Incubator Cash Flow Management

Transcription

1 Incubator Cash Flow Management This information originally appeared in A Comprehensive Guide to Business Incubation: Completely Revised 2nd Edition, 2004 by the National Business Incubation Association. Any incubator that has experienced the sudden departure of a client or been hit by an unexpectedly expensive repair or utility bill knows how hard it can be to manage cash flow and avoid cash crunches. Take the case of the Center for Emerging Technologies (CET) in St. Louis, Missouri. During the center s first summer of operation, Vice President and Chief Operating Officer William Simon had no idea how much its air conditioning was costing until he was holding an $8,500 electric bill for the month of July. We didn t have enough money to pay it, he says. I called the electric company and said, Hey guys, this is more than I expected, and it s more than I ve got. I ll come over with $4,500 and please don t turn off our electricity. Subsequent payments in the next two weeks paid off the difference and disaster was averted, Simon says, but not until management found itself raiding clients security deposits to cover operating expenses for the remaining summer months (the security deposits were subsequently restored). Simon s story illustrates one type of cash crunch a sudden short-term rise in expenses or drop in income that leaves incubator management searching for a quick fix until equilibrium can be restored. The Arizona Technology Incubator (ATI) in Scottsdale, Arizona, faced another type of cash crunch, one that was structural, long-term and that led, ultimately, to the incubator s demise, says Woodrow Maggard, former ATI director and current director of the University of Buffalo Technology Incubator (UBTI) in Buffalo, New York. ATI s building was debt-financed at market rate, so its income from client rents its only stable source of income went to monthly mortgage payments, he says. The best you could do was break even, he says, and that was if you charged all of your companies market rate. Because it was paying a mortgage on 100 percent of its space, ATI was subsidizing all its common areas and any leasable space that wasn t occupied, Maggard says. After grants and the goodwill of financial supporters dried up, the incubator was forced to close. We never had enough cash, Maggard says. The cost of the lease payments on the building was constantly eroding any effort to gain cash flow. Although problems as deep-rooted as ATI s can really only be averted by making prudent major decisions during the incubator planning process, more situational problems don t always have to be cause for panic or hard times. But how can incubator managers anticipate every sudden jump in expenses or every sharp drop in income? They can t with absolute reliability, managers say. They can, however, do careful planning and develop financial systems that track income and expenses and help them survive tough times. By budgeting carefully, being disciplined about collections and spending, and saving for rainy days, incubators can go a long way toward making sure they have the cash on hand to deal with any fiscal challenge they might face. Good Projections Many cash flow problems can be avoided with detailed, disciplined, no-assumptions-made projections and planning, incubator managers say, both for the short term and the long term. This means doing a line-item annual budget, broken down month by month and based on previous fiscal years, with flags on anything that may need adjustment. Cash flow analysis requires tracking annual and monthly inflows and outflows of cash, as well as being clear about what constitutes a truly reliable source of income, says Lisa Ison, president of The New Century Venture Center (NCVC) in Roanoke,

2 National Business Incubation Association Virginia. Ison says incubator managers should never assume that grants will always be available. [Look] at your actual line items and possibilities for income that you can generate without using those sources, she says. When the Business Technology Development Center (BizTech) in Huntsville, Alabama, creates its annual budget, management assumes that the incubator will receive no grant support even though it regularly secures that kind of income, says Dick Reeves, BizTech president. The value of conservative planning also applies to estimating occupancy, managers say. An incubator that assumes a constant high level of occupancy and budgets around that assumption is setting itself up for a rude awakening, says Devron Veasley, director of the Bessemer Business Incubation System (BBIS) in Bessemer, Alabama. Even though BBIS regularly maintains 80 percent to 85 percent occupancy, Veasley says he would never budget that high. I base my projections on my break-even point based on my expenses, he says. For me to break even, I need to have about 74 percent occupancy, so I make my budget out