In last month’s article detailing the options to consider when choosing the path for you start-up company, I touched on two significant issues for start-up businesses. One, the importance of knowing your market, and two, the danger of not considering risks. These two issues can make or break your business, and should be fully addressed up front.
Way too many businesses fail simply because owners and/or managers don’t understand their market, or more commonly, they overestimate their market. Potential business owners really have to look hard and objectively at the data for the market targeted to operate within. Analyze the data to determine if your product/service can find a viable niche within the market. Even though you may determine that excess demand exists in the market, you must consider whether the market is large enough for you to be financially successful. If not, can you broaden your market via an online sales channel, social media, or a more geographically diverse sales force?
A common perception about accountants is that they are cautious and conservative. That perception is often true, with the reason being their inherent need to fully weigh the risks of each key business decision (especially if they can quantify it). Having said that, it is a good thing for innovation and the economy that not everyone has the risk aversion that accountants have, or far fewer ventures would ever get off the ground. However, don’t dismiss risk aversion as something fully negative. With that in mind, let’s look at some new business risks.
Address the financial risk by analyzing your cash flow needs over the first year. You may hope to achieve sales of $1,000,000 in the first year of operations, however put this number under a stress test. Test your sales number under the worst case scenario. Let’s say you determine that the very lowest your sales could possibly be is $500,000 in the first year. If that is the case, then stress test your cash flow for sales of $500,000. Can you still generate sufficient cash flows to cover loans and overhead costs while at the same time being able to feed yourself? Once you create this cash flow model you can run various tests for different sales levels. However, if you find that the cash flows are negative under the worst case scenario, then you either have to look at reducing overhead costs and debt servicing costs or find ways to realistically increase your worst-case sales projection. We will explore cash flow projections in a future article, however, the basic premise of a cash flow model is to project the sources of cash coming in (both sales and loans proceeds), and cash going out to service debt obligations and pay for business operations.
Be cautious of scaling up and expanding the business before achieving significant milestones. Milestones might be based on sales volume, number of employees, profitability, or any combination of these. However, before any expansion plans are finalized, run another cash flow stress test including the new variables that will be introduced to the model.
Failure to deliver your service or product as promised could ruin your dream within a very short time. One of the critical success factors of a start-up business is building a solid customer base. The old saying of ‘under promise and over deliver’ is very relevant in building customer loyalty. Your key initial focus should be on doing what is needed to build your customer base. The worst thing you can do for your business is oversell your product, services or delivery time. Feel free to ask your customers for feedback, and be prepared for responses that may be tough to hear. Stay positive and don’t get defensive if you do hear something negative. This is an opportunity for improvement, so take it as constructive criticism. The ideal customer base is one that will eagerly advocate for your business, but that requires consistent delivery of products or services, or better yet, over delivery.
By understanding your market, and through addressing a few of the business risks, you can feel secure that you are starting off on the right track.
Jonathon (Tug) McGraw, BCOMM, CPA, CA
BDO Canada LLP
Jonathan can be reached at: email@example.com