Too Much Leverage

3. Too Much Leverage and too much financial optimism

One of the key things all start ups are encouraged to do is the financial forecast and the business plan.

By virtue of the fact that you, as the owner want to be successful means that often the financials are extremely optimistic.

Will sales happen as fast as you are predicting, but the most important question of all is when will the cash actually hit your account?

Mature companies can predict revenues over the next few quarters with some degree of certainty. These businesses can make prudent use of leverage, both financial (debt) and operating (fixed overhead costs), to improve equity returns.

Revenue projections for early-stage companies can be all over the map, which means that new ventures have even less margin for error than larger competitors. In this environment, it can be dangerous to take on more than a modest amount of debt or other fixed obligations (rent, salaries, etc.). Revenues frequently take longer to ramp up than expected, so you may find yourself handing the keys of your business over to your creditors, or at least start to experience nights of not sleeping while you think about the mounting bills. We recommend that whatever outlook you have forecast for revenue to start to flow, add at least three more months, and in some instances add six months.

It's best to keep most costs variable at first and use equity capital to finance your startup until your company has been around long enough to develop confidence in your ability to forecast sales. Delay making investments or taking on fixed obligations until you have a critical mass of customers. You'll know when it's time to rent a larger office space or hire that second shift when you've got a backlog of orders on the books. A wise entrepreneur once told me “securing cashflow is sanity, all other expenditure is vanity.”

It’s great to have nice offices and maybe a great company car to drive around in, just make sure before making these commitments that you and the business can really afford them.

Cash really is king in a start-up, so make sure you have it flowing in before major expenditures and investments.

Transformanceinc