Ceramic Business Financing – Part 2: Money you need for your business

How money is generated

Armed with the wisdom about how you should think about financing your studio (see part 1), let’s start to work on how much you need and, later, some ideas where to find it.

Your needs will be totally dictated by the stage your business is in. Not yet started? Recently started? Mature?

We cannot possibly cover all of these three stages but, luckily the general rules apply to them all. It’s just a matter of scale.

Start very slowly

I have seen ceramic studio businesses starting around the kitchen table, with a few students from the neighborhood, a kiln in the basement and tons of enthusiasm radiating from the owner to the students. Or – a potter starting in the garage with little more equipment than a small blender, an extruder, a potter’s wheel, a slab roller and a kiln. The fascination in ceramics starts where  moist clay or cast slip, decorated or not, meet heat.

 

In the business of ceramics you know that it can be started with hardly much more than your personal savings, the above basic equipment, your personal strength, intelligence and entrepreneurial “get-up-and-go” spirit.

The magic of creating or teaching, finding customers as enthusiastic as you and lots of patience and a vision, is the start of any business. In ceramics, the need for capital can be very small.

 

As you grow, you can set a very slow growth having the profits from it finance the gradual acquisition of more equipment and fixtures and a growing amount of inventory. Or – if you have access to more money – you can achieve steeper growth curve and become an established (often referred to as “mature”) business in a much shorter time. Time, speed, skill and your ability to live within your means will dictate how long that journey takes.

As simple as it sounds, this is how money is generated and businesses are built – starting small, adding cent to cent, dollar to dollar and avoiding overhead and other costs for as long as it is avoidable.

As you grow, though, certain economic challenges will face all of us. How you deal with them is super important. And the more you understand about the financial aspects of growing a business, the more you will enjoy that journey and the fewer problems you will face. If you do not understand how your accountant can declare that your business is highly profitable and taxes are due, but you lack the funds, then this chapter is for you. (See foot note at the end of the chapter).

 

Let’s calculate how much money is invested in any business: Let’s learn the language of accounting

Long term or Fixed Assets

 

The easiest part is to add up what the investment in machinery, equipment, furniture and fixtures will be. After all, if you are in a start-up situation, these objects all exist already in your dream – you can see them even before they are yours. This part of financing is called the fixed assets. You have a very good idea what you need and probably already have seen at other studios, similar to what you are dreaming about, and thus know from their experience what to look for and where to look.

Depending on how ambitious you are and the funds you have at your disposal, you can dovetail your fixed assets to what your bank accounts allows you. All equipment you need exists as new or used. Take a good look at what used equipment is available. New equipment looks good, may be more efficient and have more up-to-date “bells and whistles”. But what do you need as a minimum? Talk to colleagues and compare notes. Not only may you get good advice, but your best friend might have just one piece of machinery or tools that you need – available at a good price.

 

Used equipment can help to get started

Used ceramic equipment is an industry in itself. Contact someone like Art Mohr Corporation, Clay Machinery Sales, Inc. in Los Angeles, CA or many other reputable and knowledgeable sellers of used machinery, equipment and accessories. Check with your local equipment auctioneers – some auction houses sell used ceramic equipment and may have real bargains for you. And, by all means, ask kiln manufacturers for advice in regards to used kilns. They may sell them and have good recommendations on what you should be looking for.

 

The buying process

Take your time and do not fall for the first attractive offer you get. Once the word is out that you are looking, offers may come from the most unexpected sources. Be careful though, and explain in depth what your needs are – how you will used it in your business. Can you get the equipment with a warranty? If you buy from a seller of both new and used equipment, they may have a repair shop and offer warranties on refurbished machinery.

 

Go on line and check out both the ranking of the brand of equipment you are buying and the firm that sells it. And discuss the service factor – is there support available over the phone? What are the repair costs? Compare one complete offer with another. It’s a long term investment.

Also check out both the ranking of the brand of equipment you are buying, the firm that sells it and what service they offer. You are thinking about heavy investments so take your time.

 

The investment in ceramic equipment and other long term equipment varies strongly with the type of your ceramic studio as pointed out above. For instance, a potter may have substantially lower investments than a teaching studio which typically has relatively high demand for space, show room, teaching area, party room, kiln room, furniture, room for casting, storage, display, shelving and other.

We will revert later in this book to the subject of finding machinery and equipment that is ideal for you under the category of operating your studio. For now, let’s leave the subject and revert to the financial side.

 

Since procurement of fixed part of your investment takes place over time, it is easy to calculate and to stay on top of. An asset that will have longer life in your studio than five years should be classified as fixed. Check with your accountant.

Short term assets – inventory and accounts receivabInventory

 

Books have been written about various approaches to having a balanced inventory. Without inventory – be it raw materials, work in progress or finished goods, your business cannot function. The trick is to have just the right amount. It’s all too easy to have too much inventory. Any business owner’s aim should be to know how much to stock of each kind, vs. how much you actually have, and have a smart way of quickly making a decision how to fix the difference.

How much of finished inventory?

 

For a small business, like a ceramic arts studio, there is a need to find a “short-cut” way to calculate where to strike a balance between having too little – and thereby losing business – or too much and thus having ‘dead money” on the shelves. By “short-cut”, I mean an easy formula to calculate how much to stock. In most cases, that formula is set, by you, based on sales and expressed in turn-over per time period. Example: A fast moving item should be classified as an “A” item in your books and might require a substantial inventory. How many items you need to have on your shelves is dictated by:

  1. how much time it takes to procure the item – the time between placing the order and receiving, unpacking and putting the items away on your shelves, anhow many items you sell per a specific period of time, such as one month.

2.         how many items you sell per a specific period of time, such as one month.

