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19 Jan 2017
During the holidays, many people take the time to reflect on their life and make plans for the future. There will be a number of people that have decided that they would like to work for themselves and set up a new business. Whether you are new to business or have been trading for many years, one of the key fundamentals is the same - Cash Is King.
You can have a very profitable business, but if cashflow is not managed, it can easily fail.
Whether setting up a new business, or managing an existing business, the first challenge is to calculate what investment the business requires to operate. You will need funds to buy initial equipment and perhaps stock etc. This might be funded from a mixture of your personal resources as well as the bank.
But it is important to remember that in most businesses you don’t make a sale immediately, and you don’t get paid at the same time.
You will typically be paying staff, rent, rates, power, fuel costs all before your first treasured customer pays you.
Therefore you have to make sure you have sufficient funds to pay these bills as well. The funds required for stock and operating expenses is referred to as working capital.
All too often we see business operators who under estimate their working capital requirements. This means that the business is struggling from day one, and will find it hard to recover. This is akin to staring a 100m race, but 10 metres behind everyone else.
Once you have injected enough funds into the business, it is important to maintain this position and ensure you are covering your costs. In technical jargon this is known as the “breakeven position”.
For a business with predominantly fixed costs the calculation is very simple. Add up the total costs for the month and divide it by the number of working days. So if your average monthly costs are say $22,000 and there are 22 working days in the month, then you need to generate income of $1,000 per day. Remember we are dealing with cash transactions, so you need to include the loan repayments to the bank and payments to the IRD. You should also include the cash you need to withdraw from the business to pay your own personal costs, such as the mortgage and grocery bill.
For say a retailer or wholesaler it is slightly trickier, as they have to take account of the purchase cost of the goods. However the principle is the same. Using the above example if you have a gross profit margin of 20%, you will need to sell $5,000 of product to make a gross profit of $1,000 to cover your costs.
If you know your daily breakeven number, you can then monitor it on a daily basis. You will be able to spot quickly whether a problem is arising, and take action as appropriate.
A copy of a simple spreadsheet which calculates your breakeven position is available on our website www.pkffa.co.nz
Of course, many businesses in the Far North are seasonal and therefore need to earn enough income over the busy months, to cover the leaner months. But your breakeven point can be tailored to take account of this.
If you notice that you are struggling to cover costs, speak early and do not bury your head in the sand.
If you deal with the situation early, it stops it from becoming a bigger problem. Keep your bank manager and accountant in the loop; they may be able to suggest some ideas as to how you can survive the winter.
For more information on how we can help your business, get in touch