It always surprised me when a business owner became flustered if I responded to their loan request by saying, “No, we can’t make a loan to a bankrupt business.” After the shock of my words passed, I would get an earful about their million dollar homes, children’s private schools, and really nice vacations…all of which was supposed to prove they were anything but bankrupt.
And it was true–they did all those things–by draining every cent of earnings from their business. They weren’t bankrupt–but their company was.
Most of these folks drew a modest personal salary, but they spared no personal expenses when it was paid directly out of the business–to avoid paying personal taxes on the cost. Fancy meals, family vacations, several cellphones and cars all helped the owner sidestep the tax man, but at the same time devalued the enterprise that produced these dollars, with no capital left for deferred maintenance, expansion or a full value exit strategy.
While their accountant produced financial statements that reflected a business that generated impressive revenues and strong gross profits, it could not hide excessive overhead that diluted the success generated by the business. While the company managed to repay all their debts, the owner seemed to try to spend everything left over.
And as a result, the company was left as a hollow shell without the capacity to borrow additional sums needed to expand or take advantage of new opportunities.
The subtle message, of course, is that businesses need to retain earnings. The blatant alarm was that the owner had absolutely no idea what I was talking about.
Beyond giving orders to the bookkeeper to avoid as many taxes as possible and pay out more to the owner, the owner had never looked at the company’s financial statement. And to be even more honest, most business owners cannot read a financial statement anyway.
Small business owners are the bedrock of our economy: they repair our cars, take care of our children, serve us meals, provide us with the latest fashions or electronics, and create innovation for our lives in ways we can’t imagine.
But most don’t have a good handle on how to manage the business of owning a business. Beyond the mechanics of whatever they sell or provide, accounting for their performance is the only measurement that counts when getting a loan or selling their business.
Too often, these bad habits and lack of financial literacy renders them unprepared to respond to changing economics, or disqualified to acquire funding when a new opportunity arises.
How smart is it to be unable to understand how to read your monthly financial report or annual tax return when handing them over to a bank that will these reports as the primary factor in their decision about whether or not to make the loan?
The lack of knowledge about business cash cycles, capital adequacy, or even revenue capacity is evident by the glaring statistic that 63% of all new companies fail within 4 years.
Business owners owe it to themselves, and the investment they have in time and money, to know better. Understanding how much cash it takes to get from opening the doors to building a sustainable client base, how much capital is required to support revenues, and how to justify additional funding when growth opportunities appear?
The answers to these questions can be the difference between surviving and thriving, and more importantly to reaching the goal of some day exiting your business at full value.
Charles H. Green is Vice President of First Bank Financial Centre, a preferred SBA lending bank. Contact him at Charles@Childcare-Finance.com