Hi Sandhu
Great to hear your business is doing well.
I haven’t made an investment as significant as this in my own business - in part because I also work as a management consultant and I have seen many salon owners end up working for nothing, just to pay for finance and landlord costs.
My first thoughts are as follows:
- Do you have an established client base purchasing treatments at £100-£700? Does this price point fit with your client base and marketing funnel? Are you already getting these sorts of enquiries?
- Do you offer any other technical treatments? Are your clients comfortable with these procedures and the costs involved?
- Is your customer base big enough to sustain these treatment costs? For example, can you sell two to three treatment courses a month for three years, as this is what is usually required to cover the cost of financing a machine?
- As well as assessing demand you also need to think about the operational side of the business. How will your newly trained staff gain experience? Who will support and guide them? Staff usually need a minimum of 6 months mentoring and experience before operating independently.
Assuming you have sufficient demand for these services, you also need to think about the investment in your business. Is this the right time and can your business afford this sort of investment?
As you will already be registered for VAT and have an accountant running management (monthly) accounts for you, ask your accountant’s advice on whether your business can support this loan. Accountants use gearing ratios to compare income, liabilities and profitability. There are two things to think about 1) can the business support the investment and 2) is this the best use for £40k investment?
For 1) Usually you look at the ratio between the value of all the cash and selling stock in the business and compare this with all the outgoings you have over the next 12 months. In other words, you don’t count the value of services you haven’t yet sold, just the cash in the bank, retail stock and anything else you could sell quickly, such as a car and see whether that’s enough to pay your bills for a year. You usually want a ratio of between 1.5 and 3. In other words you should be able to pay the next 18 months to 3 years worth of rent, debt repayments, wages including redundancy and holiday pay, insurance, tax, and any other costs you can’t cancel with 3 months notice. If you don’t have enough liquidity (cash in the bank) you are running the risk that you run out of the cash to operate your business before you’ve established traction in the marketplace.
When I set up my business we nearly ran out of money. I got down to 6 weeks reserves which was very scary and I had to let a staff member go even though I’d spent thousands upgrading her qualifications. So my investment in the long term future of the business turned out to be unaffordable and the money I’d spent was wasted.
For 2). You have to think about return on investment and opportunity cost. What else could you do with £40k? How much money could you make if you invested in something else? For instance you could add a part-time staff member, or pay off a chunk of a mortgage or other loan, or save up a deposit on a holiday home. How much money would these alternate investments make/save you?
The next question is whether you have fully understood the terms of the loan. For instance do you pay a lump sum at the end of the agreement or is the machine yours? Can you surrender the machine and owe nothing? Have you shopped around for other forms of finance that might work out cheaper? Have you considered remortgaging your home or using zero interest balance transfer credit card deals to fast pay off the loan to save interest? As your business is so new, you are unlikely to be offered reasonable interest rates on a commercial loan. Have you considered waiting until you have 3 years accounts to help you get better terms, or just saving up a larger deposit?
My next question is have you considered your related costs? Will you need to upgrade your Council licence? Your planning permissions? Do you know how much insurance, servicing and replacement parts cost? - tip, the cost of servicing always includes new parts and the cost can be rather startling.
Have you thought through the ongoing costs of training? Are you certain the training is the correct standard - for instance you need level 4 training for most aesthetic services and often level 5 training. Have you factored in a pay rise for your newly trained staff? Will they leave for a pay rise elsewhere once they are trained and experienced? What happens when staff leave? What will it cost you to train new staff?
The last question is one that most salon owners don’t think about. What is the true capital cost?
- The Capital cost is the loss in value (trade in or resale) of the machine each year, plus the appreciation in value of its replacement plus an allowance for the opportunity cost of the money invested into purchasing the machine that could have been invested into something else. Once a machine is purchased the amount needed to replace (perhaps every 5 years) can be 35-40% of the total cost, so keeping it to a minimum has a big influence on overall ownership cost.
Factors that affect trade in/ resale values include:
- Operating hours, age and condition
- Obsolete model or technology - there are always new models and new technologies being launched,
- Access to parts, - I bought a machine made in China and the company moved manufacturing to the U.K.. it meant they couldn’t supply parts for my nearly new machine.
- Factory incentives and dealer support.
Ask whether they have any reconditioned or trade in machines for sale. This will give you an idea of the trade in value of your machine after a couple of years. Expect the machine to lose around 50% of its value within a year. I advised a beauty therapist who was struggling to pay a £15,000 loan for an Ipl machine. I worked really hard with her to help her increase her sales to cover the last 6 months loan repayments (she’d been badly stung by a £700 increase in her insurance and the unwelcome discovery that servicing and new parts cost £1500 a year). Then she was offered an upgrade to a new model for another £5000 plus continuing her loan. She was so sure she could cover the repayments because she’d had such success selling treatments over the previous 6 months. Unfortunately she had marketed to the whole of her client base already and only a few people bought additional courses and her new enquiries had slowed to a trickle. If she’d kept her old machine, she’d have been in profit, instead she drowned in debt and went out of business within the year.
So my thoughts are that you need to allow maybe double the loan cost as a rolling monthly cost. Forever. This will be the total of insurance, staff training, servicing, insurance, replacing the machine for a newer model after 3 years etc. and you need to ask yourself whether this £2k per month investment will make you as much money as say buying a house to let out and whether it will be a way to make money, or a headache that impoverishes the business and sucks out all the profit. Most beauty salons make less than 15% profit. If you are paying say 18% interest that could really take a big chunk out of your take home pay. Ask yourself whether you are investing or speculating? There’s a difference.
Best of luck
