Stage 3: Constructing the cashflow and survival models
The survival model takes money coming in from customers and takes money out to cover fixed and variable costs. By doing this we can work out how many sales we need to make per month to break even.

In any given month, assume you run a marketing campaign, make some sales, take customer payment and then pay your suppliers. Following the example given earlier:

  • Fixed costs: In the example above, these have been added up to a monthly total of £450. The example model also starts with the start up costs of £800 in this case
  • Marketing campaign costs: Calculate your cost per lead. So, if you intend to spend £500 on a typical marketing campaign, which will deliver 10 sales leads, then the cost per lead is £500/ 10 = £50
  • Sales costs: Calculate the cost per sale. You estimate that you will convert 6 of the 10 leads and take 6 bookings. Selling literature and postage is the only variable sales costs which will cost £10 per lead (£100 in total). So the cost per sale, in this example, is the total marketing (£500) and sales spend (£100) divided by the number of bookings (6) so £100 per sale. So, it costs your business £100 to generate a sale, which is called the cost per sale. In time, you may well become obsessed with the costs per lead and cost per sale
  • Variable margin: Take customer payment and pay suppliers (including other non sales and marketing variable costs).The average booking is worth £1,000, of which you pay suppliers £750, leaving £250. However, you spent £100 generating the sale, leaving £150 of variable margin
Each sale generates £150 variable margin, £150 more than the variable costs of generating that sale. So this business needs to sell three sales per month to cover its fixed costs and just break even. That is fixed costs (£450) divided by variable margin (£150).
 

Now you have done all that work, you should also construct a cash flow model. The final assumptions are that you receive customer payment and pay suppliers three months after you incur the costs of marketing and selling. You also intend to generate 6 sales per month. This generates the following cash flow model.


As you can see, even when you are selling 6 packages per month, the business takes 12 months to move into holding a profit. You have generated more profit, but it hasn't worked through the system yet.

The key point being that the business will need to fund the negative cash balance with an overdraft or loan of up to £3,950. The interest on this is itself a variable cost! Starting off with that knowledge is a key to surviving your first year. Things to think through are:

  • Are you confident that your start-up and fixed costs are realistic?
  • Are your assumptions on cost of sales, value of a booking and supplier costs realistic? The section on Marketing and Sales helps you test those assumptions
  • Given the impact of costs in the early months, how can you reduce your start-up and ongoing fixed costs?