Three Lessons Every Entrepreneur Must Remember
Thinking of starting your own business? I remember being in a business college in the mid-2000’s and I was surrounded by eager, talented, and ambitious millennials who all were planning on starting a business after graduation. Having several family members who had started or were starting their own business, I was shocked by the naiveté my colleagues.
Plenty of them knew that they wanted to run a business, and many of them would have been fine leaders had it not been for two problems. First, aside from the accounting majors (who interestingly were the smallest population of desirable entrepreneurs), most of us didn’t have the slightest clue about real-world business finance. Second, they lacked a true concept of a product or service that was in demand.
If you have been thinking of starting your own business, you task is to focus on the second obstacle. My task, and the purpose of this article, is to give you the hard truth on how the first one works and what principles you can adopt so you can keep your money and grow your business.
There are countless books and articles that cover small business finance. In them, it’s easy to get lost in different ratios, types of accounting, and all other technical aspects of it. In reality, getting lost in this can be time consuming and costly. As an entrepreneur, the primary goal when it comes to your capital is to keep it simple.
In your first year of business, capital is the only commodity that matters. You can schmooze your way with bankers, vendors, and customers but as soon as a check bounces, or you fail to deliver on a promise of payment, any goodwill is out the window. It is unfortunate, but your vendors count on your payments to provide for their families. A failure to respect that unmentioned (and rarely taught) intricacy will be returned to you tenfold.
If this sounds harsh, that’s good. Being an entrepreneur isn’t for the faint of heart and it is not for the weak stomached. Your first year in business will be test after test after test and there are no training wheels to keep you from falling down. You have to be tough minded and prepared to face all challenges. The weight of the world will be on your shoulders more often than not, so brace yourself upfront and commit to the standard of excellence. Still want to be an entrepreneur? Take these three lessons to heart and if your product can survive the market, you’ll be ok financially.
The first lesson is that you must know the cost of keeping your business open for one month. I can recall a conversation with a small business owner recently that went somewhat like this:
Me: What are your annual revenues
Business Owner: Roughly $2 million
M: How many vehicles and pieces of equipment do you have that you don’t own outright?
BO: Maybe 10
M: How much do you owe total on those 10 pieces total?
BO: I’m not sure exactly, but probably somewhere around $400,000.
M: How much is the monthly total of all the notes if you make only the minimum payment?
BO: I’m not real sure but I can check with my office manager.
M: How much is the overhead for your warehouse and office on an average month?
BO: I’d need to check with the office manager, but we always make them on time.
The conversation continued and after about 15 minutes, it appeared that the office manager knew more about the financials than the business owner. Sure enough, this business owner had more loans than were disclosed, owed twice the amount estimated, and had no clue how much it cost just to keep the doors open.
Several entrepreneurs get so wrapped up in the cost of selling their products, they forget about overhead. As a result, they’re always cash strapped when it comes time to pay expenses such as loans and rent. As a business owner, you stand to gain and lose the most, so make sure that you always know what it is going to cost you to operate your business. Trust me when I say, it is never fun to operate on the razor’s edge of bankruptcy.
After you’ve been operating your business for a period of time, you will likely have credit accounts that allow you to buy materials and pay for them later. I’ve personally seen account limits as high as $50,000 so long as no open invoices were past 90 days. Typically, $5,000 is a common starting point.
This is where the problem comes in. Let’s say you have 25 credit accounts. If each one is for $5,000, you have access to potentially $125,000 before you ever make a payment. While most business owners are smart enough to make payments on credit accounts, it is amazing the sheer number that carry balances up to 90 days.
This snowball occurs fast and for entrepreneurs who aren’t managing their payables, the next thing they know, they are low on operating capital and struggling to keep up with old open invoices. Essentially, they are throwing money into the hole for work that is 3 months old and (hopefully) already paid for. With appropriate job costing, this problem can be avoided; however, if you neglect your payable, save your money because then you will need an attorney.
Up to this point, I’ve focused on expenses and the money that goes out of your business. This is to hammer home two key points. The first – you will always be paying out money. No one likes to pay bills, get over it and accept it because if you cease to have outflows, you’ve got big problems ahead. The second – you have to collect what you are owed.
This sounds like a simple point but it is amazing how easily a few tradeoffs of work or deals cut to customers add up. Each one of these negatively impacts your bottom line. Additionally, the more customers or clients you have, the more legwork there is going to be for invoicing and billing. Consequentially, the more there is that can fall through the cracks.
My advice to most entrepreneurs is that if your industry practices allow it, negotiate a rate that will allow you to collect a portion of your total bill up front. In construction, landscaping, and several other industries, this is called a “materials deposit” and is a perfect method to help you avoid the problems regarding payables. Additionally, this method breaks up income by cost-of-goods-sold and profit.
Ultimately, there is nothing more important than collecting income. It is your organs and central nervous system rolled into one. If you get behind on it, or it dries up, revert to my second point and find an attorney. On the other hand, starting your own business is not all doom and gloom. Small businesses are the backbone of our economy and the lifeblood of the private sector. Just remember these three things: know your overhead, manage your payables, and collect what you’re owed. Do that, and you’ll be on your way to working for the best boss you’ll ever have – yourself.
About John Gainer ohn works in finance and has experience in both the private and public sectors. He has a BBA in Business Management from Abilene Christian University as well as an MPA with a focus in International Relations from Texas State University in San Marcos. In his free time, he enjoys golfing, traveling, reading, and spending time with his mini pig Zoë. You can follow him on twitter at @realjohngainer or feel free to email him with questions or comments.