You just successfully crowdfunded your hardware product and you finally have some revenue in the bank. Congratulations, things are looking up. However, I am sure like most hardware entrepreneurs you didn’t spend countless hours developing your product just to get to crowdfunding. You probably want to take that product and turn it into a vibrant, successful hardware company.
Among the many other important things you must consider when running a hardware startup there is one that will kill your hardware startup before you know it. That one thing is managing your cash flow. You might have heard the expression, “Hardware is a cash flow business,” but what does that mean?
In this post I will go through three examples of a smart home product company achieving different sales results and show how that affects the overall cash flow for the first three years. To keep things simple and best show the correlation between sales and cash flow we will keep the following variables the constant:
- Landed Cost = $25 – For our example this number will represent our Landed Costs which is the total cost you have incurred per unit to get it to your local warehouse. BOM cost (Bill of Material) is included in this number.
- Retail Price = $100 – Usually this number represents 4-5x markup on your manufactured cost so we’ll use 4x here.
- Sales price to the Retailer/Distributor = $50 – Since we are selling to a retailer we will have to give them a discount so they can meet their margins. Expect them to receive a 50% discount on your retail price.
- MOQ = 1000 pieces – The minimum order quantity the factory will accept is to make 1000 pieces.
- Payment Terms to Factory = 50% down/50% due upon receipt of goods
- Payment Terms with Retailer = Net 90
The three growth trajectories we are choosing are:
- Constant Sales: In this situation, the company was able to sell 250 units in their first month to friends and family and then add on some new small retailers over time so that they kept their sales constant at 250 pieces throughout the first two years. .
- Slow Growth: In the slow growth model we have the company on-boarding some new retailers every 6 months, thus doubling its sales every six months.
- High Growth Company: In the high growth rate model, the product comes out of the gate as a popular item, getting press coverage and more exposure through retail channels each month holding a constant growth of 25% in sales each month.
Demand and inventory
Now that we have the foundation set let’s understand how things work at the manufacturer level. When placing an MOQ order overseas in China expect that it will take at least 2 months of lead time to receive your product (once you have all the manufacturing details worked out, generally on a second or third order).
Each of our companies started with placing a MOQ order of 1000 units at $25/unit for a total of $25,000, 50% down at $12,500 and 50% due in two months (one month manufacturing time, one month ocean shipping). Each additional order is based on how many units are being sold per month with the idea that they would order enough to cover three months of sales and never have a negative inventory. (Image taken from excel model. Download original model at bottom of post. )
When considering inventory there is always the delicate balance of ordering too much and having cash tied up in unnecessary inventory versus being out-of-stocked. While most hardware startups are cautious not to be out-of-stocked, with a hot selling product, it can sometimes be a blessing, at an early stage, to tell retailers your product is selling so well that you ran out of inventory. As you grow and work with larger retailers, they become much less forgiving, but early on generally retailers can understand that you are just ramping up and will want to get their hands on products that will move off the shelves quickly.
As a general rule of thumb, it’s good to order three months worth of inventory. That gives you enough time to order more but keeps your cash available as much as possible. That is what we’ve used in our models here.
Product Revenue and Retail Terms
The retailers terms tend to be on Net 30,60, or 90 day terms. This means they don’t pay you from the sales of your product until 30-90 days later. Since retailers also can be late on payments we took to the extreme and chose the Net 90 terms. That means the money you make off of those sales won’t be accounted for in your cash flow until 90 days later. This puts a big strain on your cash flow earlier on as there is no money coming in, but a lot going out.
The Outcome and Key Takeaways
Now that we have the foundation set, let’s look at how all of these factors affect the cash flow and the livelihood of a hardware startup trying to make it as a company. The below graph shows the results of the cash in the bank for the first two years in each model:
In each company example they all start out with negative cash as they are incurring an expense from the initial order. This keeps them in the red until they are able to pay their expenses when revenue exceeds cost. As you can see in the excel sheet as the company grows they have to meet demand therefore needing to spend more money on manufacturing the product.
The key takeaways here are:
- Upfront working capital is needed to pay for production batches. This is the real beauty of crowdfunding. By receiving the money before the orders are placed with the factory, it helps tremendously to get over this first hump.
- High growth leads to increased demands on cash flow. Startups have to pay manufacturers months before they get paid by their customers. They need working capital to cover the cost of selling their product to the customers that want to buy it.
- High growth also leads to more variability in cash flow. As the numbers get bigger, both the costs grow and the revenue grows, at different intervals, so depending on those intervals, the company can be flush in cash or in significant debt.
- Slow growth can be a better model for long term sustainability, purely due to cash flow considerations.
- I’m sure that both the lack of ultimate improved cash flow after two years and the volatility of that cash flow in the high growth model jumped out of the page while reading this. This is not an error, it is a reality of the timing and market necessities. Many a startup has succumbed to this reality and gone out of business. When planning your product for great success, make sure you include in those plans ways to finance that same success!
Entrepreneurs often look at many financial numbers for their startups, but don’t always run financial models specifically for their cash flow. Hardware is a cash flow business. Everyone knows that they need to consider their profit margins and this means they have to know their overhead, their ‘COGS’ (Cost Of Goods Sold), price point, and other metrics. But, if they have no cash in the bank to place that next order and retailers drop them because they can’t keep their shelves stocked, they are out of business, no matter how popular or successful their product was.
If you haven’t already created a cash flow projection for your hardware startup this is something you should start doing right away. Models are generally only as good as the day they are made, but at least in considering the numbers, you’ll be much better prepared to know when you should be considering your different financing options, which need time to be put into action.
This model left a lot out as we were looking to make some clear relationships between the costs and revenues and some of the relationships of the timing and growth. Come back soon to get a more complete picture that includes our models being taken out to a further timeline with additional details such as operating costs and perhaps the realistic hiccup or two.
We’d love to hear from anyone who has had a similar experience with cash flow projections for hardware startups. What advice do you have to share with the community? Let us know in the comments section below please and don’t forget to sign up for our newsletter to get latest tips and updates on topics like shipping, costing, and manufacturing for hardware startups.