Rob asks,

I have a first child on the way. I need to buy an SUV, but I put all my money back into my business. Is there a way to use my business to write off the SUV?

[You can ask your question here]

I answer:

Since I’m not an accountant or a lawyer and more to the point, I’m not YOUR accountant or lawyer I don’t know enough to advise how the rules apply in your situation. What follows is not advice, but education.

The general idea is any cost you incurr in order to do business is a write off. That means if you have to travel on business you could fly coach, fly first class or charter your own plane. The IRS won’t tell you which choice to make as long as you pay fair value and it’s a business expense. (Fair value means it won’t work to pay your wife $10,000 to make your travel arrangements if she books a flight for $350 and takes the rest as “commission”).

Even if you could write off any of those expenses, and chartering your own plane is a bigger write off, you’d have more money in your pocket if you fly coach for the reasons I explain below.

For example, if you have a business that makes $100 profit. You’re in the 40% tax bracket (including state income tax etc) so you pay $40 in tax and put $60 in your pocket. If you spend $10 on something (that you can’t write off) you end up with $50 in your pocket.

But suppose you could write off that $10. Then you only make $90 profit. In the 40% tax bracket you pay $36 in tax and put $54 in your pocket.

Bottom line: $54 in your pocket is better than $50 but worse than $60. What does that mean? It means if you spend money you weren’t going to spend anyway – even if it’s a write off – you end up worse off. ($54 instead of $60). But if you’re going to spend the money anyway, you’re better off if you spend it in a way that you can write it off ($54 instead of $50).

There are detailed rules about how much you can write off if you have a vehicle you use for business and personal use (same with a computer or a phone line for that matter – though the rules may differ). And there are rules regarding how much travel you can write off if you combine business and personal. And no, it won’t work to charter a plane to go to Hawaii for a week and spend 2 hours (or even 168 hours) that week talking business with your wife over lunch. There has to be a business reason that you have to talk in Hawaii.

Are there ways to arrange things so that you spend money you were going to spend anyway and get a write off? Sometimes. But you better get specific advice for your situation, from someone who knows this year’s tax law.

Do people break the rules and get away with it? Yes, but it’s not a risk I like to take. The penalties run from very costly to jail.

Takeaways:

• Write-offs are not a profit center.
• Do get the right advice and write off as much as you legally can.
• After that, it’s better to put your energy and inventiveness into making more money rather than gaming the system.
• The good news about paying a lot of taxes is it means you’re making even MORE money than you’re paying Uncle Sam. Poor people don’t pay a lot of taxes.

The sign of a growing business is no cash. That’s also the sign of a dying business. Here’s how to make sure you have the first, not the second.

I hesitate to say that money is what’s most important in your business, but it’s what’s most critical. Financial repercussions connect everything that happens in your business to every other thing that happens. The weird thing about money is it’s fungible – unlike almost anything else we value. Since every dollar is like every other dollar, we often don’t realize how big an impact managinge each one can have.

But when cash is tight, your company is like a person in precarious health. Normal things that most people do without thinking must be planned and monitored so they don’t have devastating consequences.

Do it when you need to squeeze every penny. Often for these reasons:

• You’ve got a lot of debt you need to pay off
• You’re growing really fast and need every penny
• You’re in start-up mode or launching a new product and don’t know when the market will respond

Companies should also do it, when they want to maximize profit. Otherwise, you can spend 20 years of your life working at something, make a living (not much more) and have a gnawing sensation that the business should have done better financially but they don’t know where the money went.

Why don’t small companies do it more better?

• They don’t know how
• It can be tedious and not as much fun as other parts of the business (thought it’s not rocket surgery).
• They think that it won’t really affect their decisions because cash is so tight. If that’s true you aren’t doing it right.

I’m working with a client who’s paid off a lot of debt and needs to start maximizing his profit. He’s just beginning to realize how critical every cash decision is. I’ll be posting how we develop the system for him to manage it.

Takeaways:

• Stay tuned for future posts on HOW to manage cash.
• In the meantime, you can see an overview of the concept here.

