Not every topic and item introduced, analyzed, and discussed in Chapter 13 will have an effect on your business, and the reality is that most of those items and concepts discussed will never intrude on your day-to-day management of the business from an operational perspective. To simply ignore these topics and dismiss them as the worries for someone else would be a mistake, however, and leave you vulnerable to surprises and shocks later on down the line. As any entrepreneur or businessperson will tell you, the last thing they want or like is a surprise. Distilling and analyzing further some of the concepts and topics we discussed in Chapter 13, I have assembled this Chapter 14 to help take some of these concepts from abstract talking points to real world concerns and topics that should be worried about. This list, and chapter, are not meant to represent an all-encompassing list of all possible items for entrepreneurs to keep on their radar, but should rather give you a basis to analyze from a real world perspective just what are some of the hot issues to focus on.
The Money Checklist for Entrepreneurs
Net income does not equal cash—this is a concept that might seem like something every businessperson would know, but I cannot overstate just how important this concept is for a budding business or entrepreneur. Net income is what you show on your income statement, and is the (hopefully) positive difference between revenues and expenses. It is important to remember that income, although it is something we are intuitively familiar with, is influenced by numerous accounting principles and topics. These accounting techniques and items definitely serve a business purpose, but might not really have anything to do with your business—some of the common items might include:
If you are not familiar with all of these terms that are perfectly okay—most people, except CPAs, really have no reason to know what these terms even mean. For our purposes, the terms accruals and deferrals can represent different sides of the same coin, and are both estimates for future items. Since the costs (accruals) or revenues (deferrals) have not actually been billed or received as of yet, management has to make some estimates to make sure everything that happened during a month is actually reported in a certain month. Warranty expenses are pretty much what they sound like, except we are examining the idea of a warranty from the perspective of a business and not an individual.
Warranties work, in general, as follows. Customers purchase warranties, and pay upfront, to help offset potential future costs if a product breaks down. Companies have to recognize this as liability in case they owe these payouts at a future date, but this is only one specific type of liability. Liabilities can be thought of, and this is a relatively simple way to think about this topic, as any money that will be owed to an external party at a future date in time. Before we dive specifically into the topic of depreciation, I do want to take a moment just to make sure you are able to connect what we are talking about here with what we already spoken about.
Depreciation and You
While it might sound like a bad name for an accounting themed drama or play, the concept of depreciation can, and does, have real world implications for you and your business on an ongoing basis. Taking a step back to actually see and analyze what depreciation is, and represents, will help us better understand just what exactly is going on when we talk about depreciation. Before we can do that, however, the first thing we have to discuss is how we even get to this item called depreciation. That, in turn, leads us back to something we have already discussed—the balance sheet.
As analyzed before, the balance sheet is comprised of three primary sections: assets, liabilities, and owner’s equity. Assets are resources that will produce a future economic benefit for the organization, and this obviously includes any investments that are made to purchase or acquire long-lived capital assets. Specifically, for the purposes of our conversation on depreciation, any dollars that are spent in order to acquire, or put into service, assets linked to the plant, property, and equipment of the company are counted toward assets that may be depreciated later on. Reviewing this again, I do want to highlight the two categories of costs that are eligible to be used for depreciation purposes:
1. Costs incurred to acquire a long-lived assets
2. Any costs incurred to place this asset into service
In practice, what this means is that any of the costs that you spend to purchase a building or heavy equipment for your business, and get these items ready to actually be used in your business are costs that are, in turn, eligible for depreciation treatment. This might sound nice, but like something that is an abstract concept more than something that you should truly be spending too much analyzing or discussing. That opinion, however, could not be further from the truth, especially as it relates to how your business performs and what future financial decisions you might make with regards to your business.
What Is Depreciation
So we know that depreciation is something related to the fixed assets of a business that are usually costly, long lived, and used in the operation of your business. What depreciation does, through some accounting machinations, is it allows you to spread the usually significant costs of these assets over the useful life of the particular asset. This bit of accounting magic is directly linked back to what we had discussed when we talked about the matching principle, the accounting principle that states all revenues and expenses must be recorded in the same period. For example, let’s analyze the following scenario, but keep in mind that useful lives (for tax purposes) are specified by the IRS so you do not have total flexibility over the useful life you are able to use for depreciation purposes.
