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Updated 29 Sep 2020

The 5 phases of cash flow you’ll experience before becoming a profitable business

You will need to help your company navigate through these five phases of cash flow before turning a worthwhile profit. This comprehensive resource can help you plan and thrive during the journey. 

Nicole Crampton, 26 April 2017  Share  0 comments  Print

All the answers to your unique business lifestage questions

As CFO or the head of the venture, you will need to navigate your company through five phases of cash flow, before the business becomes profitable. You must keep in mind, on this particular journey, that it will probably cost a business twice as much cash, and take twice as long as envisioned to achieve decent profits, says Doug and Polly White, founders of Whitestone Partners Inc – a management-consulting firm that specialises in helping small businesses grow profitably.

Ensuring sound cash flow will require planning, and savings to (successfully) navigate your business from start-up to profitability. Here are some insights to help you move forward:

Start with a business plan and a strategy

When preparing to launch, the starting point for many businesses is their business plan. Here you will decide and determine your business’ financial future and the step-by-step method you’ll use to achieve each goal along the road.

“Proof lies with the business plan,” says Doug and Polly White. This is where they look when working with clients or considering angel investment. “We had a similar revelation of our own when we started our consulting business. We expected to have enough clients to cover our business expenses and pay ourselves a salary within a few months.”

But, there’s only so much you can plan for. You can’t predict how many customers you will acquire in the coming months, but using your business plan you can at least estimate when your business will break even and when you’ll start churning some profit.

On the other hand, if you don’t plan at all, you could find yourself in a challenging situation. “It took us more than two years to match our former incomes,” Doug and Polly White add. If you don’t plan for these sorts of eventualities, do you think your business would make it to this milestone? Having a plan is essential, but you also need to be flexible enough to deviate if your initial plan isn’t working, or if some of the variables have changed.

Growing a business from scratch allows you, and your team, to discover progress phases of your business that you weren’t aware of. Doug and Polly White explain: “These experiences made us think about the different phases of cash flow. In fact, we’ve identified five distinct cash flow phases that businesses tend to traverse as they grow.”

Related: How to manage your cash flow when your company is growing

Here are the five phases of cash flow you’ll need to navigate before your business becomes profitable:

Phase 1: Funding the business out of your pocket

When launching your business from scratch, this is a position numerous business owners find themselves in. This is the phase where you find the need to put your personal cash into your venture to cover costs such as operating expenses and capital purchases.

“For instance, while our business wasn’t capital intensive, it did require that we invest in marketing and some computer equipment,” says the Whites. “We decided to take personal loans to cover our business expenses.” However, during this time the White’s still had to pay their mortgage and fund their household, so they had to live off their savings, while propping their business up with money from their personal accounts. 

There both advantages and disadvantages to funding your business using personal finances. Hartford’s recent Small Business Success Survey shows that 36% of owners are choosing to use personal finances including savings, credit cards, and retirement funds, to start-up and sustain their enterprise. The survey also reveals that 44% of Millennial business owners aim to use their own money to help finance their first ventures.

Here are some advantages to self-financing your business:

Advantages to self-finance 

1) You’ll run a better business

With skin-in-the-game, you’re going to take your business seriously and be driven to make it a success. “If you’ve got your own money on the line, you’re going to look at your business very differently,” says Stephen Key, author of One Simple Idea for Start-ups and Entrepreneurs. You’ll want to do your due diligence to ensure you’re minimising the risk of losing your money.

Key explains: “You’re going to plan differently. It becomes all about planning, all about homework, and all about having a solid business plan.” As a result, you will run a smarter, better enterprise and all the rewards will be yours and not your lender’s.

2) You’re in charge

One of the chief advantages of funding your own business is having complete control. Emily Chase Smith, author of The Financially Savvy Entrepreneur explains: “You’re not beholden to anybody but yourself. You don’t have investors looking over your shoulders asking for specific returns. You decide how the money is being used. You decide how fast you’re looking for a return.” This is why so many business owners decide to fund and sustain their start-ups themselves. 

But, funding your business from your personal accounts has its pitfalls as well.

Here are some disadvantages to self-financing your venture:

Disadvantages to self-finance 

1) Increased risk of debt and bankruptcy

If you’re funding your enterprise from your personal accounts, you’re probably drawing from your retirement accounts, savings and personal credit cards or other lines of credit. Smith says that numerous entrepreneurs get into trouble using this method of funding. “A lot of small business owners are taking on debt on the personal side. Let’s say they’re taking on a line of credit for their business with the bank. They have to then personally guarantee that money. If the business goes under, then the entrepreneur will either spend the next decade paying it off on the personal side, or need to file for personal bankruptcy.” You need to be sure you can live with both of these undesirable outcomes should they happen.

2) You might not have enough money

Consider this if self-financing your venture: You’ve developed your product and now your target audience wants a large order. You will need to deliver on that order, but you’ll only see payment 90 days after delivery, meaning you actually can’t afford to give your target market what they want.

Key cautions: “If you’re going to be successful, you’re going to need capital. The whole dilemma of cash flow comes up real quick.” This is why a loan from the bank can give you more financial room for success, while a dip into your savings could result in the collapse of your business.

Smith adds that: “You could have the world’s best business idea, you can be smart, you can be a serious hustler, but if you run out of cash, your business is gone. No cash, no business.”

Related: Lead your business to high-impact, high-growth returns

Phase 2: Breaking even

Your business is doing well, and you’ve reached your breakeven point. The only challenge is your business still isn’t covering any of your personal expenses. Doug and Polly White say: “After several months, which is longer than we had first expected, we arrived at a point where our business was making enough to sustain itself, but not our personal expenses. We were still paying those expenses out of our savings.”

