Cash and the first year

A shop can be profitable on paper and still run out of money. The equipment, the bond, the electrical work and the first stock are paid for before the first job is done; the first months bring less work than a full shop; materials for each job are bought before the customer pays; and business customers pay thirty days or more after the invoice. Between the day the lease is signed and the day the takings catch up with the bills, the business needs cash, and a new owner who has not forecast it can find the bank account empty in the fourth month while the order book is full.

This chapter totals the money Mara needed to open, forecasts the first year’s cash month by month, sizes the reserve the forecast showed she would need, and reviews the year against the plan. The figures are illustrations; a real forecast should be prepared with an accountant.

The money to open

Figure 1Cash needed before the first job

	A$, excluding GST	Notes
Equipment paid up front	36,000	the rest on equipment finance
Electrical work on the unit	7,500	new circuits and outlets, Chapter 3
Rent bond	8,500	three months, held by the landlord
Insurance, first year	6,500	paid annually in advance
Opening stock of consumables	3,500	wire, electrodes, discs, tips
Signage, website, stationery	2,000	—
Registration, legal and accounting set-up	1,500	—
Total before opening	65,500	—

Mara funded the opening with A$60,000 of savings and a business loan of A$30,000, A$90,000 in all, leaving about A$24,500 in the bank on the day the shop opened. That looked comfortable until she forecast the first year. The equipment finance and the business loan both had to be repaid monthly from the start, and those repayments are part of the fixed payments in the forecast below, alongside the wages and the rent.

How the work builds up

A new shop does not start full. Customers have to find it, try it, and come back. Mara assumed, as an illustration, that the shop would bill about 40% of its full hours in the first month, 55% in the second, 70% in the third, 85% in the fourth and 100% from the fifth, using the 2,340 billable hours a year from Chapter 1, about 195 a month when full.

Revenue, receipts and payments

Each month’s revenue is the labour billed at the shop rate plus the materials charged with their markup. This is an illustration. Mara assumed that materials cost about 60% of the labour billed and are charged at cost plus 15%, so that a full month’s revenue is about 195 × 130 = A$25,350 of labour plus about A$17,490 of materials, about A$42,840.

But revenue is not cash. About half the shop’s customers, the private and new ones, pay on collection; the other half, the business customers, pay about thirty days after the invoice. So each month’s receipts are half of that month’s revenue and half of the previous month’s. The payments, meanwhile, are the fixed costs of the business every month, about A$22,700 including wages, rent, insurance spread monthly, loan and finance repayments but not depreciation, which is not a cash payment, plus the materials for the month’s jobs, paid when bought.

The first year’s cash

Figure 2Mara's forecast bank balance through the first year

Forecast balance

Bank balance (A$ thousands)Month

Mara's forecast bank balance through the first year data

Month	Forecast balance
0	24.5
1	4.3
2	-6.5
3	-13.0
4	-15.5
5	-13.8
6	-8.8
7	-3.9
8	1.0
10	10.8
12	20.7

The forecast showed the balance falling from A$24,500 on opening day to about A$4,300 at the end of the first month, below zero in the second, and to a low of about −A$15,500 in the fourth, before the full workload and the receipts from earlier months brought it back above zero in the eighth month and to about A$20,700 by the end of the year. The business was forecast to be profitable from the fifth month, but its cash would not recover from the slow start until the eighth.

Profit and cash are different

The forecast shows why profit and cash must be watched separately. From the fifth month, the shop’s revenue exceeds its costs, so on paper it is profitable, yet its bank balance is below zero until the eighth month. The difference is timing: money spent on opening, materials bought before jobs are paid for, and customers who pay a month after the work. Depreciation works the other way, as a cost in the profit figures that is not a payment in the cash figures, because the equipment was paid for at the start. An owner who watches only profit can be surprised by an empty account; one who watches only cash can mistake a good month of receipts for a profitable business. Mara watched both, the profit from her monthly accounts and the cash from the bank and the forecast.

GST and tax in the cash

The forecast excludes GST, but the bank account does not. The shop collects GST on its invoices and pays it on its purchases, and remits the difference to the tax office each quarter, or each month if it chooses. Between collection and remittance, the GST sits in the bank account looking like the business’s money; it is not, and a shop that spends it faces a large bill at the end of the quarter. Mara moved the GST portion of each payment received into a separate account, and set aside a share of each month’s surplus for income tax, on her accountant’s advice, so that neither bill would land on an empty account.

Paying the owner in the first year

Mara’s costs included her full wage (Chapter 8), but in the first months the cash forecast could not afford to pay it all. She drew a reduced amount for the first six months, enough to live on, and recorded the difference as money owed to her by the business, to be repaid when the cash allowed. Many new owners do the same, and it is a reasonable way to fund the slow start, provided it is a deliberate, recorded decision rather than a hope that the money will somehow appear, and provided the owner’s personal finances can stand it. The cash forecast told her how long the reduced drawings would need to last.

Seasons in the forecast

The forecast above assumes a steady workload once the shop is full, but Chapter 1 showed that the work is seasonal, with a crush in late winter and spring and a quiet patch in midsummer. A seasonal forecast moves the low point: if the shop opens just before the quiet season, the slow start and the quiet months add together, and the low point is deeper and later. Mara timed the opening for the start of the busy season, which helped the first months fill faster than they otherwise would, and built a second, smaller dip into the forecast for the summer.

