A business owner knocks on your front door and offers you shares in a business. It’s making a healthy (but modest) profit. However, this profit only exists because the business is paying the owner less than they’re truly worth.
Here’s the thing: all too often we see owners running businesses and only making slightly more than what they’d earn in a day-job. They’re working more hours than they should, their business sets the agenda, and they’re not earning their worth. They’ve lost the time, control and money that they went into business to get.
If those same owners were asked to invest as an outsider into their own business they’d (quickly) say no. Despite this, they keep reinvesting into their business by working for free, by not drawing the profit they deserve, or by not taking a holiday.
In this article, we’re touching on the three ways to use profit in a business, and how they can help you develop an Investor’s Attitude towards your own business.
Debt is cheaper than equity
If you went to your bank and asked for a business loan, would you get the cash? If you do, the interest rate could be anywhere from 10 to 15%.
Business school teaches that debt is always cheaper than equity. Put another way, someone investing in a business expects a higher return than someone lending to the business. If the bank is expecting 10 to 15%, what should you expect as an investor in your business?
If you’ve tipped in initial cash to get the business off the ground, then are you getting a return on that? If you’re working double the hours of your staff, but not taking double pay, are you getting a return on the unpaid work?
If the bank is asking for what many feel is an extortionate interest rate, then why aren’t you taking the same approach to your own business? At the end of the day, you’ve got more on the line with your business than your bank does, so get the cash you deserve.
Three uses of profit
Let’s assume that your business is generating enough profit—after paying yourself a fair salary—to give a return on your money.
You’ve got three different ways to use that profit. Either:
- Reinvest it in more stock to keep your business spinning;
- Reinvest it in more plant or equipment to improve efficiency, and make the business spin more quickly; or
- Take a dividend
The most successful business owners we see are those who act like investors—they make clear, deliberate choices about where they put their profit, instead of just letting the profit goes where the profit goes.
Reinvesting in Stock
For many, they plough more and more money into stock. It’s an attempt to get bigger, brighter and better. All too often, though, they find that the bottom line doesn’t move as desired.
This approach is along the lines of: “if we get a bit bigger, then the profit will be there.” Instead, the business spins more quickly, makes a little more money, and acquires many more fires to fight. The business owner spends more time fighting these fires, dropping more unpaid labour into their business in the process.
Their reinvestment into more stock costs them more time, generates less profit, and ruins their investor attitude towards their business.
Reinvesting in Plant and Equipment
Often, some of the profit is spent on productive plant and equipment. Note that we’re talking about productive plant and equipment—not a new toy, gadget or ute (sorry).
The productive equipment should give you an edge in production—making you spin work more quickly or more effectively. All too often, though, cash goes on stock rather than on plant. People are putting their profit in the wrong place.
Take a Dividend
If there’s anything left after reinvesting in stock or plant, then (hopefully) you’re able to pay this out as a dividend.
By dividend, we’re talking about a meaningful cash payment. With a meaningful payment, you’re able to make a fundamental change in your home finances. Pay down your mortgage, or buy an investment property. Don’t just throw it on a new car or holiday home. Yes, us accountants can play the Grinch and take away the fun.
The thing is, very few business owners take meaningful dividends. They just take small drawings from their businesses and throw the cash away.
We worked with a business owner recently who took a significant fortnightly pay from their business. After their pay, the business still made $350,000 per year. Of that, the owner took $120,000 per year in ad hoc drawings—things like holidays, clothing and gifts paid for by the business. Between the $120,000 in drawings and the $90,000 new ute, it was clear to see where the profit was going (even though the owner couldn’t believe it…).
Which results in…
When you’re able to make a conscious choice about where your money goes, then you’re able to grow your business in a deliberate fashion. The alternative is fighting fires and letting your business go where it naturally goes—you’re not in control, your business is.
To get control over your profit, we’re not advocating budgeting or forecasting for the sake of budgeting or forecasting. We’re talking about creating a plan for the direction of your business, and getting accountability to that plan.
It’s about coming up with a specific, actionable plan to build your business. Start with making a clear and deliberate choice about where the profit from your business goes. That gives you the power to take an Investor’s Attitude towards your business, and get the return on your investment you need.