Q. I’ve had my business for about nine months. Initially, I was putting my personal money into the business to pay expenses. Now, I’m not having to put money into the business to keep it going, but I’m not paying myself either. Are there a series of phases through which a business goes with respect to cash flow? If so, how long should I expect each phase to take?
A. We’ve identified five distinct cash flow steps that businesses can traverse as they grow. Those steps are:
1. Putting personal cash into the business – If you launch a business from scratch, this is usually where you start. Here, you aren’t taking money out of the business, rather, you are putting your personal cash into the enterprise to pay the operating expenses, make capital purchases, etc. This is where your business started. However, it seems that you have moved beyond this step. Congratulations, many companies die without getting past this step.
2. Business self-sufficient, buy not throwing off cash – This is where you say your company is now. The business is making enough to sustain itself, but not you. You are still paying your personal expenses out of your savings. Unless you are independently wealthy, you’ll have to move beyond this step reasonably quickly. Staying here too long will eventually deplete your resources and you’ll have to get a job to stay afloat.
3. Business throwing off some cash still paying some expenses out of savings – At this step, you are paying yourself something. Occasionally, you still have to supplement your income with money you take out of savings. This is better, but you are still not home free. Sustainability doesn’t come until the next step.
4. Paying business and personal expenses out of cash flow from the business – 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. You can sustain your lifestyle indefinitely. 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 got to move to the point where the business is generating cash flow that exceeds your expenses.
5. Investing – This is the objective. You want your business to throw off cash that exceeds 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. You could choose to reinvest the money in growing your business. In many cases, this is the best option. Alternatively, you may choose to diversify investments. You might buy or start another company. You might invest in the stock market. The options are almost limitless.
These are the five steps entrepreneurs experience as their business grow—we certainly did. Your second question regarding how long it will take to move through each step is more difficult to answer. In the case of our business, it took three years to reach Step 5. However, some reach this step much more quickly, while others take considerably longer. In fact, most businesses don’t make it as far as Step 4 and even fewer make it to Step 5.
It’s also possible to take a step backwards. For example, you may have been living on Step 4 for several years, but if business conditions change, you may find yourself dipping into savings again. Therefore, we can’t give you a good rule of thumb for how long you should expect to take to move through each step.
What’s important is that you understand the five steps outlined above and that you have a very clear plan for moving your business through each. Make sure you have enough resources to get you through the early steps where your personal cash flow is negative. Finally, our experience is that launching a business takes twice as long and costs twice as much as you think it will. Make sure you have reserves that are adequate to cover this extra expense.