The Bumps in the Road

For many start ups, the beginning can be a bit like living hand to mouth, and the financial bumps in the road caused by bad clients, poor cash flow etc, can be quite a challenge. If the challenges did become too much, you might find yourself considering Insolvency and in need of advice from an Insolvency Practitioner but I wanted this article to look at how to manage common financial issues (the big and the small) in the first months/years of a new start up business to avoid letting the bumps get the best of you.

Starting a business is a major life step change. There are many early financial challenges that need management and planning. Approach and execute these in a systematic way.

Planning

Planning a new business venture is fundamental to its success. Financial planning involves budgeting and putting required finances in place.

Budgeting involves estimating revenues and expenses for the business monthly, usually for its first three years. You need to be confident that the business will generate a profit after all costs, and enough profit to give you an income that you can live on.

You next need to extend that into a cash flow forecast which anticipates the bank receipts and payments monthly. This will indicate the finance requirements of the business, which will include monies you can invest in it at the start, and external finance such as a bank overdraft facility. If adequate finances are not available to fund the cash flow forecast, then the project is not viable. This could lead you to look at other potential sources of finance (such as crowd funding) revisiting the budget to cut its scale; or abandoning the project completely.

The final step is to test the model for risk. What is the effect on profitability and/or cash flow if: sales are 10% less than expected; stock purchase prices rise unexpectedly; or bank interest rates increase? You then need to consider strategies for these events, and look at ways of mitigating the risk. For example if the risk of a customer going bust before they pay you would devastate the business cash position to the stage where it would itself run out of money, then appropriate mitigation might be improved credit vetting procedures and taking out bad debts insurance.

Most new businesses fail because they run out of cash. As a general rule longer life assets (plant and vehicles) should be financed by long term finance (hire purchase or bank loan.) Other working capital cash requirements should be funded by cash introduced personally and/or bank overdraft. Be wary of introducing funding yourself that you have had to borrow personally (e.g. credit cards or home equity loans.) If the business fails then you are going to have to live with the consequences for years after.

Check with your accountant or tax helpline whether or not you need to register for VAT or PAYE. If you are liable to do so and do not do so then there are financial penalties and back-dated recoveries. With many businesses such as eBay traders, VAT registration can dramatically affect the profitability, and it may well be worth restricting the business sales to below the registration thresholds.

Recording

It is necessary to record the businesses actually performance to comply with tax legislation and also to see how actual results compare against your budgets so that you have early warning of potential problems and can act on them. There are a lot of time demands on the entrepreneur, and it is easy to under-resource bookkeeping and reporting at the price of say marketing activity. Follow certain rules to make the process simpler and more accurate.

Choose a simple bookkeeping system that is not over-sophisticated for the nature of what you are doing. Solicit external bookkeeping help if accounting matters are complicated or there are a large number of transactions.

All business expenses need to be recorded, otherwise a false picture of profitability is given. Many costs are incurred between having the business idea and achieving the first sale (e.g.: professional fees; marketing; company formation; visits to suppliers.) These are all business expenses and should be recorded as such. Similarly when the business starts you might use a personal asset (e.g. a laptop) for business use; use your own car; or dedicate part of your house for a business office. These costs should be apportioned and recorded.

Open a separate business bank account. All business transactions should go through it. Draw your salary to live on as one monthly amount. Don’t take out varying small amounts of money as personally needed. Don’t put any other personal expenses through the business account, and don’t pay business expenses through your personal bank account or credit card.

Prepare monthly accounts and don’t rely on the bank balance as a measure of success. Some of these bank funds may be PAYE or VAT and don’t belong to the business.

Consider using relevant tax elections available to reduce the administrative burden on small business (e.g. Annual PAYE; and the Flat-rate, Annual Accounting, and Cash Accounting VAT schemes.)

Monitoring

So we have a plan, and when we start trading a monthly record of how well we have done against that plan.

Act on any large negative variances, for example if sales fall below budget the need for greater advertising spend may be indicated. If things do not move to correct themselves in future months more dramatic action may be required: get a part-time job to supplement business income; or cut the size of the workforce.

On the other hand if things are going better than planned, don’t immediately take out a cash bonus for yourself. Recognize that individual monthly figures can be distorted, for example by seasonal trading. Rewarding yourself for good performance is better done after one year’s trading; in discussion with your accountant; and in consideration of the tax effects.

Business start-ups have a high failure rate. Some of these will be poor business ideas which were not viable in the first place. Much the larger number will fail because the entrepreneurs have neglected the financial planning recording and monitoring of their businesses. So to take steps to avoid that unpleasant winding up petition, begin with systematic approach to monitoring, then you can minimize the risk of failure, and reduce its effects if it does happen.