Company ABC purchases a new building as part of an expansion process, and plans to use this building to help manufacture and produce new lines of products and services for new and existing customers. The building itself was appraised as $300,000, the land separately appraised at $500,000, and the various commissions, fees, and licenses required to complete the purchase totaled $50,000. Additionally, to set up and get the building ready for use for the business, a total of $75,000 was spent on renovations. The building has been assigned a financial accounting life (different from tax) of 20 years. What is the total asset value worth to the business on a cost basis, and what is the annual depreciation expense?
First, let’s take a look at the total costs that have to be incurred to actually purchase this asset and get it into business shape for our business identified in this problem. The actual asset itself costs $800,000 (for both the building and land), various fees and other payments cost $50,000, and the company had to pay for $75,000 worth of upgrades to the building. This brings our total cost of $925,000 in order to both purchase this asset, and get it into the appropriate condition to be used for business operations. The next step we need to figure out is just how much depreciation we are able to take on this building on an annual basis, and fortunately that is a relatively simple calculation that is (total costs/useful life), or in our ($925,000/20) to arrive at an annual depreciation expense of $46,250 annually.
If you think this sounds like a nice chunk of change you are right! It is certainly not an insignificant amount of money, but the dollar amount alone should not cause you any heartburn, and here is why. Although you are booking this annual expense every single year no matter what, the actual cash that had to be paid to acquire these assets had to be spent out front. In other words, although the organization will be booking this expense every year there is absolutely no additional cash leaving the business during these time periods. Without getting too much into tax policy and details, this provides an important benefit for management teams and organizations to remember.
From a business management perspective, it is important to remember that, although depreciation might show up as an expense on your balance sheet, it has no impact on your business cash flows. This results in the following reality—although your income is reduced by the annual depreciation expense, there is no money actually leaving the firm. As a result of this lower reported income, which is completely correct and ethical, the organization will end paying less in taxes than if the company had not invested in these long-lived assets. This is what is known as the depreciation tax shield. The cash flowing in and out of the business is how you, the entrepreneur, can pay bills, manage your vendor payments, and reinvest money back into the business. Depreciation, on the contrary, is merely an accounting entry on your income statement and has no impact on the profitability of your business, the cash flows generated by the business, or how the business actually is performing.
Key takeaway for entrepreneurs—depreciation is an expense but is a non-cash expense not related to business operations or performance.
Other Tips
Depreciation might be a high-level item that shows us a big ticket expense on your income statement, but that does not mean that this is the only financial item you should keep on your short list as an entrepreneur. Business is influenced and changed by a whole host of factors outside of depreciation and continuing operating, and these items can have a dramatic effect on how your business performs presently and in the future. As an entrepreneur or small to medium size business owner it is even more important for you to keep an eye on these financially oriented factors and themes in order to maximize business performance. Framed in the context of take away information that you can act on beginning today, this list might be viewed as a short cut to help you better manage business finances.
1. Expenses—It is never fun to talk about expenses, profits are just more fun. But do you really know what your small business or startup is spending money on? For example, are you paying too much for webhosting? When was the last time you checked the effectiveness of your advertisements? Getting a handle on costs is half the battle toward a profitable new business.
2. Taxes—The fun continues! All kidding aside, taxes are a part of life for individuals and small businesses—it is on you to know what your tax obligation is for the year. While you are keeping track of your taxes, be sure to check and make sure you are taking advantage of every credit and deduction your business is eligible for. From hybrid vehicles to solar panels, your business might qualify for more than you think.
3. Credit—Two quick things about credit. First, do not mix and match your personal credit cards and business credit—it can get messy very quickly. Second, credit (debt) is not always a bad thing—it is a tool like any other, and can give a millennial entrepreneur the breathing room they need to get things and running. Like any tool, however, debt must be used properly—millennials are acutely aware of the damage runaway debt can cause.
4. Technology—Social media, although fun, is literally just the tip of the iceberg when it comes to technology. From payment management apps, property management apps and programs, and the numerous (and mainly free) tools to video chat and do business with anyone at any time, why not make technology work for you? For instance, every food service should always have new pictures of their menu—bon appétit!
5. Get organized—Being organized and keeping track of the information related to your business, both operationally and financially, is the first step toward improving your current performance, and generating improved future performance. You do not have to invest in sophisticated software or tracking tools to track your information however, you can begin tracking and organizing yourself with something as simple as pen and paper.