based on 75 percent. Anything that comes in after that, I consider gravy. What is true for income is also true for expenses, managers say. Incubators should assume that utility bills are going to go up and that repair expenses could be higher than anticipated. Veasley, for instance, averages his utility bills from the previous year and adds 5 percent to arrive at a projection for the next fiscal year. To take as much variance as possible out of expenses, Veasley also recommends getting as many of them as possible into the fixed-cost category of the budget. For BBIS, this means negotiating fixed-rate, long-term contracts for janitorial, telephone/internet, equipment repair and maintenance, and other services. It also means negotiating labor and replacement costs into service contracts regular payments in the event equipment must be replaced. Although adding this insurance against costly equipment replacement raised BBIS s monthly payment to $300 from the $184 it was paying for a maintenance contract that didn t include replacement parts and labor, Veasley believes the contract pays off in peace of mind. I ve had to have five [air conditioning] compressors replaced for $1,000 each and I haven t paid a dime extra for them, he says. Although detailed one-year forecasts of expenses and income are critical, incubator managers also should look two to three years into the future. A new roof, the likely departure of a client that occupies a significant amount of space, and replacement of carpeting all are examples of expenses that an incubator should try to anticipate more than one year in advance, managers say. Day-to-Day Vigilance Once an incubator has a line-item, monthly budget in place, it must manage cash flow judiciously so that its day-to-day operations reflect its projections, managers say. To achieve this, managers load their actual inflows and outflows into their accounting program regularly (week-to-week, if not day-to-day) to determine how close their actual financial situation is to what the budget calls for. We track our budget daily to make sure that we re on target, Ison says. A critical step toward meeting projections is collecting rents, service fees, and other sources of income on time, Maggard says. For cash flow, you should be very diligent about collections, he says. You can t have any sloppiness in that area. If somebody s not paying you, you need to get on it right away. At NCVC, delinquent clients pay a 5 percent penalty for being one day late on their rent and/or service fees, Ison says. If your monthly rent is $500, then you re going to pay a $25 late charge, she says. After a couple times they get popped with that, they don t pay late again. Given the challenges that start-up businesses face, however, many incubators including NCVC try to be flexible about client payments while still keeping an eye on their own cash-flow needs. For example, BBIS considers 65 percent of clients rent as payment for the actual space leased and 35 percent as payment toward the cost of providing common areas and utilities. If clients are experiencing financial trouble, Veasley allows them to lower their monthly rent payments by 35 percent, so that they re paying only for the space they occupy. The fact that he budgets an-

3 nually for lower occupancy than he s able to achieve allows him to offer his clients this flexibility, he says. In the rare event that a client is seriously delinquent on payments, however, and must be evicted from the incubator, Veasley turns to a professional collections agency to collect what the incubator is owed, thus protecting his budget, he says. In addition to making sure clients pay on time, incubators should have some method in place to monitor how long clients are planning to remain in the incubator, managers say. Clients sometimes break leases, so keeping up-to-date with clients plans is important in order to fill unexpected vacancies, either through recruiting new clients or finding existing clients who want to expand. Raising Cash Here are some tips managers can use to generate money. Adjust rents. Expenses go up; it s a fact of life. Inflation alone pushes utility and maintenance costs higher every year. Where do incubators find the revenue to keep pace? Consider factoring an annual increase into your clients rent, managers say. When Devron Veasley took over as director of the Bessemer Business Incubation System (BBIS) in Bessemer, Alabama, in 2000, he realized clients were paying the same rents they had paid since Costs had gone up to the tune of about 2 percent every year, he says. The incubator was just pouring money out the door and not bringing enough in. Veasley instituted a 7 percent rent increase the next year and now raises rents 5 percent annually. I didn t have anybody balk, he says. Become the middleman. The Center for Emerging Technology (CET) in St. Louis, Missouri, often achieves an annual surplus in the Telecom