You started a contracting business. You just closed on a 10,000 square foot custom build in the very best part of town. They want the newest high tech and finest building materials. Here is the biggest opportunity you've ever had, but how will you make it happen?
You need to get your business in order, buy framing lumber and concrete, rent equipment and hire on journeymen, but you don't have cash in the bank.
Business capital is simply the funding you need to operate. One of the first steps in expanding an existing business is determining your business capital needs.
Read on to learn more.
Business Capital 101
It's vitally important to understand the costs specific to your project and your business. Get the number right to determine what financing you need to get off the ground, what it will take to reach profitability, and manage cash flow once you're in operation.
Types of Costs
Costs like legal fees for incorporation, licenses, and surety bonds are one-time only. Deposit and first month's rent on an office, equipment, and starting supplies are also typical one-time only costs.
Other one-time only costs might be to do research, print marketing material or make a website. As an established contracting business, these are sunk costs and every job contributes a portion, but you don't anticipate needing to fund them again.
Typically, recurring costs, are things like rent, utilities, employee salaries. They tend to be paid on a regular basis and don't vary much from month to month. These costs might be paid annually, quarterly or at some other interval.
Oftentimes, recurring costs are fixed. That is, they do not rise and fall with sales volume. Contrast this with variable costs. Variable costs change with each unit sold, such as fuel for a trucking business or lumber for a contractor.
Making Your Expense Estimates
When looking at your costs, you might want to pad your figures by at least 10% to cover contingencies.
Entrepreneur Magazine suggests:
- Double your estimates for advertising and marketing costs
- Triple your estimates for legal, insurance and licensing fees
- Keep track of direct sales and customer service time as a direct labor expense even if you do these activities yourself (you want to pay yourself, right?)
The Small Business Administration has a useful worksheet to help you estimate your startup costs.
The other side of determining how much business capital you need is getting an accurate estimate of revenues. Since this is a new job, you can use historical financial information or experience with the client or with other types of projects to keep your sales forecasts from being overly optimistic.
Inaccurate forecasts can lead to mismanaged expenses and cash flow crisis.
Don't just toss out a number guess. Document your assumptions and ground the revenue projection in reality.
Do a step by step sales funnel and walk through arriving at an accurate prediction. ProjectionHub has an app to help guide you through the revenue forecasting process.
Make at Least Two Projections
Project at least two scenarios, one aggressively optimistic and another conservatively cautious. Neither is likely completely accurate but make projections for both.
Take into consideration major factors that could impact your business, such as regulatory interference, competition, or even overall economic slowdown.
Your conservative projections might assume some market interference, low price points, high labor cost, and higher expenses. Your optimistic projections might assume multiple price points, no regulatory interference, and an ample supply of skilled labor.
Look at the Ratios
Certain key financial ratios such as gross margin, operating profit margin, and total headcount per customer should be compared to your closest competitor.
If your projections include one or more of these ratios improving by over 10 percent or your ratios are significantly superior to all competitors, revise them!
Total direct costs to total revenue
Assumptions that make your gross margin jump from industry standard 4% to 45% for example, should be re-examined.
Total operating costs to total revenue
You expect positive movement with this ratio. Overhead costs should represent a smaller proportion of total costs as revenue grows.
Headcount per job
If you plan to grow the business on your own, pay special attention to this ratio. Divide the number of employees in your business by the total number of builds you plan.
If your projections call for business growth, is this ratio realistic? Will you still be sane with five times the complexity and still only yourself on payroll? If not, revisit your assumptions about revenue or payroll expenses.
Considering your cash flow is essential. Not too far into your growth cycle, gross margin growth becomes more important.
Consider Your Cash Flow
You need business capital to support your build in its start-up phase through the first several milestones. Experts suggest 6-12 months beyond final delivery, although certain industries are more stable and require fewer months.
Slightly more volatile businesses have longer cycles.
How long until your business revenues cover necessary business and personal expenses such as payroll, rent, utilities, etc.? Experienced entrepreneurs suggest doubling the number of months you forecast.
What about clients who have taken delivery, but have not yet paid? Accounts receivable is an asset, but it can't cover payroll.
Might want to consider learning more about cash flow in this article, How to use a Business Capital Loan to Improve Cash Flow.
Funding Your Needs
By your best projections, you may have months where you are waiting for payment, or months without revenue where you must front construction costs for the coming season. The lights still need to be kept on, your employees need to be paid and the tax man isn't waiting.
Businesses rarely have revenues match perfectly with expenses. Even if revenues and expenses match, there will be nothing left to fund growth. If your cash on hand is insufficient to cover current expenses, what are your options?
You have two choices. You convince your client to pay earlier and more often (good luck!) or borrow the funds you need to avoid losing momentum.
Contact us to discuss a capital loan designed to help businesses manage the day to day cash flow challenges and invest in growth. Let us answer your questions and get you started today!