6. Your network—Everyone has a network, and it is up to you to maximize the value of your network for your business activities. Your network provides you with potential customers, connections to other local businesses, and an audience to bounce ideas off. Do not underestimate the value of maximizing your network, or the importance of making the most of your connections.
7. Acquisition costs—Revenues and expenses are items that we have talked about throughout this text, and should be items that we are relatively comfortable with, but what about the idea of acquisition costs? Acquiring customers and developing new business costs money, and you must be able to acquire and gather business leads in a cost efficient manner. Think of it this way—if you are paying $5 to acquire every new customer, and these customers are only generating $4 of revenue for the operations, you are not acquiring customers in a cost-efficient manner.
8. Customer profitability—generating new business and acquiring new customers is primary concern for every entrepreneur and small business owner, but you have to be sure that you are actually attracting profitable customers. Expanded in the next section, the very concept and idea of customer profitability is one that too many entrepreneurs and business owners do not spend enough time focusing on.
9. Marketing—Not everyone is a born marketer, but that is no excuse to not engage in marketing behavior and to try to expand your market presence. Whether you market by using word of mouth, focus on pictorial marketing, or leverage social media to help build your business the emphasis is the same. In order to attract business, generate new customers, and grow your client book you need to reach out and engage with your customer base.
10. Use the experts—Taxes and legal advice can be some of the most confusing topics and concepts for anyone, least of all a busy entrepreneur that is trying to bootstrap a business from the ground up. Fortunately, a multitude of online services are available, many of which are very affordable and, increasingly, intuitive to use.
Customer Profitability
Acquiring new customers and building out your book of business is something that every entrepreneur and business owner should spend quite a bit of time thinking about. Revenue is the starting point for profitability, cash flow, and provides you the platform and opportunity to advance your business agenda in the marketplace. There are entire books, seminar lecture series, and endless YouTube/audio podcasts that focus on how to sell more goods and services to the marketplace. Professional sellers, experts in the art of selling, and entire industries have sprung up around how to help entrepreneurs and smaller to midsize businesses attract new business, but one aspect of this industry is often overlooked. More customers, generally, means good news for the business, both in the current and long term—but how profitable are these customers?
Let me explain a little bit about what exactly I am asking in that question, and this builds on something that we had introduced before in our checklist. This is truly a core question for any business owner as they seek to expand, grow, and develop new lines of business regardless of whether they operate in a product or service market. It will always, 100 percent of the time, cost money, energy, and time to attract new customers to your business. Additionally, and especially if you are operating in a services industry, it very well might cost even more to onboard these new customers into your system and deal with switching costs.
Switching costs represent the costs and inconvenience you experience when changing from one service provider to another. Think of it like when you try to change cable companies, or learn how to use an Apple device after using Samsung products—there is always friction.
Customer Profits
As a business owner, your gut instinct is to assume that every customer or client you bring into the business will generate positive results for your business, and this might very well be the reality of the situation. That said, there are two costs, or cost buckets, that must be integrated into any analysis of customer profitability, both for current customers and prospective customers. Clearly this is not going to be an all-encompassing list of costs to be considered when prospective for new customers and business, but this should give you some food for thought. The key takeaway to keep in mind during this conversation and analysis is that hustling for new customers and business is always important, but you have to pay attention to the profits of these customers.
1. Acquisition costs—bringing new customers and clients into your business environment always costs you money, even if you are not directly dedicating funds to these efforts. Advertising costs, expanding an online presence, developing and augmenting current product and service offerings all require funding, management time, and take place at the expense of other options. How much are you spending on advertising and other engagement/reach out initiatives, and how much is being generated by these efforts in the form of new customers?
2. Unprofitable customers—once you have brought new customers and business into the fold, you must always check and make sure that these customers are profitable for you in the short and long term. For example, if you are offering discounts to get customers in the door, and these discounts are generating losses for the business, that is not a sustainable strategy. One metric to check, in this case, might be to watch and see whether new customers leave once introductory discounts expire or are not kept on.
