One of the most frequent, and preventable, reasons that businesses stall is that they get the funding number wrong. It’s not difficult to see how. Revenues and costs are notoriously hard to predict. Systems and plant can break down, customers can suddenly defect to a competitor, and new ones can unexpectedly flood in.
Separate your spending before you set a number
The primary mistake most business owners make is assuming ‘funding’ is one bucket. It isn’t. There are two completely separate things, and never the twain should meet.
Capital expenditure (CapEx) is all the one-off stuff you need to buy – equipment, fit-out, vehicles, technology structure. It’s an asset that sits on your balance sheet, and in many cases, will have some value when you discard it. Operating expenses (OpEx) is everything else – the stuff you need to pay for to keep the lights on, the business running and the doors open. It’s ongoing, and it’s not an asset.
This matters because the way you should finance the two types of expenditure are almost polar opposites. Long-term secured loans to pay for monthly operating costs is a recipe for disaster. Short-term working capital to fund the purchase of something you’ll use for five years isn’t great either. Make a list of everything you need funded, and slot it into one of those two categories. Then, add it up.
Build a 12-month cash flow forecast, not a rough estimate
It’s a fact that a cash flow forecast lies at the heart of any serious financing calculation. This isn’t a sales estimate – it’s a detailed, month-by-month plan of the money you have coming in and the money you have going out, and the timing differences between the two.
One number many business owners overlook is days sales outstanding (DSO) – the number of days it takes customers to pay you. If you’re invoicing on 30-day terms but your DSO is 52, then for 22 days you’re financing operations from your own bank account. Multiply that by the monthly sales those invoices represent, and you’ll quickly see how much cash you need to cover this shortfall.
Infact, many small businesses that go under do so because of cash flow issues, not because they are unprofitable. The company perhaps wasn’t making a loss – it simply didn’t have enough cash when it needed it.
Calculate your burn rate and set a minimum runway
The amount of cash your business consumes before monthly revenue exceeds it is the burn rate. This is the number that really counts for a start-up or early-stage business.
Once you have your monthly burn rate, take that number in context with your beginning cash balance and planned new borrowings. This will give you the number of months you can operate (your “runway”) based on the current expectations. When comparing your options, looking at specialized Business Loans Brisbane products gives you access to lenders who understand local market conditions and can structure repayment terms around your specific cash flow cycles. Many entrepreneurs’ worst habit is that they will jump from “this new business is going to set the world on fire” expectations to “we are going broke and life as we know it is about to end” in a single month. If you’re closer to expecting the former, plan to take off two months to be conservative.
Add a contingency buffer – then stop second-guessing it
When you have a viable number from your CapEx listing, OpEx estimate, and runway tally, include an extra 15% to 20%. This isn’t because you’re certain to face a problem, but because you’re guaranteed to face something unexpected.
Inflation can alter the prices of your suppliers during a contract. Deliveries can take longer than anticipated. Rules can change. A part of machinery can break while being transported to your site. These occurrences aren’t uncommon, but the context of how they’ll occur is unknowable. The slack isn’t precautionary. It’s accuracy.
Evaluate what the debt actually costs
Understanding how much you have to borrow is the easy part. Working out what that borrowing is going to cost, and whether the outgoings associated with the credit are easily covered by the positive cash flows or returns generated, is the more complex issue.
But there are ways to simplify that too. For a start, always check the annual percentage rate (APR) across any product options you’re looking at. This can vary. For example, two loans of the same amount can have different APRs based on the loan term, but the same monthly repayment figure and total amount repayable. A lower APR is a simple step to lowering the cash cost of borrowing. Remember the assets and activities you’re funding will probably not change in cost, so any reduction in cost of funding goes straight to your bottom line.
Then look at your personal return on investment. If this is a business loan, as long as the borrowing doesn’t bring personal risks like your home into play, that means what are you going to make from the business relative to what you’re going to have to pay out on repaying the loan.
The number is only as good as the assumptions behind it
Ensuring you have the right funding amount is an ongoing assessment. When your forecast assumptions alter – whether it’s new deals, launch delays, or modified growth expectations – go back and reevaluate the amount of capital you need. The objective is to know exactly how much to ask for in a financing discussion with finances that back up your request, not just an estimated number because you’re feeling hopeful. This level of accuracy will help shield you from overborrowing, underborrowing, and borrowing unnecessarily.