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14 Feb 2019
Cash Is King is recognised as a key fundamental, whether you are setting up a business or have been trading for many years.
When cashflow is not managed, even very profitable businesses can easily fail.
The challenge for either new or established businesses is to calculate what investment the business needs to operate. For new businesses, this includes funds to buy initial equipment and perhaps stock etc. This might be funded from a mix of personal resources and the bank.
It is important to remember that most businesses don’t make sales immediately on start-up, that initial income can be minimal. However, staff need paying, as well as rent, rates, power, and fuel - all before getting that first treasured customer.
Funds for stock and operating expenses are referred to as working capital and it is important to have enough funds to pay these bills.
All too often we see business operators under-estimate working capital requirements, with those businesses struggling from day one and finding it hard to recover – akin to starting a 100m race 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 – referred to as the “breakeven position”.
For a business with predominantly fixed costs the calculation is very simple. Add the total costs for the month and divide it by the number of working days e.g. if your average monthly costs are, say, $22,000 and there are 22 working days in the month, then you need to generate $1000 per day income.
Remember, we are dealing with cash transactions, so you need to include loan repayments to the bank and IRD payments. You should also include the cash you need to withdraw from the business to pay personal costs, such as mortgage and grocery bills.
For retailers or wholesalers, it is slightly trickier - they must take account of the purchase cost of 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 $5000 of product to make a gross profit of $1000 to cover your costs.
If you know your daily breakeven number, then you can monitor it daily and quickly spot potential problems - and act as appropriate.
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. Your breakeven point can be tailored to take account of this.
If you notice that you are struggling to cover costs, don’t bury your head in the sand. Deal with the situation early before it becomes a bigger problem.
A simple spreadsheet which calculates your breakeven position is available on our website www.pkffa.co.nz – under Publications (use the search box). As reputable chartered accountants, we can help - ask the right questions, analyse the problem, offer solutions and help deal with your bank.
For more information on how we can help your business, get in touch