The whole concept of profitability, on a customer by customer basis, is a relatively new concept that is now possible due to the increased use of analytics and information in the marketplace. As we have been discussing throughout this book, for individuals and entrepreneurs, the sheer number of technology options and data gathering tools now available is nearly overwhelming. In addition to letting you know which customers are profitable, and what trends and factors seem to drive customer profitability are items that you also use to decide how to interact with customers. For example, if based on reviewing your books, records, and other business data you come across a group of customers that seems to be more profitable than average, it might be worth investing some extra effort to remain engaged with them. On the other hand, if you notice a certain group of customers are break-even, or even unprofitable, you might want to reconsider how you are marketing your product. A takeaway from this insight, might possibly, be a reduction in introductory discounts and free trials as techniques to attract new business. Why invest the time and energy in attracting these new customers if they are, in fact, only sticking around because you are offering discounts to help get them in the proverbial door? The key to any of these actions is having access to the necessary data to help you make better decisions, so let’s take a look at how any business, large or small, can leverage data and analytics to make better business decisions.
Analytics and big data are terms and ideas that certainly have been receiving quite a bit of attention in the last several years, and this is for good reason. The proliferation of technology, integration of Wi-Fi into virtually every device imaginable, and the nearly limitless amounts of information available via social media have transformed what it means to be in business. Whereas in the past some business decisions might have had to rely purely on gut, intuition, and experience now entrepreneurs have the ability (and responsibility) to make decisions using the best available information available. That said, the sheer quantity and number of different options out there for entrepreneurs to use technology have the potential to overwhelm even the savviest small business owners. Compounding this possibility is the stark reality that technology can be expensive, and using technology for business purposes can quickly generate quite a large bill. In essence, technology can become a destroyer of profits and business success instead of a multiplier, but it does not have to be that way.
By thinking about analytics, big data, and technology in general from a business management perspective, any entrepreneur can effectively use technology without breaking the bank. To start this conversation off it is important that we boil down the different ways in which an entrepreneur and small business owner can and should use technology to help maximize business success. Your business might be different, but I guarantee that thinking about these areas will help improve your decision making, and help you stretch those technology dollars.
1. Customer analytics—building on our previous conversation regarding customer profitability I think it is a logical next step to start analyzing your customers. You already have quite a bit of information on the people that do business with you (shopping habits, purchases, dates, times, locations, etc.) so why not make the most of this information? Better yet, once you start to really analyze and critically examine just how your customers are shopping with and doing business with you, you might even uncover a few traits and characteristics you had not previously thought of.
2. Experimenting—every good businessperson knows that stagnation and not changing are twin recipes to decline and failure, so constant experimentation and tweaking of your business, products, and services is absolutely required. Even a simple change as a basic redesign of your online web page, virtual shopping cart, or posting routines on social media can have a dramatic effect on how your business performs. Since all of your changes, and subsequent customers interactions with them, take place in an online environment there is no reason not to measure the changes that your tweaks cause.
3. Potential customers—obviously, the best types of customers are the customers you already have or are drawing into your business, but there is a whole pool of potential customers that might not even know are considering your business. How do you measure these potential customers? Using a physical store as a point of reference for this example, it might go something like this. Hooking a motion sensor to your CCTV, monitor and watch what type of potential customers stop and look at your storefront during a given period of time. What is the traffic like on weekdays versus the weekend? Is there a specific time of day that foot traffic (potential customers) seems to be at its highest point consistently?
a. Then, and here is where the true potential of data analytics for business shines. Based on this information that you have gathered, specifically when the foot traffic and activity outside your store front is at its zenith, you might be able to construct and rollout changes to your business model that generate additional sales.
b. If traffic is highest outside your store around lunchtime during the week, for example, why not put out a little stand, some balloons, and be sure to make yourself available? This works especially well if people are already window shopping—why not turn that into actual shopping?
Analytics and big data have the potential to tell you a lot about your business, how your business is operating, and can also help you identify room and areas for future improvement—all good things. That said, we would be remiss in our discussion of analytics and business insights if we did not also touch on the reality that of all these analytical tools require technology tools and techniques to implement. Technology, especially in the current environment, has a connotation with social media, which can have a more or less positive connection to you and your business, and might have dissuaded you from thinking too much about this topic. Not thinking about technology, however, will only leave you with a partial picture of how exactly to implement business improvements while also making the best use of analytics.
