Wise Working Capital Management Calculation and Planning

Posted by Jim Otto on Fri, Oct 10, 2014 @ 12:10 PM

Many business's have failed due to lack of sufficient working capital. So how much is enough and what formula do you use to figure it out? I would recommend using a bottom up approach, or put another way, what could go wrong that you may not have anticipated that could cause your new business to need more working capital then you thought.

Take franchises for example, the Item 7 in the Franchise Disclosure Document, referred to as the FDD, is the estimated cost to build out the franchise and typically includes working capital as a line item. In an effort to keep the cost of the franchise business low the working capital is sometimes understated. This can contribute to high failure rates of new businesses, as working capital is the life blood of a new business.

MARKETING

Many new businesses fail because of lack of marketing. Getting your name out in the community, building a loyal customer base and differentiating yourself from the competition can take a new business on average 3 to 5 years. Therefore whatever you anticipate spending on marketing you can pretty much double that amount. The busier your location becomes the less you can spend on marketing. But getting that initial foot traffic can be costly. 

In the initial stages of your business you must market to the masses. Once you have a client base you can save money by target marketing to your existing customers - or to new customers only.  You will have gathered customer information (i.e. email addresses, etc.) that will allow your to touch your client base more economically.

moneyPAYROLL

Obviously if your goal is to provide a superior customer experience and customer service your location needs to be properly staffed. Ideally your payroll should be less then 35% of your overall revenue but that may not be possible in a new location. Expect your percentage of payroll to be higher initially in a new location until you have the proper benchmarks in place to track your traffic. Most franchised businesses can give you these benchmarks based on the historical data of previous locations within there systems.

If you are appointment based and even if you aren't you will need to get the feel for your traffic flow and staff accordingly.  In the beginning the worst thing you can do is to be understaffed when those customers come through your door!  So overstaffing is really a must spend in the beginning!

INVENTORY

It doesn't do much good to bring in new customers if you don't have the product that they need. Replenishing your inventory is a key monthly expense that you need plan for. In our Chldren's salons anywhere between 15 and 40% of our monthly revenues can come from retail products. A good business owner will plan in advance and anticipate the demand based on what time of the year it is, as an example most all businesses sell more product during the holidays but that inventory will need to be purchased in early fall to have it delivered in time to be marked and displayed.

Analyzing your business, it's sales trends, customer traffic and other historical patterns are vital to figuring out how to use your working capital wisely. It's all in the numbers.

SEASONALITY OF YOUR BUSINESS

There are very few businesses that have steady income throughout the year!  A Construction company focusing on cement and asphalt will be slow in the winter but busy in the spring and summer.  Retail businesses are busy during the fall and back to school.  When are you opening your business?  If you are not opening until the busy season than your premarketing expenditure needs to be extra large as you will want to get your name out there when customers are thinking about your type of business.  If you are opening during a slower time of the year than you will need operating expenses to keep open with the income is not going to be there - but this is still advantageous as you will have a chance to practice good business operations before you get the busy season rush!

If you have a very seasonal business you will want to look into a business line of credit for working capital requirements during those slow times.  This will probably be a yearly need as keeping good employees happy and the doors open during slow times is important!

OTHER EXPENSES

Imagine your business day from the time you walk in and turn on the lights and security system to the time that you leave for the evening. Lights = utilities, Bathroom = Cleaning Supplies, Taking a Charge Card = equipment, merchant service fees, Printer = ink & paper (Office Supplies), Insurance, etc.

UNEXPECTED BUSINESS EXPENDITURES

Every new business is going to have some expenses that were not planned for!  What will those be?

  • The Landlord gets the new tax rates and suddenly yours goes up and you have to make up the shortfall.  This frequently happens in newer shopping areas.
  • Do you have a used AC Unit - what if it goes out?
  • Unexpected Lease Requirements - when are you getting the reimbursement for your Build Out Costs?  What requirements must be met before those funds are released?  Is there anything that could delay this?
  • The contractor did not include essentials in the bid for work and both parties overlooked this.  Plan for at least a 10 - 15% overrun.

Padding the Working Capital Expected will prepare you for any of these instances and more.  AND if none occur then you are still in business with dollars to spare!

Shear Madness Franchising franchises Shear Madness Haircuts for Kids salons.  We have worked with franchise stores and have seen the unexpected happen!  When it does we help by identifying and helping with unfair situations for franchisees.  Presenting options that help prevent these events as well.  Most franchise owners have not opened businesses before.  Having someone who can advise them and help prevent working capital misuse is one of the significant advantages of franchise ownership.

If you are thinking of opening your own business exploring franchises could help you make better decisions in this process.  We have put together a toolkit that explains how you might go about exploring franchise ownership, what you can learn, and how it all works.  Just click below to get this tool!

Exploring a Children's Salon Franchise

Topics: how to begin a business, franchise buyers, Business Tips, small business how-tos, working capital