When to grow

The first year’s records also told Mara when the shop could grow. The test she set herself was three months in a row with billable hours above the plan and a waiting list of work longer than two weeks, together with a cash balance that could fund the first months of a new person’s wages before their work brought in revenue. Growing too early, on the strength of one good month, would put the business back into the position of its opening months, with costs rising before the work and the cash to carry them.

Sizing the reserve

A forecast low of −A$15,500 means the business needs at least that much more cash available, and more as a margin for the forecast being wrong: a slower start, a large customer who pays in sixty days, a machine that fails. Mara arranged an overdraft facility of A$30,000 with her bank before signing the lease, about twice the forecast shortfall, so that a worse-than-expected first half-year would not stop the business. She hoped not to use much of it; the facility’s purpose was to make sure that a cash shortage did not force her to turn work away, delay paying Sam, or miss a rent payment.

What moves the low point

The forecast is most sensitive to a few assumptions, and Mara tested each:

• a slower start: if the work took two months longer to reach full, the low point fell to about −A$30,000;
• slower payers: if business customers paid in forty-five days instead of thirty, the low point fell by about A$8,000 more;
• deposits on large jobs: taking deposits covering materials on trailers and structural work raised the low point by several thousand dollars;
• the rate: every A$10 an hour on the rate added about A$1,950 a month at full work, which shortened the recovery by weeks.

The tests showed that the overdraft would cover a slow start but not a slow start combined with slow payers, which made the deposit policy in Chapter 9 and prompt invoicing more important than they had seemed.

Records that run the business

The job cards (Chapter 9) feed a small set of figures that Mara checks every week or month:

Figure 3Figures Mara checks to run the shop

• Avoid: Billable hours against the planweekly, from job cards
• Avoid: Utilisation for each personmonthly
• Avoid: Estimated against actual hours on fixed-price jobsmonthly
• Avoid: Money owed by customers and how long overdueweekly
• Avoid: Bank balance against the cash forecastweekly
• Do: ? Costs against the budget, and the ratequarterly

None of the figures takes long to produce, and together they show, months before the end-of-year accounts, whether the shop is on track. The money owed by customers deserves particular attention: an invoice that is thirty days overdue gets a phone call, not another statement, because the longer a debt runs the less likely it is to be paid.

The first year, reviewed

This is an illustration. At the end of the first year, Mara compared the results with the plan.

Figure 4Mara's first year against the plan

2,180Billable hoursagainst 2,340 planned

61%Overall utilisationagainst 65% planned

A$9,500Lowest bank balance below zeroin month four, within the A$30,000 overdraft

A$18,400Surplus after paying both peopleagainst about A$33,000 planned

The shop billed about 160 hours fewer than planned, because Mara’s own utilisation was lower than she had hoped: quoting, ordering and customer visits took more time than expected. Deposits and prompt invoicing kept the cash low point to about −A$9,500, better than forecast. The surplus, after paying both Sam and Mara, was about A$18,400 instead of the planned A$33,000. The shop had survived its first year, paid its people and its loans, and built a list of regular customers. Its job cards now held a year of real hours, costs and estimates to plan the second year from.

For the second year, Mara raised the shop rate to A$135 an hour, took on a part-time bookkeeper to give herself more billable hours, bought the bender her job records showed she needed (Chapter 6), and set a target of 2,400 billable hours.

Bringing it together

Each chapter of this book put one decision about a new shop into numbers. The work decided the floor, the equipment and the hours that could be sold. The largest job and the zones sized the building. The machines’ inputs, added realistically, decided whether the supply was enough. Arc hours gave the gas, and the hood distance the fume control. Each piece of equipment had a yearly cost. Sparks travel metres, and fire precautions follow from it. The costs divided by the billable hours gave the rate, and the job card turned estimates into a record. And the cash forecast decided how much money the shop needed to survive its first year. The early writers’ advice, to know your costs, keep a card for every job and practise before you sell, runs through all of it.

A failure: the big order in month three

This is an illustration. In the shop’s third month, a transport operator ordered three trailers at once, about A$23,000 of work with about A$9,000 of steel and parts, on thirty-day terms. Mara, delighted with the order, bought all the materials at once, before her forecast’s low point. The bank balance dropped to the limit of the overdraft facility she had then arranged, which was smaller than the one in her plan, and for a week she could not buy steel for another job.

She resolved it by asking the transport operator for a deposit on the second and third trailers, which he agreed to, and by increasing the overdraft facility to the A$30,000 in her plan. The lesson was that a big order is good news for profit and bad news for cash, and that deposits are part of pricing, not an imposition on customers.

Exercise: the cost of slow payment

A business customer who regularly orders about A$8,000 of work a month starts paying in sixty days instead of thirty. How much extra cash does the shop need to carry permanently because of it? If the overdraft costs an illustrative 9% a year, what does the slow payment cost the shop in a year?

Paying thirty days later means the shop is always owed one extra month of that customer’s work, about A$8,000, which it must fund from its own cash or the overdraft. At 9% a year, carrying A$8,000 costs about 0.09 × 8,000 = A$720 a year, about 0.75% of the customer’s annual orders of A$96,000. The shop could ask the customer to return to thirty-day terms, offer a small discount for prompt payment, or build the cost into its prices for that customer, but it should not simply absorb it unnoticed.