a story about someone who wanted to start a new business, but did not know where to turn to formalize a business plan. This person went to one of the big accounting firms in town just to get some ideas. The firm prepared a beautiful business plan and handed him a $20,000 bill for its services.
This business founder read the plan and did not understand a word of it. Frustrated, this person went back to my friend and asked him what he should do. My friend advised him not to pay the bill. My friend said if the business founder could not understand the plan it has no value. Why pay for a business plan having little or no value?
The moral of the story is if you want to build a business plan one of the most important steps you need to take is to internalize it. If you do not own the plan what value is it? Successful business founders must live and die by the plans they create. The founder must understand the plan like the back of his or her hand. If not, the plan has little value.
I encourage people to do their own research before embarking on a new venture. Certainly, I can help lead a person in the right direction, but at the end of the day the business plan belongs to the founder. How many times have you seen someone who cannot express their plan in an elevator pitch? Chances are such people have not internalized their plans. Learn more.
Small business entrepreneurs can improve the likelihood of succeeding through experience and education. Many universities have programs for small business and some have entrepreneurship programs. Most of these programs cater to traditional students and are part of a traditional setting. Ask yourself if this sounds like the type of setting that allows you to pursue opportunities or does it stymie your efforts to build the business you are passionate about.
A small business entrepreneur learns more efficiently and effectively on the job, while pursuing his or her passion. Entrepreneurs do their best work trying new things and learning from what they try. A business school can talk about experimenting with ideas, but the ideas get lost or someone else pursues them before the student has an opportunity to act on them.
Entrepreneurs have more likelihood of succeeding by developing a network of experts they can rely on for areas outside their expertise. Ask yourself how an entrepreneur can network in a traditional college setting and find the needed experts he or she can rely on. The best way to find the needed expertise is to experience building business relationships on the job.
The small business owner wears many hats and can easily spread him or herself too thin. What is the best use of your time? What can you farm out to someone in your network so you can continue working on what is most important in developing opportunities?
Do you have a guide at your side? Do you have a coach and a mentor you can rely on? What do you want to get off your shoulders? Contact http://www.apgacademyofentrepreneurship.com/ for a free consultation.
I theorize that innovation works best in a small firm because different goals exist than in the larger firm. Some justification exists in the literature supporting this theory. Large firms place improving shareholder value through stock price appreciation ahead of discovery of innovative solutions (Crochetiere, 2011). Corporate managers concern themselves with shareholder wealth enhancement and emphasize short-term profitability.
Founders of small innovative firms put products and services first ahead of profitability. Steve Jobs offers a good example with his obsession to create computers for students. Job’s passion put product ahead of profits (Deutschman, 2000). Jobs exited from Apple when the company put the focus on shareholder wealth instead of perfecting the product (Levy, 2011).
Small business owners starting a company should consider their goal. A founder should consider if the motivation is to cash out or extinguish a burning fire to solve a problem with a new product or innovative service. A firm that opts for the latter should avoid acquisition by larger firms and keep it simple.
Crochetiere (2011) found evidence suggesting large firms produce fewer patents and innovations than smaller firms. Larger firms not only produce fewer patents, but lose stakeholders and their acquisitions result in greater variability in stock prices.
What is the goal for innovation in your business? If you need help planning your strategy click here!
Crochetiere, B. (2011). Transcending technological innovation: The impact of acquisitions on entrepreneurial technical organizations. (D.B.A. 3482298), Walden University, United States — Minnesota. Retrieved from http://search.proquest.com/docview/909085620?accountid=35812 ProQuest Dissertations & Theses (PQDT) database.
Deutschman, A. (2000). The second coming of Steve Jobs. New York, NY: Random House.
Levy, S. (2011). The revolution according to Steve Jobs. Wired. Retrieved from http://www.wired.com/magazine/2011/11/ff_stevejobs/all/1
Often people who want to start a small business immediately think of going to the bank for a loan. Unfortunately, the bank is not the best place to start. A business founder should consider informal financing sources and trade credit first. Studies have shown that informal financing improves a firms efficiency and performance because it improves return on assets. Informal sources of finance and trade credit can relieve cash flow anxiety and improve a private firm’s ability to reinvest net income (Su & Sun, 2011).
Bank financing increases cash flow tensions and takes the focus off growth and achieving efficiency. New firms also find less access to more formal sources of financing such as angel investors and venture capitalists. Su and Sun (2011) explained “informal financing and trade credit are the life-blood of private firms” (p. 398). In countries like China interest rates on informal sources of finance are not subject to regulation, and financing is not rationed by imposing higher interest rates. More relaxed relationships with informal lenders promotes competitive advantage.
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Su, J., & Sun, Y. (2011). Informal finance, trade credit and private firm performance. Nankai Business Review International, 2(4), 383-400. doi: 10.1108/20408741111178816