Accurate forecasting of cash flow is the first step toward ensuring financial stability of any new coffee business.
It takes more than beans to found and operate a successful coffee enterprise. Always keep funding in mind.
The coffee sector has long appealed to entrepreneurs thanks to growth rates in the double digits in some business categories and markets. New entrants are attracted to businesses like cafes, online retailing, roasteries, training centers, professional services, equipment, repairs, software, farms, post-harvest processing centers, and more.
But success takes more than having a good product or service; it also requires financial savvy. First-time business owners should heed the importance of having good access to funds. Money is needed to get started and to expand. And ongoing operations require a cushion of working capital to proceed smoothly.
These were some of the points raised in an informative presentation at SCA Expo 2023 by Emily McIntyre, co-founder of Portland, Oregon-based Catalyst Trade, a specialty green coffee company.
Cash is king
One powerful business lesson from the Covid-19 pandemic is that when bad things happen, a company “needs money in order to be resilient,” McIntyre said. It must be able not only to cover routine expenditures like payroll and supplies but also to capitalize on new opportunities.
Economic downturns and disruptions sometimes open up gaps in the market that a business can fill if it is able to invest. But when cash comes in more slowly than it goes out, a business can’t take advantage. And the business might stumble in other ways if cash flow is erratic. That’s why it is good to seek opportunities to be paid in advance by loyal customers, such as by subscriptions, membership programs, pre-pay offers, or deposits.
If you rely mostly on cash flow, you need to think carefully and ask yourself: How much money do I need for this business? And what mistakes should I avoid?
For these reasons, it is crucial to forecast cash flow effectively. Estimate worst-case, most likely case, and best-case scenarios. “If your worst-case scenario actually works, if there’s enough money in it, if you can deliver on those deliverables, it’s probably going to work for you,” McIntyre said.
A good rule of thumb is to overestimate costs and underestimate revenue. Prepare by having enough funds in reserve. If you do not have enough money, consider changing the business plan or spend more time preparing so that you can improve your position before you begin.
“Always include a buffer, not just for founding, but also for resilience. Buffer upward with costs and downward with revenue. Business almost never works out as well as you think it will. You can’t control closely the factors that influence your success. And you need to get some very clear cash flow forecasts going,“ McIntyre said.
Founding a business clearly takes capital. But so does expansion. Many companies are built around plans to scale, either gradually or rapidly. That requires being as realistic as possible and as pessimistic as needed. Try keeping overhead costs as low as feasible. Do not hire anyone until it is painful not to hire. Growing your business is almost impossible without access to capital, according to McIntyre.
Fintech companies offer online platforms for transactions, savings, fast loans, and crowdsourced equity funding based on software, the internet, and big data.
Equity
By funding with equity, you can increase the value of the business because it does not add debt to the balance sheet. Unlike a loan, you don’t have to pay it back. Instead, you pay dividends to investors, usually from profits, typically on a quarterly or annual basis. But if you sell the business, you’ll have to share the proceeds.
Equity is attractive for many founders when first starting a business and hence they spend lots of time pursuing investors. An equity investor will have many expectations that your company will need to manage over time. For this reason, you need an investor that is aligned with you and your business, McIntyre said. If you do not see eye to eye from the beginning, the future can become difficult, especially if the investor holds a controlling interest. If your investor has a 51% share, it might mean you someday have to do what they say, whether you like it or not.
Debt
Debt funding keeps you in control. But it’s not free. Debt is money you rent by paying interest. Nevertheless, borrowing can be less expensive than selling equity if there are solid prospects for financial success. “When you consider long term success for your business, debt is cheaper,” said McIntyre.
The most widely utilized form of finance is credit from a bank. Bank lending is relatively cheap, but somewhat hard to obtain. Banks do not extend credit unless the risk of non-payment is low.
To borrow, you’ll have to put something on the line as collateral, whether your house, your inventory, your equipment, or some other asset. Then if the business fails, the lender has something to offset the loan.
It takes at least two to three months, if not six to nine months, to get a loan. Factor this period into your business planning timeline, McIntyre advised.
Debt financing comes in two primary forms: a term loan or revolving credit. With a term loan, the company will make equal payments each month until the balance is paid off, whether the term is as short as three months or as long as 30 years. This can be problematic, however, if the monthly payment must come from cash flow, said McIntyre. It also puts more debt on your company’s balance sheet.
A revolving line of credit gives you access to funds that you pay down as wanted. By paying the outstanding balance down, you usually can gain access to a larger line of credit. You establish a credit history with a bank, which provides a good way to grow in the future.