[tags] cashflow, business tool, manage cash, cash, profit, accounting [/tags]

Sorry for the delay in posting – I’ve been at what I heard was the largest venture fair east of the Mississippi. It was my first time at something like this. Very enlightening.

Over 100 companies asking for money. 25 in “late state” meaning they had revenue of over $1million and the rest “early state.” The industries ranged all over the map. A medical device to cool spinal fluid and reduce paralysis to a replacement for terazzo tile made with recycled glass. There was a portable solar hot water heater and an online video game for women.

All of what I saw was well thought out and most was well presented. All were past the “just an idea” stage – at least a prototype and some had been in business for 10 years and were raising money for the next stage of growth.

It’s the 13th annual one that this group put on. The concensus was there were not enough investors there – perhaps it’s gotten so popular nobody goes there anymore. It also seems that Connecticut is behind the curve in organizing investors at the angel level (where I play). That may have something to do with it. I heard that nation wide in 2005 angel investors put up the same amount of money as VCs but they put it into 49,000 deals where as VCs funded 3,000 (not sure those numbers are exact, but the scale is).

I found 3 companies that look interesting. Not sure I’ll put money into any of them but I’ll continue my research. Mostly I made some good connections for a company I’m working with and with some other investors to learm more about how this game is played.

I’ll keep you posted.

DON’T

Says Seth Godin. I think he gives a pretty good alternative.

Takeaways:

• Not all VC funding is bad for every company.
• Thinking that funding is always the solution is bad for every company.

In case you missed it: Part 1 – Part 2 – Part 3 – Part 4

Payback

Payback is the third reason for a company to spend money after COGS and Operations. I don’t mean payback as in sending some goon out to break a bunch of kneecaps. Payback is what I’m calling the money you use to pay back lenders and investors who gave you cash to get the business going. If it’s a loan, the payments are usually figured as overhead, because you have to pay them every month. If investors contributed the funds, payback is usually figured as a dividend, or share of profits or maybe return on investment. It’s not usually figured all in one place, after COGS and Operations. And that accounting methodology has made it harder than it should be for entrepreneurs to raise financing. Let me explain.

Entrepreneurs tend to focus on potential (size of the market) and cash flow (making it through the month paying all the bills). Investors and lenders know that after paying all the bills there has to be something left over to pay back their investment and make a profit on it. Sure they want to see potential, but they also want to know how long it will take before there’s enought money to pay them back without hurting the operations. And they want to see that the risks of them never getting paid back have been minimized. So if you want to raise funds, be prepared to show how you’ll pay back your investors from cash flow, and when. Thinking about it as a separate category makes this easier to show.

Tech bubbles happen when investors too, forget about this and figure they’ll get paid back by selling the company to GOOGLE for $25million. But I digress.

I suggest that when you do cash flow projections you separate all the people you’ll pay into groups. Put the payments for COGs in one group, the payments for operations in the second group and the payements to payback in the third. This should show you and investors how much cash will be available to return their contribution, and when.

Takeaways:

• Use a separate category to show how you’ll have money to pay back your loans and investors without hurting the cash you need for COGS or Operations.

What do you call a person who speaks two languages? Bi-lingual. What do you call a person who speaks three languages? Tri-lingual. What do you call a person who speaks only one language? An American. – Old Joke

Numbers are the language of business, yet many business owners don’t really know that language. They survive, but not as well as they could. My learning of this language has been completely self-taught, as a result, my understanding is less than orthodox. In some ways that’s better.

• I’ve tried to learn to use the language, not to produce reports that I’m “supposed” to have but to actually accomplish what I need. Usually what I need is some basis for making a decision. The language isn’t designed for that, but the process of learning it myself has been very helpful.
• Because I don’t know the language very well, I don’t trust my understanding of it, I usually come at a problem from several different angles. If they all point in the same direction, I’m reasonably confident that I’m on the right track. But I don’t stop looking for a new angle. This has given me confidence in my decisions through tough times.

You’ll see the ideas above in the numbers below. Advice for MBA’s and accountants: You are schooled in numbers: the language of business. But knowing the language doesn’t mean you have anything to say. If you want to help entrepreneurs, you have to learn to use that language in the context of what a small company needs.