section of its budget by managing its own phone system and network/internet service, says Vice President and Chief Operating Officer William Simon. The CET contracts with Southwestern Bell for 400 phone numbers on a wholesale basis, then manages its own phone system, renting clients phones for $7 to $12 per month and charging them $35 per line/month for phone service, voic , installation, and maintenance (Southwestern Bell charges $48 per line, Simon notes). Clients also pay metered long distance and $8 per port/ month for T-1 Internet service and networking, he says. After the CET s annual costs of $130,000 to $140,000 to provide and maintain these services are accounted for, Simon says, the incubator generally ends up with a $10,000 to $20,000 annual surplus. Get creative. We look for all kinds of little things to do that generate revenue plus giving us exposure, says Lisa Ison, president of The New Century Venture Center (NCVC) in Roanoke, Virginia. For example, during Virginia s Business Appreciation Week in May of 2004, the incubator held the 1st Annual NCVC Commerce Cup, a corporate basketball tournament pitting local teams against one another. Between participation fees and sponsorships, NCVC raised more than $5,300, Ison says. The incubator also brings together clients, graduates, and board members to sell concessions at the local civic center and plans to hold a surplus furniture sale. We figured out that we re probably sitting on a gold mine here, Ison says. Lease space to service providers. BBIS offers the opportunity for one accountant, one lawyer, and one insurance agent to set up shop in the incubator once per month for a year, Veasley says. But not for free. Each vendor pays $2,000 per year to gain access to clients each month and get the chance to create relationships that could pay off in the future. Provide a service. NCVC hosts business seminars up to three times per month, Ison says. While clients pay nothing to attend, outside businesses pay $69 per person, or $59 per person if an organization sends three or more people. Depending on participation, NCVC brings in between $1,500 to $2,000 per seminar and brought in $21,000 in gross revenue from its FY2003 seminars. It s basically a cash cow for us, Ison says. Associated expenses include refreshments, fees for some presenters, and staff time to contact presenters, set dates, and develop and disseminate marketing materials via fax and . Ison estimates that managing the seminars takes about 25 percent of one of her full-time staff member s time. She explains that these tasks take less time as the years go on, however, since they re working with established presenters and the marketing materials need only minor alterations each time. An added bonus, according to Ison: NCVC [is] recognized as the place to go for training that is timely and affordable.

4 National Business Incubation Association On the outflow side, one way incubators can avoid short-term cash crunches is to stagger expensive equipment upgrades or capital purchases throughout the year, Simon says. For example, CET needs a new voic system and a new computer. The incubator will make the two purchases months apart so it s not paying for both at once and depleting its available cash, he says. Planning to make large purchases late in the year can also be a good strategy for making sure operating cash stays at acceptable levels, Reeves says. Our budget this year calls for the replacement of some of our computer systems, he says. We have an allocation for that, but I won t spend it until the middle or latter part of the year when it becomes clear that we won t need that money for other purposes. Delaying complete payment of large bills or purchases is another strategy incubators can use to avoid cash crunches, Veasley says. For instance, BBIS received a $7,500 bill in January for roof repairs and it didn t have the cash on hand to pay it all at once. Conserving Cash Here are some tips managers can use to conserve money. Shop it around. With expenses such as insurance programs and maintenance contracts, incubators can take advantage of competition by soliciting a variety of quotes and/or bids when contracts expire. The New Century Venture Center (NCVC) in Roanoke, Virginia, for instance, discovered it could save $333 annually on its directors and officers insurance by switching providers, says NCVC President Lisa Ison. However, NCVC doesn t seek to switch health insurers because of the hassle it would cause employees to learn a new system and perhaps find new healthcare providers, Ison says. Incubators should be careful about switching partners having stable relationships with reliable providers can pay off, too. One of the most important things for me is who the people are, says William Simon, vice president and chief operating officer at the Center for Emerging Technologies in St. Louis, Missouri. Will they take twice as long to get the job