Would-be skateboard entrepreneurs face a host of issues.

When a market gets hot, people start companies. When the capital costs and entry barriers are low, new start-ups are much more common. When there’s enthusiasm for the industry and the lifestyle, people often start them for all the wrong reasons and without adequate, or any, business planning. It looks like easy money, but it usually isn’t.

Well, God bless naïve, enthusiastic entrepreneurs, because if everybody understood the risks and stresses of starting new businesses, none would ever be started. I don’t want to discourage anybody from starting their business, but I’d like them to know what they are getting into, what’s going to happen if they have some early success, and why it’s too late to begin when the market is already hot. The genius of the entrepreneur is in starting his or her business before everybody else sees the opportunity.

Just for fun, let’s say you want to start an independent skate-shoe company. Now? Today? Okay, okay, stop laughing. Pretend it’s two years ago.

In The Beginning

You’re a sponsored skater with a good reputation, and a following among local retailers. You don’t like the shoes available to you. Conversations with retailers you know make it “obvious” they’d be receptive to some new colors and designs. Response to your color sketches and description is positive. “Cool! We’ll buy them for sure,” they say almost without exception.

Ka-ching!” you think. Easy money, here I come. Not that anybody gets into the business for the money, of course …

Let’s make this simple. Magically, you’re through the product-development cycle and are ready for production. You did all the work yourself. A friend introduces you to a manufacturer who loves you and your shoes so much he agrees to produce a thousand pairs with no money up front, and he gives you 60 days after delivery to pay. Orders from some retailers materialize, though not from everybody who said they would buy, and not always as large as you’d like. You successfully grovel, taking the “I’m just a poor skate entrepreneur” approach with your new customers, and they reluctantly agree to pay you cash on delivery.

Your shoes arrive on time (right). All the people who said they’d buy your shoes buy them (sure they do). They all pay you cash as promised (uh-huh). You put the money in the bank and earn interest until you have to pay the factory that made the shoes for you. The shoes all sell through great (of course). Reorders flow in like water over Niagara Falls during the rainy season. What a terrific business this is. Here’s what your income statement for this little business looks like after the first 1,000 pairs.

Net Sales $25,000

Cost of Goods $15,000

Gross Profit $10,000 (40 percent)

Operating Expenses$2,000

Pretax Income $8,000

Remember that everything went perfectly. Also, you worked for yourself for free and did everything yourself. Your operating expense was almost all for travel and communications. At the end of the day, you’ve got yourself a nice little 32-percent profit margin. Isn’t that wonderful!

Having run a distributor that was selling imported product, I am here to tell you that everything working right is a full-on, drug-induced, hit-your-head-while-skating-without-a-helmet hallucination.

But it’s a great hallucination to have, so let’s assume it continues except for a couple of little things. You’re so hot that your next order is for 10,000 pairs.

The Next Step Up

Your supplier still likes you, but hey, this is business. With an order that size, he wants a letter of credit or a deposit up front, and you’ll have to pay him the balance when he ships the shoes. Remember, though, that this is a hallucination, so he gives you a break and says you just need to pay him when the shoes ship.

Your retailers still like you, but hey, this is business (you’re starting to hear that a lot ayour company grows). They want 45-day terms just like they say they get from the other companies. The 10,000 pair cost you 150,000 dollars, including freight and duty. Your supplier says, “I’m ready to ship, send the money.”

Details like this can really put a damper on a perfectly good hallucination. The bank won’t lend you any money, your credit-card limit isn’t quite that big, and none of those lottery tickets you’ve bought have been winners. You need 150,000 dollars or you’re out of business. Let’s assume somebody comes along and lends you the money for only an exorbitant interest rate and doesn’t want 50 percent of the equity in your company to do it. Remember, this is a pleasant hallucination.

The shoes are delivered to you, and in turn, to your customers. You’ve sold the shoes, you’ve got the same 40-percent gross profit that you had when you sold 1,000 pair, but this time it’s 40 percent of 250,000 dollars, or 100,000 dollars.

Inconvenient Realities

The expense side looks a little different, though. You had to get some help warehousing and delivering the product. Retailers want some service, so you need some phone lines and somebody to answer them. Some promotional product has to go out the door for free. The guy you borrowed the 150,000 dollars from wants interest. You’re still making money at the bottom line, but that 32-percent pretax margin has evaporated. If you’re lucky, it’s still as high as fifteen percent but heading south fast as you become an established company.

