We expanded without thinking about margins and cash flow

Our sales growth was rapid and very quickly we found that we were doing a lot of business in a city 60 miles away. The transport and service costs were high so we opened a depot there.

We only had 12 people in the company. One person moved and we hired two more. The extra salary and rent meant that all the operations in the new town were unprofitable. We needed more sales quickly. I sent our best sales person there and we saw a 20% increase in volume but the margins were low. At the same time sales in our home market stopped growing. 

By the third month with the new depot, the pattern got worse with an actual decline in the home market and only 5% growth in the new market. We weren’t covering our operating cost and the cash flow turned negative. I closed the new depot, which meant writing off our investment and closure costs. It took us three months to regain our sales momentum and we will lose money this year.

There were some clear lesson here, sales without margin are useless, margin is necessary to cover fixed costs, and start up cost for a new depot take more cash than you ever anticipate.


 

Is cash or profit more important for my business?

I don’t know which is more important, cash or profit, for my early stage business. I know I need to reduce stock levels and this will increase cash flow, but it will also have a negative impact on my margins. I know I need new computers, but this will increase cash outflow and the depreciation will negatively impact my earnings.

I talked with a serial entrepreneur and she said that the only reality in business is cash, that accounting and profit are an art form. She told me you need cash to pay bills and salaries and that profit and cash were not the same thing. She said not to worry about depreciation, it was a non-cash item. She said get what you really need and can afford and don’t worry about depreciation.

The investor wouldn't let me take my loan back

When the business had been in operation for nine months, some customers didn’t pay on time and the business was running short of cash. I knew they would eventually pay, so I loaned the company $10K. I didn’t make any formal documentation because I was going to get the money back at the end of the month.

At the end of the month, we had to order more inventory because sales were growing faster than expected. With my track record, I raised a seed round from friends and family and one outside investor. I wanted to get my loan back because I don’t take a big salary. The independent investor said there was no legal agreement in place and that if I took the money out, he wouldn’t invest.

The importance of inventory and cash management

After leaving business school I moved back to my home country and started a retail business with money from family and friends. I had taken classes in finance, operations, retail management, and two in entrepreneurship and had done very well. I felt well-prepared.

I opened a bank account in my home country and started importing stock from the US and China. Sales went really well for the first 6 months. Then the economy started to slow and my sales also slowed. Inventory started to build up and the store began to look bad with stock from different seasons and odd sizes and colors piled up.

I had 30-day credit with my suppliers but I had to place minimum order quantities. The rent had to be paid at the first of each month and the shop staff were paid every two weeks. I did not want to reduce the margins as this would affect my profits even though everyone else in the shopping area where offering 40-60% sale discounts.

I always planned to have 45 days of cash in the bank but with slow sales, suppliers’ payments, salaries and rent, I found myself caught short. I had piles of stock but less than a week’s worth of cash and I could not pay the next month’s rent. By the time I decided to cut my margins and liquidate my stock, it was too late. I had to borrow more money from my family just to stay afloat. It took me 10 weeks to recover and over 6 months to get my credit line back at the bank.