Here are 5 numbers every business owner should know.

#1. Your COGS – Cost of Goods Sold. As a percent, this is how much of every sales dollar goes to buy the material and make it into a form that it will generate that sales dollar. If you sell only a few things, you should know your COGS for every product. If you sell a lot of items, perhaps you can group them and figure your COGS by product line or market. If you do a lot of custom work, you may need to figure out your COGS for each sale.

#2 Your Gross Profit in dollars per month. This is what’s left after you subtract COGS from your sales. This dollar amount has to cover overhead, payback and profits. It’s also the lowest price you can sell your next widget for without actually paying the customer to take it. Obviously you can’t sell them all at this price or you’d never cover overhead. But if you hit a dry spell and want to keep your crew busy, or if you want to entice a new customer with a loss leader, this is as low as you can go without really taking a loss. Gross Profit as a percentage of sales is called Gross Margin. You’ll need the margin for the next one.

#3 Value of your next customer. Here’s how it works. You take the dollar amount of your average sale TIMES the number of sales the average customer makes over their lifetime as a customer TIMES the Gross Margin. This is how much money your next customer will put in your pocket.

EXAMPLE: Let’s say you run a country club. Your average member stays a member for 5 years (60 months) and spends $1,000 a month in dues, green fees and restaurant meals. Your COGS for all that is $600 a month. So your gross margin is 40%. Your next average customer is worth $24,000: $1,000 per month sale TIMES 60 months TIMES 40%

CAVEAT: This is only true for your NEXT customer. Or the next number of customers you can serve without adding to your overhead, or making some capital expense. But in that context it can be useful to determine ways to increase the value of each customer (“You want fries with that?”) and you use it to compare to #4

#4 Cost of acquiring the next customer. This is money spent on marketing, advertising and sales DIVIDED BY the number of new customers that effort brings. Effort that brings in more value than it costs is worth it.

#5 The Magic number. Every business has one number that summarizes the health of the whole business – usually on a daily basis. Sometimes it’s obvious: a hotel uses % occupancy, a restaurant, the # of meals sold per night. But sometimes it helps to get creative. One manufacturer used the weight of all the items they shipped out in a day. It turns out for them, pounds on the shipping dock did a good aggregation of profit margins in different product lines. One restaurant owner used the number of people in line at 8:30 PM. If there were a lot of people waiting, his staff turned tables quicker to sell more meals. If not, they encouraged dessert and after dinner drinks to sell more that way.

The Magic number for a start-up is always your break even point. You must know that. When you hit it consistently you’re not a start-up anymore.

Takeaways:

• Know your numbers.
• Make them easy to use and train your staff to use them.
• Be sure you know what assumptions your numbers are based on. The Apartment industry has been using Occupancy Rates as a magic number. But recently as their market went south, staff would give away concessions (free rent) to entice people to sign leases. This kept their occupancy (and presumably bonuses), high while profits tanked. It took some companies a surprisingly long time to figure out this disconnect.

In case you missed it: Part 1 – Part 2 – Part 3 – Part 4

Operations
The second reason to spend money is on operations. These are called fixed costs by accountants and they are the costs that stay the same from month to month just to keep the lights on and the doors open. Rent, utilities, marketing and advertising costs, taxes and labor that is not COGS go in this category.

There are two keys to operations costs. The first is sales volume. Very often people get seduced into starting a consulting business of some sort by not considering sales volume. They see that if they sell their skill at graphic design, or wedding planning, or computer programming or some such they can get $100 per hour. Their COGS is close to zero and working out of their home, so is overhead. Except for their salary. But if they only sell a couple hours a month their sales volume won’t cover much, even at a high hourly rate. At the other extreme, Starbucks sells coffee for about $3. Even though their COGS is pretty low, it doesn’t leave much from a $3 sale. But they sell so many that it covers the rent, and the green aprons and the comfy chairs.

So no mater how high your gross profit is, if you can’t sell enough volume to cover your overhead you’re sunk. One problem start-ups have is estimating how long it will take to ramp up their sales volume high enough.