Oh, and by the way, you’ve got no cash. Your retailers aren’t paying you for 45 days and, strangely enough, not all the cash shows up exactly on the 45th day. But the people you’re hiring to man the phones and deliver the product don’t seem to want to wait 45 days to get paid. It’s the lament of the entrepreneur to their accountant – if I’m making so much money, how come I can’t pay my bills?! Now, waking from our dreamlike state, we find that the supplier wants a letter of credit before he’ll produce any more, and the order isn’t really big enough to get his attention anyway. Retailers are asking about your team and your promotion budget. Some shoes sell and some don’t. Certain retailers you really want to keep carrying the shoes want a credit for the ones that haven’t moved. There’s so much to do that you need to hire more people to help you. The government wants you to fill out a bunch of paperwork, and they want their piece, too. You’ve got every cent you can find invested in the business, and it’s barely enough – for the moment.

Congratulations – you’re no longer an entrepreneur, you’re a manager. Overall, your income has increased. But your net margin on each pair of shoes sold has declined as the cost of running the business gets bigger.

You didn’t do anything wrong. This is all normal stuff. Every time volume increases and margins decline, more working capital has to be invested in the business. Working capital is nothing but the money you have to spend to pay bills, get product made, and market your brand while you wait for retailers to pay you. Almost every successful, growing business I’ve ever seen has working capital crunches as a normal part of growth.

Managing By The Numbers

What can you do to avoid this financial hand grenade? Nothing. It comes with being in business. But you can try and minimize its impact by a little planning. Do it on a computer or a piece of paper. Here’s a format I’ve used with some success in a variety of businesses. Don’t get fixated by the categories I’ve used. Change them to work for your business.

INCOMEJan. Feb. March Etc.

Beginning Cash Balance

Sources of Cash

Cash Sales

Collection of Receivables

Borrowings

Other

Total Sources of Cash

Total Cash Available:

EXPENDITURES

Product Purchases

Payroll

Rent

Utilities

Advertising

Phone/Fax

Miscellaneous

Total Uses of Cash:

Ending Cash Balance (Cash Available Minus Total Uses):

The beginning cash balance is probably whatever is in your checking account. The ending cash balance each month becomes the beginning cash balance for the next period. Depending on how quickly your situation is changing, your estimate of expenses can usually be based on your experience. But remember that just because you get your phone bill in July doesn’t mean you pay it that month. Typically many of your operating expenses will be paid in the month following receipts, and your cash flow has to take this into account.

Don’t get too caught up in the process of creating a perfect model. Get it done and work with it. Modify it as you learn more. Look at your projections versus what actually happens. Creating the model isn’t really where you get the benefit – using it and watching the variables change with each other is. It’s a lot like learning a language. You only get better with practice, and as soon as you stop speaking it, you start to lose it.

Rules To Live By

Rule one, then, is don’t try to grow your business faster than you can finance it. Rule two for the budding skate entrepreneur is to know the difference between starting a company and running one. Get the help you need. Rule three is that it’s easy to sell when you’re new and small, and harder as you grow. Know how you’re going to compete. Follow these three rules and maybe the glamour of having your own company won’t wear off so quickly.

Jeff Harbaugh has spent seventeen years working with companies to help them grow, the last seven in action sports. Reach him at (206) 232-3138.ginning cash balance is probably whatever is in your checking account. The ending cash balance each month becomes the beginning cash balance for the next period. Depending on how quickly your situation is changing, your estimate of expenses can usually be based on your experience. But remember that just because you get your phone bill in July doesn’t mean you pay it that month. Typically many of your operating expenses will be paid in the month following receipts, and your cash flow has to take this into account.

Don’t get too caught up in the process of creating a perfect model. Get it done and work with it. Modify it as you learn more. Look at your projections versus what actually happens. Creating the model isn’t really where you get the benefit – using it and watching the variables change with each other is. It’s a lot like learning a language. You only get better with practice, and as soon as you stop speaking it, you start to lose it.

Rules To Live By

Rule one, then, is don’t try to grow your business faster than you can finance it. Rule two for the budding skate entrepreneur is to know the difference between starting a company and running one. Get the help you need. Rule three is that it’s easy to sell when you’re new and small, and harder as you grow. Know how you’re going to compete. Follow these three rules and maybe the glamour of having your own company won’t wear off so quickly.

Jeff Harbaugh has spent seventeen years working with companies to help them grow, the last seven in action sports. Reach him at (206) 232-3138.