done? Do they know where everything is? Conserve energy. With energy costs high, incubators can t afford to be casual about their utility use, managers say. Turning off lights and encouraging clients to do the same is one way to conserve, they say, but heating and air conditioning costs are much higher and merit more attention. Keeping thermostats out of the control of clients can go a long way toward minimizing these costs, Ison says. NCVC s thermostats are covered and locked, she says, but incubator staff can access them. Being mindful of the weather can lower costs, too, says Devron Veasley, director of the Bessemer Business Incubation System in Bessemer, Alabama. I m in Alabama, he says. During the winter I m not using my air conditioning because it s 65 degrees outside. Don t pay rent. An incubator ideally should be a debt-free building, says Woodrow Maggard, director of the University of Buffalo Technology Incubator (UBTI) in Buffalo, New York. Even incubators that don t have prime sponsors such as a university or economic development agency should seek sufficient initial support to build, renovate, or acquire their own building outright, he says. Incubators that don t endanger the long-term viability of their programs, he says. The building can really be the biggest albatross that you have, he says. You should not have to be paying debt service or lease payments because when you do, you re on a slippery slope that you can often never get over. Be thrifty. There are many small ways an incubator can save money, managers say. For example, take advantage of sales and other tax exemptions incubators are entitled to under local, state, and federal law, Simon says. Whenever we buy food or office supplies, we have a Sam s Club card that says not-for-profit, he notes. We make sure everybody knows, even to the point that anyone who hands me a receipt that has sales tax on it, I say, Why didn t you take the sales tax exemption letter with you? Incubator staff can make personal choices that result in savings, too, says Veasley. When Veasley travels, Instead of paying $1,000 to go on some of these trips, I say, I ll go stay at the Holiday Inn.

5 I went into the contractor, and I negotiated to pay it over a three-month period, Veasley says. Quite often, you re able to do things like that. Rainy-Day Reserve Even with careful planning and disciplined day-to-day cash management, incubators may face unforeseeable cash crunches. Catastrophic building or equipment failures, unexpected client departures, and/or serious economic downturns can leave an incubator with much less cash on hand than it planned for in its budget. This is why it s important to build a cash reserve, open a line of credit, and/or have a sponsor that can step in with a short-term loan or additional operating money when plans go sour, managers say. Estimates vary on how much cash is appropriate to keep in reserve ranging among interviewees for this chapter from the equivalent of one month s operating expenses to a full year s worth but managers agree a cash reserve is important. Ideally, incubators can develop a rent structure that allows them to make a monthly contribution to their cash reserve, managers say. NCVC puts ten cents per square foot of its rental income into its reserve fund, for example. With an annual operating budget of about $300,000, the program has saved about $20,000, which it takes care not to budget as available cash, Ison says. The incubator also has a line of credit but has never had to use it, she says. Although BizTech maintains a cash reserve, Reeves determines the amount to add or remove according to whether the incubator achieves a budget surplus or shortfall in any given year, he says. Because it has only 6,500 square feet of leasable space, the incubator never meets its budget entirely through rent or fees for service, but through other sources, such as grants, loans, and the occasional return on equity stakes in clients, he says. When financial crises arise, BizTech turns first to the Huntsville city government for short-term loans, Reeves says. The city can lend up to $100,000 and does not charge interest. If the incubator needs a larger amount of cash, it still has the flexibility of utilizing a line of credit (with interest) that is secured at a local bank. Estimates as to the appropriate size of a line of credit vary, but Maggard estimates that an incubator should negotiate a line of at least 10 percent of its annual operating budget. However an incubator achieves it, managers agree on the importance of having money available to tap into when the unexpected occurs. Cash reserves, lines of credit, and/or strong relationships with reliable financial sponsors are excellent ways for incubators to cover shortfalls even the most sophisticated planning can t predict. By Justin Boyd Justin Boyd is a freelance writer and playwright. He is the author of a book on business incubation.