The other key to controlling operations costs is chunking. You want to keep these costs as low as possible. But operations buys you capacity, and you can’t serve your customers without capacity. Every time Kinko’s gets a new copy machine, its capacity to sell copies goes up. Paper and toner are COGS, but the cost of the machine is the same whether anyone uses it or not. So their operational costs increase or decrease in “chunks” the size of a copy machine.

You can think of operations cost and the capacity it buys like a stair step. They stay constant for a while till you “chunk” up to the next step. (COGS on the other hand is like a roller coaster – constantly moving up or down with sales).

The trick is to run close to the top of your chunk. The most profitable companies are ones who are close to maxing out their capacity because their operational costs are low compared to their sales volume.

Takeaways:

• No matter how high your profit margin is, if your sales volume isn’t enough to cover your fixed costs, you’ll run out of cash.
• Operations costs buy you capacity. Try to run as close to maxing out your capacity as you can – that allows the greatest amount of your sales volume to flow through to the bottom line.
• In other words, don’t buy more capacity than you can use to serve customers.

This is a longer article, so I’ll post it in sections. Part 1 – Part 2 – Part 3 – Part 4
It’s conventional wisdom that companies die because they run out of money. One reason they do is that if you’ve never learned to look at why you spend money, you make all money decisions the same way: Urgency. In this series of posts, I’ll try to show you some other options.

Where does the money go?
Actually it only goes 4 places. Or more correctly said, a business spends money for only 4 reasons. One of the problems with traditional accounting methods is they only tell you what you spent money on but not why. This is a problem because you can make better decisions if you think about why. The good news is there are only four reasons. We’ll cover the first one here.

It all comes from the customer.
Where does the money come from? The only place is sales. From Customers. The only place. Investors and lenders may supply cash but that’s not “real money” it’s only a temporary fix, because you have to pay it back [hate it when that happens].

COGS
The first reason to spend money is to have something to sell. Accountants call this COGS (Cost Of Goods Sold) or Variable Costs because they vary with the number of units you sell. Double your sales and COGS will double. Sell zero and COGS will be zero. COGS includes the actual stuff you sell (like the burger and the bun) plus packaging & shipping costs (plate and napkin) garnishes (ketchup and mustard) and relevant labor.

The first way to think about managing COGS is percentage. Your COGS should be a certain percentage of your sales. The actual percentage varies with your product and your industry. Food costs at a restaurant are typically around 35% liquor costs are around 20%. [Now you know why the first thing the waiter says is "Can I take your drink order?"] I imagine COGS at Starbucks are much lower and those at a car dealership much higher. If you don’t know what’s standard in your situation you should find out and try and beat those numbers. You can improve your percentage by lowering costs or by raising prices. Try both and find the happy medium.

The internet stunned everyone back in the 1990′s because it looked like COGS would go to zero. Compared to a book or newspaper there is no cost of paper, printing, or distribution. One problem was there were no sales either. But the other problem was in some situations it makes sense to count the cost of sales as a COG. Commissions, for example, vary directly with sales and should be counted as such. Of course, if sales are zero then any COGS at all makes for a very high percentage.

Timing
The other trick in managing COGS is timing. Usually you need to pay for stuff before you can sell it, otherwise you have nothing to sell. If your customers pay on terms, it takes a while for you to get paid while you have to lay out more money to have something to sell your next customer. This is one reason distributors often give their customers terms – in effect acting like their bank. Where’s the interest on those loans? In the price. You get a discount if you pay COD or within 10 days.

Many companies use lines of credit to deal with the timing issues of COGS. If their sales are seasonal, they’ll need cash to buy more before they sell, and will have cash after the season to pay it back. A growing company needs cash as well because they have to stock the shelves to keep the growth on track.

Obviously if something sells more quickly, you’ll get your profit faster than if something sells more slowly. Timing of this sort is measured in inventory turns. Either how many days does it take to turn your inventory, or how many turns do you get in a year. Given a fixed percentage of COGS, more turns will lower the cost of cash you have to borrow to fund COGS and will toss off more money each month to be used for the other reasons you spend money. Again there are standards for your industry and product. Learn them and try to beat them

To think about COGs spending you have to consider the percentage (mark-up) you’ll be able to sell it for as well as the timing and turns.

