Growing your business and surviving the pain you experience in your cash flow
A Case Study
Rede Accountants Gold Coast, Brisbane & Byron Bay
You’re looking at growing your business but know that the costs come before you generate additional revenue. On paper you might be making a profit, cash flow wise you are in a hole.
How can you manage these costs in the interim without sending the business broke because it is successful? It does happen, businesses often over expand and realise too late that they can’t meet this month’s bills because they won’t be paid for another 2 or 3 months or they are still to generate the revenue.
A typical situation of business crystal balling
Christian operates a legal firm and wants to double his business sales in the next year from $1 million to $2 million. Currently, his net profit is $250,000 per annum, a good living and a comfortable lifestyle.
To do so he knows he needs to invest and spend as follows:
- Employ 3 solicitors and 3 secretaries at a total cost of $390,000 per annum. Solicitors cost $240,000 and the secretaries cost $150,000. Monthly cost is $32,500.
- Employment agency charges $60,000 for recruitment
- Office furniture, computers and printers for 6 extra staff costing $42,000.
- More office space. He takes space next door for $48,000 per annum or $4 000 per month.
- Other overheads will increase by $50 000 per annum.
- Expected annual additional profit is $410,000.
Christian has stars in his eyes. That looks an exceptional return if only Christian can generate the revenue quickly. Christian decides to back himself. After all the worst surely that could happen if it does not work is he downscales again and makes a good living.
This is what is likely to happen with his cash flow.
It takes 2 months for the newly employed solicitors to settle in and starting becoming productive. The solicitors hardly bill anything for those first 2 months. In the third month, they bill $100,000. In the fourth month, Christian is paid $80,000. One customer decides he did not like the quality of work produced by the new solicitors. Christian decides to discount the fee from $20,000 to $10,000. The client finally pays $10,000 in the sixth month.
The three solicitors bill $80,000 in that fourth month and start producing this on a regular basis. There is some client disquiet because some want to work with Christian who has brought them to the practice. These clients don’t want to work with upstarts. It all reminds Christian of his former career in advertising and why he left that industry!!
For the first 4 months, Christian has additional cash inflows of $80,000 and additional costs of $264,000!! A cash flow hole of $184,000. How does he fund this!?!
The good news is that by the fourth month the solicitors are starting to bill as well as he anticipated. Month 5 looks much better. Christian collects $80,000 and his expenses are $40,000.
That’s much better, Christian can eat again!! This continues for another 7 months to end the end at 30 June 2019.
Christian has net cash outlays in months 1 to 4 of $184,000. The next 7 months have produced net cash inflows of $290,000. Christian’s income for the year is $356,000. Somehow he got through the startup phase.
Happy days says Christian, next year should a bumper year.
WE COULD STOP HERE AND MAYBE PAD OUT THE PAIN BEFORE CLEAR WATERS EMERGE. NO SOLUTIONS ARE PROVIDED.
Dark clouds emerge on the horizon.
Christian has devoted all his energy to developing this side of the business. Suddenly he loses $100,000 of his original fees. The clients say Christian is to busy looking after other people.
This is effectively straight off Christian’s return. He cuts some overheads but his return from the original $900,000 of income falls from $250,000 to $170,000. That’s hard to take when he is supporting his former wife as well as his current wife.
On 5 July (after a year) the 3 new solicitors approach Christian to say they feel they are grossly underpaid and should be sharing in the profits of the new business division. They are the ones doing the work and who have the contacts and client relationships. They demand at least $400,000 or 50% of the revenue going forward. Christian works out his extra profit would now be $250 000 for the extra $1 million of revenue. That’s still a reasonable return and Christian agrees.
Three months later monthly revenue falls to $50,000 and continues for the remainder of the year. One of the solicitors has become lazy and the other 2 are arguing with each other, their clients and their secretaries on a regular basis. Suddenly the monthly profit falls from $20,000 to a loss of $4,000.
Christian is back in the cash flow hole. His annual business income is now $120,000, less than half of what it was before he started the new division.
How could it all go so wrong?
Christian decides he will abandon the new division. He immediately terminates the employment of the 3 solicitors and the 3 secretaries. He is stuck with space next door for another 2 years but is able to trim his overheads. He calculates his annual return will now be $120,000.
Maybe he can sublease the premises next door and recoup rent of $48,000 per annum? Christian is confident he can rebuild the business to what it was.
Two weeks later he is served notice to appear in the Fair Work Commission. The 6 former employees seek damages for being unfairly dismissed. Christian negotiates with the former employees and agrees to an out of court agreement where he pays them $100,000.
Six months later Christian has gradually rebuilt. He notices a new legal firm operating over the road. He learns that 2 former employees have gone into the competition. All the clients of the new division have left Christian and joined the new firm. They are the way of the future according to the clients. They are a bright and innovative firm. Other clients hear of this and gradually leave as well.
By the end of the second year, Christian’s fees have fallen to $650,000 and he is making $150,000 a year working 100 hours a week. Only one year to go before I can give up the premises next door muses Christian. That will save $50,000 per annum.
The costs of expansion have dealt Christian a tough blow to his income and his lifestyle.
Did Christian discuss any of this with his accountants at any time?
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