Technology for Business
From any analysis of media headlines or business magazines it is almost impossible to overestimate the importance of technology on business operations and performance in the current marketplace. Facebook, Twitter, WeWork, Uber, and Lyft are all examples of how integrated technology companies are revolutionizing how business is done, and how organizations interact with each other and their customers. That said, I have far too many examples of how technology is seen as the be all and end all of business solutions that causes entrepreneurs to spend far too much on technology without putting together a technology plan. Charting out a technology plan and strategy might not seem like the most enjoyable activity to undertake, but it is critically important to you and your business. Technology is a powerful tool, but it can very quickly become an expensive tool—let’s take a look at a few of things to keep in mind and to plan to help you maximize your technology dollars.
Focus on your goal—It is easy to be overwhelmed by the sheer number of technology options, and with the pace of technology integration only increasing this risk is especially important for entrepreneurs and small business owners. Taking into account Facebook, Instagram, Snapchat, Pinterest, YouTube, and do not forget that customers can use Yelp to review your services, it is relatively easy to see how you can invest quite a bit of time and money in technology without accomplishing any significant. What is, perhaps, a better strategy for using technology effectively for your business is to link your technology strategy and ideas to your overall business goal.
a. If you approach technology with a scattershot or disorganized mentality how can you honestly expect to obtain a reasonable return on your technology strategy? Using technology for business purposes requires that you have an overall framework and/or strategy that you use technology to amplify. Once you have your business strategy outlined and organize then you start to look at what technology options give you the most bang for your buck.
b. For example, if you own a food services restaurant or are a budding fashionista you might be very served to utilize photo friendly tools like Instragram, Pinterest, and Snapchat to engage with customers.
Add value—This is an important point that is critically important to business, is a concept that every entrepreneur intuitively realizes, but is an idea that can be completely overlooked when it comes to technology. In order to attract, retain, and develop new and existing customers you must be able to meet their needs and requirements, and do so in a way that adds value to what they are looking for. Every business should fulfill a need that is either going unmet in the current marketplace, or do so in a way that is innovative and adds value in a meaningful way. Linking back to this discussion around technology there are two items that must be firmly identified and established before a technology plan or strategy can really be put into place.
a. What are you good at? In your analysis of the marketplace, and this should be done even if you are already in business and looking to develop new products. Which aspects of the market allow you to add value for your clients and customers, do so in a way that is profitable to you, and that can be done in a sustainable manner? If you cannot articulate and identify what you and your business do better than alternatives, how can you expect your customers to do so?
b. Adding value—It is important to draw a fine line on this point before we continue down this path, and that is reality that not everything you are good at will be equally as valued by the marketplace. Competitive juggler training, as an example, might be something that you have expertise in, can address in a sustainable manner, and do so in a value additive way. That said, the addressable market for this skill and training is not incredibly large, and might render this business idea unviable. The key takeaway is to make sure that the new product or service you are developing both adds value and addresses a market large enough to make the idea financially viable.
Definition: Addressable market—what this term means, and is thrown around quite a bit in the recent technology driven market, is just how big your total market can actually be. Mass market products, such as automobiles and sneakers, have a much larger total addressable market than a niche market such as high end luxury automobiles. It is important to note, however, that just because a potential market is smaller than comparable firms might have does not mean that the market is doomed. Take a look at Apple as an example; even though Apple does not have leading market share for smartphones and tablets it consistently generates the highest profit margins. Sometimes quality is more important than quantity.
Technology strategy—As an entrepreneur focusing on building a business, establishing a brand strategy, generating new business, and generating more from existing business lines, having a technology strategy can sometimes be relegated lower down on the proverbial to do list. As you experiment, tweak, and roll out different platforms and strategies as they link to your technology strategy you absolutely must do so with an overall plan in mind. Linking back to our earlier conversation around the importance of different platforms for different business models, your strategy may change and evolve over time, but it is important that you have one to work with.
a. This can be as simple as laying out a timeline for what you are going to be doing with technology, what tactics you will use to promote your efforts on technology platforms, and how long you will experiment with these different platforms. It is important to have a framework within which you be experimenting with in order to get the best value for your technology dollars.
b. It is also important that, as you are launching your products and services into the technology market, you have some sort of benchmarks and metrics that you can use to measure the effectiveness of what you are actually doing. Page views, engagements, interactions, and (ultimately) purchases are just a handful of the metrics and data points you can, and should, gather in order to obtain a better handle on how your technology strategy is performing.