At least you’re no longer putting money in, but if you don’t move on to the next phase quickly, you’ll find your resources might become depleted. 

Determine your future profitability with a pro forma income statement

To determine when your business will break-even, you can conduct a break-even analysis, but to determine when your business will become profitable, you can conduct a pro forma income statement. This step contains four components:

  • Sales projections:You’ll need to estimate your sales for every month for at least one to three years. Using the research and knowledge of your industry, you can determine an educated guess of your expected sales.
  • Costs of goods sold or value of services:If you manufacture a product and sell it, you’ll need to create a cost of goods sold budget report. If you’re running a service business, simply place a value on your services and use that figure.
  • Expenses:Now, determine the cost of other expenses, such as rent, phone, Internet, accounting fees, website maintenance, marketing and advertising, insurance utilities, salaries and debt repayments. When you total them up, you’ll reach your monthly fixed expenses.
  • Gross profit estimate:With all this information, you can determine exactly when your business will become profitable. Use sales projections to calculate income, then deduct your expenses; it will leave you with gross profit.

Doug and Polly White explain: “Some budding entrepreneurs supplement this phase by working part-time or full-time, while building their business. This strategy may help cover your personal expenses, but might also keep you tied to a ‘one foot on shore, the other in the boat’ mentality. At some point you will need to fully commit.”

Phase 3: Earning a slight profit

In this phase, your business is making enough money to cover its expenses and some of yours. However, you need to consider carefully what to do with that extra profit. Doug and Polly White, for example, had their business repay the loans they’d given it when they started the company, instead of cutting themselves a salary cheque.

If you can, it’s better to invest your profits back into your business to fund growth. Garrett Gunderson, author of bestselling novel, Killing Sacred Cowssays: “Build opportunity for your business by retaining the cash in your business as an opportunity war chest.” Cash from profits, he says, is your ‘best’ investment that allows you to make strategic moves when opportunity knocks.

At this stage in your start-up’s cash flow, you still have to supplement your income with money from your savings, which is still not sustainable, but you’re in a better position than before. Doug and Polly White say: “This is a better position to be in, but you’re still not home free. Sustainability and a full night’s sleep don’t come until the next phase.” Building up a business is a process, which can be challenging but at least sustainability is in sight at this point.

Phase 4: Earning enough profit

Your business is finally making enough profit to cover its expenses. You can finally draw a salary. This is a great phase, as it shows that your venture is moving forward and growing, and that it’s finally sustainable.  

“That step had taken much longer to reach than we had expected, but we realised that we'd beaten the odds. When you reach this step, you’ve made it, sort of. Your business is throwing off enough cash to allow you to pay your bills, and you can sustain your lifestyle indefinitely,” explains Doug and Polly White. 

Sustainability, however, isn’t growth and if you wish to enjoy the comforts of wealth and a growing business, you’ll want to reinvest into your business. “However, if you stay at this point, unless you can sell your business, you won’t create much wealth, and retirement will always be a dream. You have to move to the point where the business is generating cash flow that exceeds your expenses,” the Whites explain. Reinvest in your business to increase growth, which will allow you to go from strength to strength, instead of jogging on the spot.

From Henry Ford to Bill Gates and Warren Buffett, continued investment has proven itself again and again. Follow in their footsteps and invest small amounts in areas that will generate a sound return for your business, such as marketing, or software. Keep good records of what is working within your business so you know what to reinvest in.

Related: How you can use your creditors to fund your business growth

Phase 5: Investment

Now that you’ve decided to progress to the next stage of growth there are a few things you need to know. “This is the ultimate objective. You want your business to throw off enough cash to exceed what you need to maintain your lifestyle; you want it to create wealth for you. Of course, you have been investing in your business all along, but now you have discretionary funds. You can choose where to put them to work,” Doug and Polly White say. 

With your discretionary funds in hand, you can begin to invest in departments and areas that will generate more income for your business. This can include converting outsourced departments into insourced units, or expanding into areas previously unexplored. These can be hits or misses, but if you keep track of what works for your business, then you can continue to strengthen the departments that help grow your company.

Doug and Polly White advise that the best option is to reinvest and grow your business. Alternatively, they say you can choose to diversify investments: “You could buy or start another company. You might invest in the stock market or real estate. The options are almost limitless.” 

The 5 phases of cash flow

These are the five phases of cash flow that will help you navigate your finances and assist you in growing your business. You’ll experience all five of these phases throughout the life of your business. How long it takes for your business to move through each step depends on you, your business, the economy and several other variables.

“In the case of our business, three years lapsed before we reached phase five. Unfortunately, most businesses don’t make it as far as phase four,” says Doug and Polly White.  It takes dedication, a carefully crafted business plan and strategic decision making to make it all the way to the final phase described here.

But, growing a company isn’t a one-way street and it’s quite possible for your business to power through the phases quickly. The Whites say: “You may have been living in phase four for several years, but if business conditions change, you may find yourself dipping into your savings again.”

The important thing to remember is that the five phases outlined create a clear and direct path for you and your business to move through. Each phase will have its challenges, and you will need to plan for the cash flow fluctuations to ensure the health of the business.

Parting shot from Doug and Polly White

Learning from the lessons of others is the fastest way to grow your business and avoid any pitfalls along the way.

“Make sure you have enough resources to get you through the early steps where your personal cash flow is negative. Our experience is that launching a business takes twice as long and costs twice as much as you think it will. Ensure you have reserves that will adequately cover these extra expenses.” 

Having a thought-out plan will assist you in navigating the journey of growing your business, even if you have to back-track and try again, more wisely.

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Nicole Crampton

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