Most new business owners think that increasing sales is the solution to generating cash. What they fail to realize is that they require cash to generate additional sales. It is important to remember that time is required to generate new sales.
There may also be a collection period, and there are overhead costs to consider as well. Consider an example.
D3 Team Travel has been in business for a year. It generated $365,000 in sales during that first year.
From month-to-month, it has been able to maintain $1,500-$2,200 in cash-in-hand. Its goal is to increase sales by $50,000 during the second year of operation. The company's gross profit (GP) margin is 25 percent of sales. The average collection period (ACP) is 45 days.
The vice president (VP) of sales estimates the extra overhead (EO) to generate the extra sales (travel expenses, advertising, and promotion) will be $8,500.
Use the following formula to determine the extra cash required (ECR) to generate this $50,000 sales increase: ECR = ((ISG - GP + EO) x ACP)/365 where, ISG = Increase in sales goal GP = Gross profit in dollars on the sales increase goal EO = Extra overhead costs to meet sales increase goal ACP = Average collection period in days Determine the ECR to support D3 Team Travel's goal to generate an additional $50,000 in sales over the next year.
Considering its average monthly cash-in-hand, would you recommend that it fund the $50,000 ISG? If so, justify your answer with hard figures. If not, determine an ISG that you would support, if any, and justify your answer.