Leverage free—With so much technology out in the marketplace, and highlighted as absolutely critical for business, it is tempting to start spending money on technology options, tools, and hardware that you might not actually have to spend money for. Think about it for a second, especially the technology platforms and options that we discuss on an almost daily basis, and you will see quickly how much technology is actually available for free in the marketplace. Facebook, Twitter, YouTube, and Instagram, for example, are available for free, so why not take advantage of these free product and service offerings to help bootstrap your business?
a. For example, you can build out a YouTube channel, Facebook page, Twitter handle and profile, and start posting various pictures, videos, and information for absolutely no charge. The only thing that it will cost you to build out your technology presence and strategy is some time and proverbial elbow grease.
Use social media—speaking of, and building on the whole idea of leveraging free technology and tools for your business, it is absolutely imperative that you make an effective use of social media to help build your brand and your business. Social media is something that, I think as we all know, can occupy and take up a large amount of time without generating too much in terms of business returns, but that is no excuse to not develop and effectively use social media for your business.
a. Design metrics—whether you want to track the number of views your videos are getting, or simply want to track how many people come to your website, social media and virtual platforms provide you endless information with which to better engage customers. If you want your post, video, or product to go viral you are going to have to track how your current efforts are performing.
b. Tweak and redesign—when engaging in a social media strategy, or even just dabbling in various social media ideas and concepts you will inevitably have to update, tweak, and redesign what exactly you are doing. Posting content at different times of day, different types of content, developing and using different SEO strategies, and tagging (engaging) with different social media users might very well result in a different performance for your posted content.
c. Engage—social media is, almost by definition, a platform and way for individuals and businesses to engage with each other, work together, and collaborate to find better solutions. That said, it always surprises me how often individuals and businesses will simply upload content onto a platform one time and do nothing else to help promote or spread this content.
Keep current—technology changes, and will have changed by the time this book is published, so it is virtually impossible to design too far in advance what technology platforms and tools will form the foundation of your technology strategy. Watching Fox Business, Bloomberg, and CNBC it is easy to feel overwhelmed and a tremendous pressure to suddenly enroll in a coding academy or start an app course. Now, it is important to keep your technical skills current, but that is no reason to suddenly pivot and invest money and energy into learning skills and competencies that will not add value to your business.
a. Enroll in a MOOC—the proliferation and spread of massively open online course, many of which are available for free or at a deeply discounted price point. You can enroll and take courses from prestigious institutions including Wharton, Harvard, and many others that introduce, focus, and develop different skills in a variety of areas.
What Entrepreneurs Need to Know About Debt
Debt, especially in the aftermath of the financial crisis, has taken on a negative connotation that seems to have grouped the word debt into the categories of the other 4-letter words that are not to be spoken in front of polite company. Alternatively referred to as credit, which has a nicer ring to it than simply debt, this is an important tool that every entrepreneur and small business owners must know how to use, leverage, and get the most out of. I know we had discussed the ideas surrounding, and the importance of, debt management and credit repayment for individuals, but this concept is arguable as important for entrepreneurs and small business owners. Debt and credit is an incredibly powerful tool, but it is like a jackhammer—you can use it to help jump-start and assist with what you are doing, but if you do not know what you are doing you can cause a lot of collateral damage to you and your surroundings (business finances). Let’s take a look at a few of the things you should keep an eye on when thinking about debt/credit and your business.
Interest—the idea of interest is one that generates quite a bit of headline attention, is the focus of numerous commercials, and drives a lot of conversations amongst individuals and business owners. What interest represents for our discussion and purposes are funds and dollars that you are paying on your debt that does nothing to reduce the overall level of money you are to pay back to your lenders. Interest payments are how the lenders and creditors are compensated for the risk of lending your business money, on top of the actual principal that they lent out in the first place. On top of the less than pleasant prospect of paying money to a creditor, credit card company, or commercial lenders, there are a few other prospects that you should keep an eye when analyzing credit and your business.
a. Introductory rates—the rates that you first pay on your credit card, loan, or other type of financing tool are commonly known as the introductory rates that will increase over time. It is important to not be lulled into a false sense of security, running up larger than average debts and debt burdens, only to have to pay higher rates on these higher levels once the introductory rates expire.
b. Credit utilization ratio—while this term might seem a complicated term that is beyond the purview of this book and discussion it is something that is arguably more important for a small business than it is even for your individual credit rating. Credit utilization, especially for a small business or entrepreneur, can be explained and rationalized in the following way. If your business has total available credit of $200,000, spread around various different tools and financing options, and you have $100,000 of it currently outstanding, that means that you are at 50 percent credit utilization. Why does that matter? It matters because the higher your utilization ratio is, the higher risk you are for future lenders and creditors, which in turn means you will end up paying higher interest rates than you would have otherwise.
