No matter how strong your 30 Days to ETA business plan is or how well you grow your team (You can read the previous post by CLICKING HERE), if your business does not have enough in its cash reserve to survive the ups and downs of the economy, black swan events, or minor financial storms selling your soon to be acquired business in the future will be a non-issue. In order to secure outside funding or know how much money you need to personally bring to the closing table, you must know how to calculate how much of a cash reserve your business needs to have on hand to withstand hard times. So in this post we’ll explore ETA Financials & Cash Flow and how they fit in with your 30 Days to ETA execution… Enjoy!
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Business Owner Myth #1,001 – Easy Money and Big Spending
When I had my first company back in 1997, I had the vision of making easy money and big spending in mind (along with a lot of time off to go and pursue my golfing passion). The reality of this vision was something completely different — Long hours, extremely difficult to come by money, and I didn’t see a golf course for several years!
Maybe I was lucky. The entrepreneurs that seemed to be all around me were making significant money, and as their cash income increased so did their spending habits. Eventually, the economy changed and some of them fell on hard times. As their revenues decreased and expense structures stayed high, they soon ran into cash flow problems. Luck was not on their side after all.
The bigger the squirrel, the bigger the nut. You do want to be a big squirrel, right?Sam Palazzolo, Managing Director @ Tip of the Spear Ventures
Withstand the Economic Storms
A key, if not the key, to business survival, is to start with enough money to get through the tough times. To withstand the storms that will eventually come, we Entrepreneur Through Acquisition (ETA) business owners must build a company that has sustainability. In other words, we must have enough cash reserved to reach consistent profitability.
You may already be months or years into your business. In that case, your sustainability depends on your ability to squirrel away enough money during seasons of prosperity to survive the coming barren seasons. Inevitably, every business will face turbulent times. We Entrepreneur Through Acquisition (ETA) business owners have to build a business that can withstand the storms.
Without substantial resources to sustain profitability, businesses will most likely fail. But lack of cash can’t be the only reason companies fail. I’ve seen many clients begin a business with more cash capital than others will make in a lifetime. I’ve also seen those same clients go bankrupt and close their business doors.
What, then, causes businesses to fail? After doing my own extensive research, I there are ten top reasons small businesses fail, and you should be aware of them at the beginning of your Acquisition Entrepreneur journey.
10 Reasons Businesses Fail at ETA Financials & Cash Flow
- Product cost comes too close to its sale’s price.
- Owners’ stubbornness, perfectionism, or greed get in the way.
- Success happens too quickly for companies to keep up with demand.
- Owners with financial knowledge fail to oversee their accounts/owners without financial know-how try to handle their own accounts.
- Business does not have enough cash capital.
- The company fails to rise above mediocre customer service or product offering.
- Owners pay too much or too little for operational expenses like rent, equipment, and labor.
- Management fights amongst themselves or with employees.
- Owners don’t develop an exit plan.
- A company’s product or service becomes outdated or unnecessary in the current market.
While all ten reasons cause businesses to fail, I believe number 5 is the number one reason businesses go under. I find that many businesses simply don’t have enough cash reserves to weather storms that come.
Calculating Cash Reserves
That leads me to the next issue — Determining how much cash reserve will be enough to sustain us through the tough times.
In most circumstances, businesses can predict capital needed with a pro forma financial statement. The methodology within the hypothetical calculation applies to almost all types of businesses, so let’s go through this process together.
- Decide how long it will take your business to move from start-up to profitability. – Let’s say it will take us two years before we become profitable.
- Calculate anticipated recurring monthly, quarterly, and yearly expenses you will incur during that time frame. – Let’s assume we’ll spend $1,000,000 over that two year period.
- Conservatively estimate the gross income you will receive during that time frame. – Hypothetically, we’ll earn $800,000 within that time frame.
- Subtract the projected income from the predicted expenses to calculate the shortfall. – $1,000,00 minus $800,000 equals $200,000.
Our projected $200,000 shortfall is the bare-bones amount of cash reserve your business will need for sustainability, for survival amidst the forthcoming storms.
Don’t stop there, though. Notice that I said “bare-bones amount.” I like to add another 20% or 30% buffer into my projected business cash needs. Therefore, if my calculations tell me I need a $200,000 cash reserve, I might want to begin with $250,000 to safeguard myself against unforeseen circumstances.
Funding the Cash Reserve
By this point, you may be saying, “How in the world can I get this much money to start my business?” If you’re already in business, you may be wondering, “Do you honestly think I’m going to be able to save that ungodly amount of money when I’m barely getting by day-to-day right now?”
This ETA Financials & Cash Flow can work. You can find funding for cash capital and cash reserve, but the funding available will most likely depend on how realistic your pro forma is. With a strong, projected financial statement, you can:
- Apply for a bank loan or line of credit.
- Get a loan from the Small Business Association.
- Reach out to an outside investor, or loan shark.
- Tap into a rich family member’s pockets.
- Save the money yourself.
- Sell assets you already own.
Cash in the Mattress
Since you know that cash is king in business sustainability, your goal should be to keep it — Squirrel it away. Put it in a savings account or a CD you can’t get to easily. Protect it. Invest it. Pay yourself first. Give yourself 10%, 15%, or 20% of your business’s gross income each month to create an emergency fund. This is the ETA Financials & Cash Flow strategy that I profess you partake in initially.
Then, do whatever it takes to get more customers. When times are good, pour extra income back into marketing and advertising so more people know you’re around. Furthermore, take care of the customers who come through your door so that when customers have to be stingier with their money during the rough times, they’ll come back to you instead of your competitors.
So if the whole point of this “30 Days to ETA” series is to buy a business to sell it, we have to focus on business sustainability. Economic storms will come. Maybe they come during natural disasters like floods, earthquakes, or tornadoes. Perhaps they come when loved ones fall ill or family members begin feuding. No matter how the storms come, we know they’re coming and we’re prepared via ETA Financials & Cash Flow.
Therefore, we stabilize our business’s scalable foundations with strong management systems. Then, we recruit the best team members we can afford to build the framework of our business’s value. But if we stop there, we’ll have no safeguard against the storms. Even if we build our business on the proverbial rock, without additional cash reserves, cushions, or protections around the structure, we’ll likely still be swept away by the waves or receive a pittance in return for our investment.