Asset-based lending involves obtaining credit that is secured by a business asset. This might be a physical asset, such as inventory or equipment. Often it is a liquid asset, such as the company’s accounts receivable, i.e., the invoices due for payment to the business. This type of financing is sometimes called invoice factoring or invoice flooring. Many large importers offer a service called three PL, or third-party logistics. They will purchase your company’s product at origin and resell it to you at its destination. That helps ease cash flow, but the service costs money. One example is when an importer gives a roaster financing. They fund the roaster to buy the coffee, they transport it, and then charge an interest fee.
Gaining access to bank credit requires keeping close track of your business’s ratio of debt to equity as well as its revenues, cash flows, and profit margins.
Public sector sources
Government agencies in many countries help companies access bank finance, such as by providing a guarantee for part of a loan’s value. In the United States, for example, the Small Business Administration (SBA) will provide a guarantee for a qualified business of 50% to 85% of a loan’s value.
SBA has special low-cost loans for businesses and agricultural cooperatives in places that have been officially declared disaster areas, called SBA Economic Injury Disaster Loans (EIDLs). These have become increasingly important amid today’s rising tide of hurricanes, floods, wildfires, winter storms, droughts, and other calamities.
During the pandemic, SBA operated a special program called the Covid-19 EIDL, which provided $351 billion in loans of up $2 million each to some 3.9 million businesses. It also ran a $790 billion Paycheck Protection Program that covered eight weeks’ worth of payroll costs including wages and benefits as well as some interest payments. More than 92% of the loans were for less than $150,000. Most were forgiven.
Over the past 10 years, the banking landscape has begun to be reshaped by the entry of financial technology companies, known as “fintech” firms, which provide new digital platforms that facilitate transactions, savings, investment, and credit based on software, the internet, and extensive use of data.
Some fintechs specialize in various types of merchant cash advance. This is a lump sum cash loan that the fintech collects by taking a margin on the borrower’s daily credit card and debit card receipts. The advantage is that a company can easily gain approval, getting access to cash within a day or two. But the cost of this kind of advance is high. “Those are starting to get risky and difficult because you’re literally pulling out of your cash flow, and there’s no way to keep that from happening,” said McIntyre.
Other fintechs offer crowdfunding, providing a digital platform that helps a new company or project obtain money from lots of online contributors. Sometimes funders provide money as free donations, other times they expect to be paid back in interest, equity, or delivery of a product or service.
Risk profile
Be sure to assess the funding climate, suggested McIntyre. “There’s still a lot of cash sitting around, where people or institutions are looking into getting interest. It can be difficult, especially, if there’s some kind of risk involved for the investor or funder. But a lot of rejections can lead to a ‘yes.’ Don’t give up!”
Know what you are getting into and show the lender that you clearly understand not only your business’s growth potential but also risk mitigation. Work on emphasizing what the lenders want to hear: low risk for them.
Develop a clear understanding of your company’s bankability across three key criteria:
- Your business’s ratio of debt to equity as well as its revenues, cash flows, and profit margins.
- The stability of your business and its pattern of cash flows. Few if any financial institutions will simply accept forecasts. They need to see a minimum of three years of performance records.
- The risk profile of the industry and the business itself.
Sometimes it is possible to obtain a loan or equity investment from an individual: a friend, colleague, or relative. A private funder might lend you money based on a personal guarantee of some kind, formalized in a promissory note, or invest in your company’s equity based on ownership of shares.
Another potential source of money includes non-government organizations, foundations, and impact investment funds. These funders provide financing for businesses that help make the world a better place by improving social and economic welfare and the environment.
Whether you are approaching an acquaintance, a philanthropist, or a banker, tell your story well. “Finance people are people, too. Some of them have really boring jobs and are just dying to have interesting clients!” When you talk with them, don’t just hand over spreadsheets. Convey a sense of the purpose of the investment or loan.
Pay attention to how you speak with business counterparts. Your presentation style can affect your likeability. Be yourself. Convey your passion, joy, dignity, and excitement. Use your storytelling to link these feelings to your business. Pick the attributes of yourself that you feel work in this context. If you are funny, go for funny, suggested McIntyre.
Rejection is common, so you’ll need to approach a number of different institutions and people to increase your chance of success. If your request is turned down, don’t take it personally. It’s just business when someone has to say no. "As painful as that is to hear, it’s not a statement of your worth,” McIntyre emphasized.
When making a pitch, sustain your counterparty’s interest every step of the way until you reach the pre-approval stage. When you present information or respond to queries, pay attention to detail. Document what is happening in your business using tax reports, insurance documents, project management software, and so on. Stay focused and be consistent.
Be clear about what you are asking for. Learn how to speak finance and banking. Find mentors. Keep in touch with people. Ask for introductions and help and be sure to follow up. You can even send out handwritten notes, suggested McIntyre. Remember what the other person wants and center that in the conversation. Understand that it takes time to build a good network. Practice, ask for feedback, and get better.