Thursday, July 5, 2012

Projections leading you down the garden path?

Garden Path JN029245 by JaniceNolan_braud
Garden Path JN029245,
a photo by 
JaniceNolan_braud on Flickr. 
During a radio interview on behalf of SCORE the other day, I was asked why startup businesses fail.  Talk about a huge question with many potential answers!  In some instances it's a retail enterprise with a nonperforming location, sometimes it's a product that only a mother could love.

But if there were one major deal-breaker for new businesses, it would be financial.  In particular, many new businesses start with too little capital, and this problem is made worse by faulty projections - or no detailed projections at all.

Let's think through an example:  Small Business A wants to open a retail location.  They have some investments to make before they even open their doors:

  • Business entity setup - fictitious name, incorporation, etc.
  • Security deposit and rent for location
  • Fixtures, equipment
  • Inventory
  • Utilities
  • Insurance - physical site and liability
Let's assume for a minute that the new business has to invest $150,000 to open the doors on Day One.  How long will it take for the owner to start to generate revenue, and in what volume will the revenue start to come in?  The rent will come due again in 30 days, as will the utility bills.  If the business owner has chosen to hire employees, those salaries will be payable weekly or biweekly.

Depending upon the product, marketing (including promotion, pricing, location, etc.), owner reputation, economic conditions - and even the usual sales process - the business might take 3, 6, 9 months or even more to reach its sales production pace.  That means that the business needs not only the initial $150,000 of capital, but that 3,6, or 9 months of operating capital available as well.

Why projections go wrong
Here's how projections take business owners down the garden path:  prospective and new entrepreneurs feel tons of enthusiasm, passion, etc. when they are starting a new venture like this one.  The owner is sometimes (often?) reluctant to hear or think about information that might be a buzz kill right in the middle of this very significant creative act.  So the new owner, swept up in positive emotions, develops projections incorporating assumptions that the community will be banging down the doors to buy on Day One, that no unexpected expenses will kick in, and that the business will experience month over month meteoric growth.

Hopeium is not helpful when you are forecasting your business results.  Conservatism, even pessimism, is your friend.  Do the numbers work?  If they do, great.  If the winds have to be blowing in one exact direction and the stars have to be aligned in order for you to do the volume you're hoping to do - you need to look at the numbers again and figure out how to make them more realistic before you risk losing your business, and maybe some of your personal assets as well.

Some projections are missing key information.  The prospective owner doesn't know what he or she doesn't know, and so some numbers with significant impact aren't part of the equation.  Here's where an expert like an accountant or a SCORE volunteer can be helpful.  They can not only help to fill in the blanks - they can help a new owner know where the blanks need to be placed in the forecast.

The owner needs to grow too
One of the ingredients in business success is the speed of the owner's learning curve.  Your cash reserves need to be big enough to cover your sales cycle, but also enough to outlast your learning process.  What if you aren't going into business already effective at sales?  What if you guess wrong about the types and quantities of inventory you need to have on hand?  What if you underestimate the amount of waste, spoilage or shrinkage (theft) that you experience while you're learning how to run the business?  Will any of these factors be enough to shut your doors?  Even a small boo-boo might be enough to send the business toes-up if there is not sufficient funding.

The upside of tight cash
It's not always a bad thing to be bootstrapping your business.  Sure, you might be living a bit close to the edge.  But near term a "have to" working environment may help you to be willing to push yourself beyond your comfort zone to engage in the tasks that you might otherwise ignore or throw money at.  There's something about "have to make payroll" that lights a fire under the derriere.

When your budget is close to the bone you may be more likely to find creative solutions to your problems rather than simply throw money at them.  And ultimately the less cash you throw at things the more of your revenue will wind up staying in your pocket instead of blowing right back out again.

1 comment:

city said...

thanks for sharing.