Example: If you sell or use up 30 items per month (which is easy to find out from your sales records) and it takes an average of two weeks to get an item into your stock, you should, ideally, order 15 items twice per month (have 15 in transit as you sell out the 15 you have in stock).  HOWEVER, “ideally” seldom exists in business, so you need a safety stock, in this case of, say 15 items. This gives you a margin of variation in your sales as well as the time it takes to get the item from your supplier. So, you will order 15-30 items each time for as long as your sales stay stable and the delivery time does not vary. Make 25 your order point.

 

From all this, you can easily see that managing inventory takes constant vigilance, flexibility and need to correct.

Therefore, inventory control is part of your daily routine.

 

Different kinds of ceramic studios have different needs for inventory. The financial ideal – to have zero worth of finished inventory – is to only make what you sell, to order. Some potters may get away with this, kudos to them. But other types of ceramic businesses might not be so lucky. Even if this can be achieved, a potter will need to constantly control work-in-process and raw materials, such as clays, minerals, chemicals as well as disposable tools, spare parts for machinery and many other items.

 

Spend time on setting up an ordering system that works for you and train your most trusted employee to understand it and learn how to manage it.

Accounts receivable

 

This short term asset consists of what your customers owe you – the credit you have extended to them. My recommendation to you as a small business owner is to not extend any credit at all. That’s the ideal. However, reality can wiggle its head and – for a variety of reasons – you end up with some customers owing you money.

 

Do not publish that you give credit. Publish – if necessary – that you do not. If you have accumulated some receivables from customers, how to do get out of it? Here is a tip. Be open with your customers who owe you money, explain to them that your business requires you to invest in more inventory, which is why you cannot afford to extend the credit. Give those customers a time period to work it down to zero, say 30-60 days.

State openly on your price list that, in order to give better service, you have to keep substantial inventory and cannot afford to extend credit. That way, you have signaled that everybody gets treated the same way. In today’s market, the use of credit cards really makes it unnecessary for a business to offer any credit at all. Just say no.

 

Adding up your short term investments and the money needed

Once you have researched and investigated all the different types of short term assets – finished inventory, work in process, accounts receivable, raw material (when applicable) – you can add them and calculate how much money you need to buy it and to store it. You can deduct the amount of accounts payable to your suppliers (they may give you 30 days terms), where the supplier under these conditions acts as a small financier of your business.

 

How much of liquid assets do I need?

Once you have researched and investigated all the different types of fixed (long term) assets and short term assets as described above, we can add it up and turn your attention to liquid assets such as cash and bank account balances.

 

In the example below, I estimate what you will be needing in a typical mature business. It might take you years to get there, but – as you know – you have to think long term.

 

Let’s assume that the fixed assets you need add up to $25.000.00 – new and used.  Let’s further assume that your investment in inventory and accounts receivable amounts to $35,000.00. You then need $60,000.00 before calculating your needs for cash (cash on hand plus bank deposits).

 

A cash cushion

A business owner needs to be prepared for both sunny and rainy days. That preparation really boils down to having a cushion of cash. We have all known studio owners who were hit by illness, whose spouse or child took ill or by many other unexpected calamities. When bad times strike, you must be prepared – if you want to continue your business. Even if you don’t, you may be liable for outlays – such as the remaining term of your lease or other liabilities.

 

Every studio has a different situation – it raises the question: How much cash does a disruption represent? Only you can figure that out. How much of fixed costs do you have to pay to survive a closing down of your business for, say, three months? You will have to pay the lease, part of the utilities, taxes, insurance and other fixed costs. And you need to support yourself and perhaps your nearest and dearest during that period.

To calculate that may not be the most invigorating exercise for you to embark on, but you should consider your circumstances, your health, your commitment to staff and all other costs that would continue to rack up a balance should you have to temporarily close down.

 

Do it by month and then make your best estimate on how long a worst type of scenario you should be prepared to weather. It for nothing else, it will bring into your awareness that a cash cushion is a must.

 

Working Capital

Why is it so important to know about working capital? What is it? How do you get an easy handle on it?

 

By most definitions, working capital is defined as cash, money in the bank, inventory and accounts receivable (what the customers owe you), less short term accounts payable (what you owe suppliers and other creditors –such as your credit card balances and your landlord –  payable within less than a month).

All the above items vary quickly over time. This makes it the more important to know how much you have of each. Controlling working capital is the most important, short term obligation of any business owner.

 

Working capital must be a positive figure and should increase over time, if your business is profitable. All business decisions should be made taking into account its impact on your working capital.

Your books should therefore be set up in a way where you can get an immediate reading of those five asset and liability classes (cash, bank accounts, inventory value, and accounts receivable less short term accounts payable).

 

Here is where your accountant plays a very important role. He should be part of setting up your accounts (chart of accounts) and guide you to understand these extremely important ones. Make it a daily routine to go over them, analyze them and watch how they develop – grow and contract.

Working capital is needed for any business – be it IBM or your studio. Without sufficient working capital, your business will fail.

Adding your needs for capital together

We already calculated the total of fixed and short term assets for a mature ceramic business to be $60.000.00.  If you calculate that you would need $30,000.00 for daily operations and to stay in business during a three months’ shut-down, then you should have a total of $90,000.00 invested in your business in good as well as bad times. Remember to keep your cash cushion as per your need, segregated and ready to use when the need may come.

How to finance your total need for capital will be covered in the next article.

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Foot note about profits: If your accounts show a profit and you are lacking cash, you have too much inventory or machinery. Trim those assets down as soon as you can = convert them to cash.

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© 2011 by Rolf E. Ericson, Oneonta, New York, publisher. All rights reserved. Photocopying, reproduction , copying, or redistribution of any kind in printed or electronic form is strictly prohibited without written permission from the publisher.