Takeaways:

• Know what percentage of sales your COGS should be for each product (or relevant product line). Industry trade groups should be able to tell you what’s normal. Then adjust that for your specific situation. Lower is better – makes you more profitable and less vulnerable to competition.
• You can lower your percentage by lowering the cost of COGS or raising your prices. Try both.
• Timing is a factor. You’ll need cash to pay for inventory before you can sell it. This can vary by month if your sales are seasonal or be a constant need if your sales are growing.
• If the rest of your company is sound, getting cash for COGS because your seasonal, or your growing should be a no-brainer. If distributiors aren’t willing to give you terms and banks won’t give you a line of credit, maybe they know something you don’t about the health of your company. Clean that up first.
• Accounting terms: COGS are also called variable costs. The amount left from a sale after you deduct COGS is called Gross Profit. The % of sales that is your Gross Profit is called Gross Margin and the amount you charge above your COGS is called markup. So let’s say you pay $10 for an item that you sell for $15. Your Mark-up is $5 or 50%.[More than you need to know: a 100% markup used to be typical in retail - it's called a keystone.] Your Gross Profit on each sale is $5 your Gross Margin is 33.3%. Your COGS is $10 or 66.6% of sales.

The irony is that people and institutions that have money to invest are spending time and energy just LOOKING for places to put that money to use while at the same time, tens of thousands of businesses die every year because they don’t have enough funding. These two groups are passing each other like email sent to the wrong account. WHY? Because in many ways they don’t think alike. You know how an optimist sees the glass half full, a pessimist sees the glass half empty and an engineer sees that you’ve got twice as much glass as you need?

If you want to catch fish, you have to think like a fish, go where they hang out, give them bait they like. If you want to catch capital, you have to think like an investor, not just like an entrepreneur.

I’ve been on both sides of this issue and I know there’s a big difference in the way they think. Entrepreneurs see opportunity; they are optimists. They have to be to keep chugging along through all the hard work it takes to get a business off the ground. So they tend to see the reward that will come with success.

Lenders and investors approach things differently. I wouldn’t exactly say they are pessimists (otherwise they wouldn’t be investing in start-ups or young companies) but they are the types that might wear a belt along with suspenders. A person who has money to lend or invest is most interested in making sure they don’t loose that money. They tend to look at the risks where an entrepreneur sees only the reward.

So how do you catch a capitalist? You have to have a story (contained in your business plan) about your business that explains not only the potential upside, but shows that you’ve considered the down side. And not only that you’ve considered it, but also that you’ve done everything you can to minimize it. If you can’t do that, investors won’t care about the reward.

The price you pay for the money you need is in direct relation to the amount of risk. When you ask for money you have to tailor your story to the person you’re telling it to. I don’t mean you bend the truth, but you make sure the proposal contains the parts that they most want to hear.

Jon [didn't post last name] gives his experience on both sides of this coin on his blog.

Takeaways:

• Focus on minimizing the chance of loss – not inflating how big the rewards might be
• The less risk there is, the cheaper will be the money you’ll get. Bank money is the cheapest because they take the least risk.

In The World’s Greatest Banker Fred Gratzon tells the story of how his company outrgrew both his cash supply and his systems to track the growth. His banker finally justified an increase in credit by asking Fred “Do you feel like you’re making money?” When it happened again, the banker encouraged Fred to kite checks. This bought him time to get his systems in order, profit from the growth and take the company public. Fred’s post is an interesting read.

It’s not that I think people who write this kind of stuff actually lie. It’s just that their perspective on what really happened makes better business porn than it makes an example you can actually apply to your situation.

The lesson you can apply is one by Peter Drucker. He said that every time a company grows by 50% its existing systems become unworkable. And that it takes a year and a half to three years to develop new ones. The actual numbers (50%, 3 years) may vary – especially for smaller firms or faster growing ones. But the point is if you have a fast growing company, you need to be working NOW on systems that will support the size that the company will be down the road.

Where do you spend your time?