Each year thousands of entrepreneurs take a leap of faith, resign from full -time employment, and begin a business with the hopes and dreams of obtaining financial success and independence. With all good intentions, they begin working on a business model, creating a plan for sales and marketing, purchase assets, and dive head first into business development.
As a commercial lender for over 30 years, I have seen countless business owners take control of their financial future only to veer off their original path and onto one they had not intended. The leading cause of business failures is the lack of capitalization, financial discipline, and a realistic understanding of what it takes to be profitable.
The success rate of a small business is entirely dependent upon the owner taking the following five actions, which are the cornerstone of their business model:
1. Create an annual budget and manage to the bottom-line. Knowing how much you make is the easy part; keeping track of what you are spending is what often causes a business to fail. For each event you book, gain a clear understanding of the costs associated with delivering your services for the event. It’s not just limited to expenses related to the day of the event, but the costs leading up to securing the event, marketing, fixed costs to running your business, insurance, office operations and future replacement of equipment.
2. Plan for capital expenditures. Save for the future by planning on putting aside 5 – 7 cents of every dollar in revenue. This will ensure that you have working capital for long-term growth. This also can be allocated for unexpected costs such as equipment replacement or short-term cash flow during slow periods of the year. When an unforeseen expense occurs, those who did not plan scramble to find cash, often at a high cost or ultimately close up shop because, in their own words, “I did not see that coming.”
3. Discounts: the exception and not the rule. You set the price of your services based upon the budget you’ve created at the beginning of the year. If you choose to discount, then you need to review your expenses and adjust them accordingly. Often, we are more focused on winning the sale without evaluating the short and long-term impact to the bottom line. An occasional discount will not have a significant impact, but over the long-term it can erode your profits quickly, resulting in a negative cash position for the business.
4. Financing that is too good to be true. Small business owners are primary targets for what I refer to as predatory lending. Easy access to working capital is often a deal too good to be true. Banks and credit cards with loan interest rates should be your primary source for capital. Pre-approved loans from non-traditional lenders such as finance companies often result in rates between 20% – 25% with higher than average loan fees.
If you accept credit cards for payment of services, do not consider accepting a loan in which payment is based upon future credit card revenues. These loans are short term in nature and have a fixed pre-determined monthly payment based upon historical credit card transaction volume. This translates into the lender taking up to 65% of your merchant receipts on a weekly basis with an effective interest rate of 25% or more. Keep accurate and timely financial records of your business so applying for a traditional bank loan or credit card is not a painstaking process.
5. Do what you do best–stick to your core business model. Entrepreneurs are prone to adding other sources of revenue to grow their businesses; in most cases, it can be successful. Be sure to avoid focusing solely on the revenue, and not assessing the overall impact to the bottom-line. Spend time thoroughly investigating what it will cost you in capital to start up this new service, additional expenses to deliver the service, both from a fixed and variable cost and if it will erode your core business.
For example, many mobile DJs quickly spent thousands of dollars investing in photo booths with the ambition of increasing profitability. The decision to invest was predicated on the sales pitch that you will add $10,000 or more to your bottom line.
Focusing on the promise of greater revenues caused many to be blinded to the fact that they did not account for the costs associated with earning this income. Once many realized they were not making the money promised, the market became flooded with a lower price point, quickly turning it into a commodity. At that point, the business owner is simply trying to recoup their initial investment, and preserve the revenue from their core business.
In summary, being a successful business owner takes planning, review, discipline and foresight to achieve your financial goals. As a commercial lender and business banker, businesses that I have financed and grew to a successful brand have embedded these five actions as the core of their business model.