1 mistake every entrepreneur is guaranteed to make

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“So what you’re telling me is that we have never made money?”

This was an actual statement from an actual entrepreneur that was not happy with our conversation. Everything I was saying was not making sense to an entrepreneur that had money in the bank, a house, cars and investments all paid for by his business. The problem was his business had never actually made any money. The business owed more to creditors that it was expecting to receive from customers and had negative equity on its balance sheet. Basically, all the personal wealth that this entrepreneur had was from the creditors in his business including the government, vendors and his bank. Cash flow does not mean profit and this entrepreneur was about to discover how big a hole he had dug.

Here’s a quick test: go get your balance sheet and look for a section labeled “Shareholders Equity” and/or “Retained Earnings” (it will be at the bottom). Is the number positive or negative? If the number is negative chances are your business has never made money. The next sections to check are “Accounts Receivable” found under the Assets section and “Accounts Payable” found under the Liabilities section. Is your business obligated to pay more out to vendors or suppliers (Accounts Payable) than it is expecting to receive from customers or clients (Accounts Receivable)? If so, your business could be struggling to make money.

Cash flow is not profit

Many entrepreneurs make the mistake of misunderstanding that money moving through their business is not necessarily profit. If your business has negative retained earnings and/or owes money to creditors over and above what is expected to come in from customers, the money moving through your business is not yours. It’s common for many businesses to run negative retained earnings or backwards cash flow which basically means that money owed to creditors, the government or the bank is being used to float operating expenses and/or cash outlays to the owners. Negative retained earnings generally means that over time your business has incurred losses and your creditors have covered the losses with the amount of money your business owes them. A business can’t survive in this fashion forever. At some point, sales will slow down or dry up and the resulting pressure will be from vendors, the government and the bank looking for their cash. This is usually the moment that life gets very real for an entrepreneur. Not only has an entrepreneur not made any money, all of the money they have taken from the business was not actually theirs to take.

You might say: but I own a home, a car and I have investments. If your business has negative retained earnings and backwards cash flow you have those things because your creditors in essence paid for them. The points being made here are of a general nature. I realize that some folks will use accounting entries to reduce their tax obligations which may result in negative retained earnings and/or negative cash flow. At some point however, a small or medium sized business will need to actually be profitable to survive.

The goal you want to strive for is to manage your business so that actual profit is being made and with the profits you are paying your creditors, bankers and the government. A business that is truly profitable is a stable business that can build up cash for a downturn, make investments that increase their bottom line and are able to contribute to the community around them. If you think your business is not running properly, take time with your accountant to figure out what is needed to ensure that the Assets and Equity on your balance sheet is greater than the Liabilities. That’s a valuable business worth having.

 

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