They say interest is a silent killer in any business. This is because you don’t really notice the impact it has on your profitability until you can look at an accumulated amount over a period a time to see how much of your profit actually goes to interest. It turns out that the money taken out of a business by an entrepreneur or the owners can also be an unnoticeable drain on profitability. Many small and medium sized business owners treat their business finances as an extension of their personal finances instead of treating their business like an investment. What many fail to realize is that without a policy or process around how owners take money from their business they may be doing more harm than good to their bottom line.
This is a question I encounter many times when reviewing the cash flow and profitability of a business with either the entrepreneur or person running the business. It is usually followed by a very frustrating conversation that involves going through accounting terminology and concepts that are foreign to the person I am speaking with. Once the frustration subsides there is usually some excitement about what can be done with this new found knowledge and while it can be difficult to follow the cash flow and profits of a business the work is worth the effort and can produce improvements in profitability and overall value.
Where is the cash going in your business…specifically?
What is your balance sheet going to look like next year? The year after? What about three years from now? Do you care? Many times the answers to these questions are: not sure, no idea, don’t know and yes I care but I don’t have the information to properly answer these questions. It’s very typical for a small or medium sized business to not know what their financial statements are projected to look like over the coming year much less the next three years. Many times they will have a budget (that is usually inconsistent with their historical performance) but haven’t done the work to take the budget one step further and have it flow into an actual set of pro forma financial statements.
What are pro forma financial statements and why do they matter?
There is no such thing as easy money right? Are you sure? There are really only two ways to grow your revenue: cut costs or sell more. There is a limit to how much more revenue your business can earn by cutting costs whereas selling more is limitless. If you only had time to do one thing in your business it should be focusing on how to sell more. There is no easy way to do that then by figuring out how to sell more to existing clients either directly or indirectly. The more systematic you can make this the more profitable your business will be and ultimately your business will be worth more.
So how do you sell more to existing clients or customers?
It’s going to cost how much!!! You must be crazy!!!
That comment is made by entrepreneurs and business owners after hearing how much it costs to borrow money from either a mid market or private lender. The comment is usually followed by a series of expletives that I won’t type here but needless to say the cost of capital is something that can scare or upset someone who maybe hasn’t thought through the opportunity cost (see past blog post here). There is no such thing as free money when it comes to business but more importantly the money your business is using has a cost to it that you may never have thought about but you might want to.