Pay Attention to the BACK of the Envelope
In the start-up stage of a business, having access to capital will often be a key factor in determining its success. An important part of that capital structure can be the effective use of debt. In fact, borrowing is often necessary to grow or effectively manage cash flow. The essential part of managing debt is being as sure as you can that you will have the appropriate cash flow to cover your debt commitments. Figuring this out on a very basic level can be as quick as a calculation you could do on the back of an envelope – hence the title “Back of the Envelope”, a worksheet created by VtSBDC to help business owners do a quick logic check on their debt obligation in terms of start up viability.
Let’s run through how this resource works:
1. Fill your loan terms into the first three cells with information in blue indicating:
a. Loan Payment (Cell F9)
b. Loan Terms in years (Cell F10)
c. Interest Rate (Cell F11)
2. This loan information will auto-populate your monthly and annual loan payments. Your yearly loan payments amount is a business’s baseline loan obligation.
3. Next, to ensure the business can cover its debt obligation the bank will want to see a cash cushion. We suggest using 25% above this baseline yearly loan payment in cell F13, which is calculated in G14.
4. Now, in the blue text (Cell G15) enter your annual draw or salary needed for household and personal expenses. It is important to factor in these expenses, to have a more accurate understanding of the true cash flow after expenses are removed to prevent overspending.
5. All this information leads to the quick calculation that your business needs X amount of yearly Cash Flow after ALL expenses to comfortably cover your debt obligations.
As the creator of these resources, VtSBDC Area Advisor Ross Hart says, “As a potential start up business owner, it’s important to remember you have to pay your loan obligations, salary, and estimated fixed operating costs before you put a dime of profit in your pocket. Taking the time to do this very basic calculation can shed significant light on the true viability of your business idea.”
Confirm that your business has enough gross profit from the sale of your product or the labor from your service to cover not only your yearly loan payments but your approximate expected salary needs. In this example, the yearly cash flow needed would be $205,359, without getting into operating costs and your other fixed costs a business would need to cover, such as maintenance, fuel or repairs. If this calculation gives you any hesitation or doubt, then it’s time to take a deeper financial look at your idea.
Using this tool will in no way be a full analysis of your financials, but rather a quick logic check. Having a quick understanding of your financial stance and debt obligations gives you the power to evaluate your situation and to make informed decisions. This information also provides a manager or owner with the ability to understand their debt obligations for each loan, and to clearly define their capital structure.
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