Or, are you buying a job?
The corporate business world responds to the demands of stockholders and boards of directors. As a small business owner you must also address similar challenges. While those in the corporate business world could lose their job with a failed business, as a small business owner you not only lose your job, you could lose the investment you have made in your business.
The investment. This is the unique aspect of owning your business. As the active owner in your business you receive a paycheck, but that money is for the work that you do each week. It is very similar to the paycheck that you give to each of your employees. The investment is the part of owning a business that is often forgotten.
When you first started your business, there was the initial outlay of cash for equipment, inventory, and the operating expenses you would incur before you made your first sale. Even as a business moves through the first months, there is often more of a cash outflow than there is an inflow.
Sometimes the owner of the business goes to a bank or outside individual to garner additional funds. When this happens a contract is created which specifies how the funds are repaid. One of the components of that contract is the interest rate charged by the lender.
While we find that most every business owner will pay attention to knowing what that interest rate is that they are paying to a lending institution or another individual, we also find that many do not ever think about the interest that their business should be repaying them on their investment.
While many do not set up a formal contract between themselves and the business, it is only right that you should expect the business to pay interest on the money you have invested. Perhaps the comment made about small business owners that ‘they have bought themselves a job’ comes from situations such as this.
In the investment world, the interest rate paid to you increases as the risk factor increases. In your business, you can make the risk factor decrease by doing a better job of understanding how your financial statements are created and the factors that go into creating them.
To answer these questions we need to gather some information from your financial statements. Follow these steps and we will not only determine how well your business investment is paying you, but how you can make it better.
We begin by looking at your year end profit and loss statement and balance sheet. Sales need to be broken into two groups; the first being cash and credit card sales and the second being the charge accounts that you may have. In addition to the information we see there, we need to do a couple of calculations based upon the balance sheets from each of the twelve months.
We need to calculate the average inventory on hand for the year. We also need to determine your average accounts receivable. From your balance sheet, we need your year end total of long term assets and the total of the current assets other than the inventory and accounts receivable that we already mentioned.
From the year end profit and loss statement, we can determine your gross margin, operating expenses as a percentage and net profit percentage. With the breakdown in sales we can also determine the percentage of sales that are on credit.
The second aspect of your investment that we can determine is your inventory turn. Increasing your inventory turn is a sure way to improve the investment in your business.
The third observation we can make about your business will be as we calculate the return on assets. This measurement indicates that of all the assets your business has, whether or not they have been paid for, how well you are leveraging them to make a profit.
While there are other calculations that we can determine from the information we have collected, there is but one ratio that we have left to look at; the return on investment. It is determining what we first asked; what kind of interest rate is the money that you have invested in your business earning for you?
Looking again at the year end profit and loss statement, you need the net profit. Divide the net profit by the net worth of the business. The net worth is on the balance sheet, but may appear in one of several forms. It may have the title of ‘net worth’, ‘equity’, or ‘stockholder’s equity’.
The answer you receive is stated as a percentage and represents the rate of return the money you have invested in your business is paying you. There is not a right or wrong answer that we can give you. Instead, the number has to be one that you are comfortable with.
It is just like your making an investment in a stock, bond, treasury note, or other investment. Are you pleased with the rate of return and do you feel secure that this is the best possible place for your money to be invested?
If so congratulations! And by knowing how well your money is working for you, and how that calculation is made, you can perform the necessary tasks to improve your business and the investment you are making.