According to PKF, poor cash flow management is the only guaranteed recipe for disaster – or at the very least, for not optimising the full potential of any business. In the face of increased competition and rising rental prices in key retail locations, cash flow management could make a difference to the very survival of any franchised operation. Following are some of the most common traps many first-time franchisees will experience. Their inclusion is designed to help you learn from the common mistakes of others, rather than from your own – something that could eventually save you time, energy and, equally important, your business.
1. Underestimating startup costs. Legal fees, accounting fees, stamp duty, security bonds and local area advertising – just for starters – can all add up to a tidy sum and, if they haven’t been accounted for at the onset, can result in a shaky start.
2. Overestimating the income stream of a greenfield site. Textbook cash flow projection generally projects significant income from day one although, in reality, that just doesn’t happen. Consumer awareness needs to grow. People need to know that your business has started up in their area. Trust needs to be built. Word of mouth needs to kick in and this doesn’t happen in only a day or two. You need to be realistic as to how long it will take for your business to register on people’s radar.
3. Omitting or underestimating capital expenditure and capital repayments. Don’t forget to count the cost of the shop fit out. And when did you last hear of any building work that has come in under budget? Never, I’ll bet. Don’t take chances – overestimate building costs, don’t underestimate. Then there is signage, Yellow pages commitments, and small start-up sundry equipment like an electrical kettle or microwave oven. Upfront costs of a car, including delivery, registration and insurance, also need to be recognised as you are still up for these costs even if the car is leased. And I’ve yet to meet the financier who didn’t want capital repaid, so the chances of getting an ‘interest only’ loan are slim at best.
4. Bad debts and debtor collections. Invariably, optimistic business owners expect that all debtors will behave like themselves and pay on time, and that bad debts do not occur. Not so. Industry averages differ, but many businesses budget for a 60-day collection on debtors – despite only offering them 14-day terms. New business owners don’t anticipate this. Another fact of like is that one in every two new businesses fail within six months, and one or some of those businesses could be your customers. Their failure will invariably affect your cash flow – initially by slow payments, in the interim by requiring you to engage collection agents or lawyers to chase the debt (never budgeted for), and finally, by forcing you to write the debt off.
And while we’re on the topic, never let any one debtor account for more than 10 per cent of your business – too many eggs in the one basket. They will either realise the strength of their position and start hammering you on price (because they can) or, worse still, their failure could severely effect your position.
5. Tax payments, including spending the GST on stock. If you make a profit, you will pay tax – maybe not in the first year, but certainly in the second. Pay As You Go (PAYG), the group tax withholding amount, needs to be paid regularly, as does GST, and both should be budgeted for.
While spending GST payments is not something that is usually budgeted for, it is something that happens. Don’t fall into the trap of buying more stock with your GST payments because you think you can make a 30 per cent gross profit and still sell the stock before the GST is due.
Often, you won’t, and when the taxman calls, you’re still carrying the stock. Even if you’ve made the sale, the collection of the debt may take another 60 days, so don’t be caught short by spending the GST money that must be passed on to the Australian Taxation Office (ATO).
6. Underestimating interest rates. Despite bank documentation clearly spelling out penalty rates, some new business owners review their financier’s documentation with rose-coloured glasses that only see the lowest benchmark rate.
Unfortunately, the ‘this couldn’t happen to me’ attitude results in more new businesses, than not, ending up in a default situation with the bank. The borrowing cost can be half as much
again if breaches occur, and while you don’t want the budget to be in default, there should be a built-in buffer.
7. Underestimating salaries. New business owners, in their enthusiasm to justify the viability of their business, often underestimate their own needs. A personal budget is a must. Most anticipate the obvious, such as rent or house payments, school fees and car costs, but the cost of food is usually light on and food prices are always are on the rise. Often also overlooked are the costs for school holidays, Christmas and birthday gifts, clothes, medical, and so on. Budget realistically by taking into account all your costs.
8. Failing the volumes test. Most businesses operate on a price for their goods or services that is fixed by what the market is willing to bear. The owner then budgets on the volume of business that he/she can attract or handle. From mobile mechanics to white goods servicers to dog washers – the problem is the same. In theory, they think they can do 10 service calls a day. In practice, it may only be four.
You must factor in traveling time. Unless all your customers, in one geographic area, want to buy from you on that day (and this is highly unlikely), this can be significant. Some jobs will run overtime or will not line up nicely one after another. This means your numbers won’t stack up, unless you are working into the night or working every day of the week, every week of the year. Many cash flows don’t allow for things like annual leave to recharge the batteries, sicknesses, inclement weather either stopping you working (for example, a mowing business) or slowing your travel to each job, time off for repairs to the vehicle and public holidays.
9. Initial stock investment is too low. A fashion shop looks empty, unless a full range of garments is available in all sizes and colours. Human nature dictates that we do not return to shops that carry a small range, but ‘will get it in for you’. The same can be said for a wine merchant, a jeweller, or any other business where customers are looking for choice.
10. Competition drives prices down. Many business owners believe that their product is better than the rest – better ice cream, a more flavoursome donut, better fingernail servicing, nicer surroundings – and deserves to be sold at a premium. But the fact is whatever you are doing well the competition will copy quickly and, even if they don’t, volume shoppers are price, rather than value-sensitive. They don’t see the value equation. If you are selling at a premium, then expect fewer more discerning customers. You can’t mass sell on value.
Read about buying a franchise and running a franchise.
26-May-2006