Fees—I could write an entire book about fees, what types of fees to look out for, and tactics to help you minimize the fees that you actually end up paying, but there are other books already out there that do a better job than I would be able to. Instead, what I really want to focus on here is the business case for why fees are charged for, and associated with, credit, and what you can look for in order to minimize their impact on your business.
a. Why—Lenders and creditors need to charge fees on certain products or services for the simple reason that in order to provide these products and services to you they must be able to do so in a profitable manner. Especially in the lower interest rate environment that has dominated the commercial and individual lending space since 2009, sometimes the only real profit driver for a lender is their fee structure.
b. Fun fact—Some airlines actually make the majority of their profits from selling airline miles to banks, and not from actually operating their business! Also, think of all of those extra surcharges and fees you pay when you fly—it is the exact same idea for airlines as it is for commercial lenders.
c. Where—Fees can appear virtually anywhere, and at any time, so as an entrepreneur you must always be on the lookout for them as you are assembling your financing options. Loan origination fees, various account fees, access fees, ATM fees, and the like can sap your earnings and profitability over time—don’t let that happen to you.
d. The takeaway—Sometimes there is no avoiding the reality that you will have to pay fees for certain items or services, but the responsibility is yours to make sure that the fees you pay are minimized to the extent possible. Check the fine print, double check your contracts and agreements, and make sure to keep an eye for any unannounced changes that might increase you free structure.
Good debt—As someone who has been bitten by the entrepreneurship bug myself I fully understand and appreciate the trepidation that many people feel about taking on new debt for any reason, least of all something as risky as starting a new business, experimenting with a new idea, or launching a new service offering. That said, let me ask you a very simple question—where are you going to obtain the funding to get your business or idea off the ground? Everything costs money, and sometimes it is not realistic or plausible to raise money using some of the crowdfunding options we had spoken about earlier. Debt is a powerful tool, and can give your business the jump-start of capital that it needs to spur some.
Like every tool, however, there are some jobs that debt is better for than others, so let’s take a look at a few examples of when it might be a good time to take out some more business debt, draw down on that line of credit, and use it for your business.
a. New business—I know, I know, taking out debt to start a new business sounds like the riskiest thing an entrepreneur could possibly every do, but let me explain. If you, let’s say, set up your startup as its own independent entity, borrow some money to help get that business started, and it does bust, what happens to your personal finances? As long as you have kept your business debt separate from your personal finances, your personal finances will be left intact. The various form of business for you might vary, but could possibly include an LLC or partnership. Check with a legal expert familiar with you and your situation before making a final decision on this.
b. Launching something new—Developing and rolling out a new product or service will always end up costing money, and this is a good time to experiment with borrowing some funds to test out this new idea. Especially with interest rates at the low levels they are, it is actually less expensive to borrow money than it is to try and raise some capital from potential shareholders.
c. Think long term—If you are building a business model and a business that you are expanding and growing, it might be worth tapping your credit lines from time to time instead of always raising money from individuals or other organizations in exchange for equity. Equity is a great thing, brings partners with some skin in the game to the table, and does not have to be paid back, but there are some reasons why it might be preferable to raise debt even if you could possibly raise equity.
a. You retain complete ownership of your company
b. No new partners to onboard and have to convince of your strategy
To conclude and wrap up our discussion about debt and your business it seems appropriate to revisit some of the key concepts and important facts about debt, and how debt can and should relate to your business. Debt is a tool that can provide with the necessary flexibility to try new things and improve your business without sacrificing any control or oversight over your business. Second, if you are able to isolate your business finances from your personal finances (which you always should), even if you are unsuccessful with a particular product launch, your personal finances are intact and you live to fight another day. Lastly, and interestingly, is the fact that sometimes potential investors (equity) will ask if you have been able to raise debt or borrow money. If the answer is yes, this lets your investors, or potential investors know, that you have been able to get out there and sell the market enough on the merits of your idea to get external backing. Debt can be a scary 4-letter word, but it does not have to be if you understand how to use it effectively.