You don’t need a degree in business studies to run a successful business, but you do need to know some basic economics (you sell and your customer buys).
You also need a modicum of common sense, which is often sadly lacking in those who fail in their attempts to run a business.
The first stage in setting up a business is to draft a business plan, which will identify whether the business will generate a profit and provide a living wage for yourself.
It is important that this task is undertaken first, because if the business does not look like a goer at this stage, it will be a waste of time devoting any further effort to it.
The drafting of a business plan is so key to the creation of a successful business that I have run through the process and included a plan for a hypothetical restaurant (JT’s Restaurant) in Chapter 12.
The plan covers the period from startup until the third year of trading and deals with all aspects of the business startup.
The creation of a business plan is one of the most important steps to take as it serves as a road map for the early years of the business. It also outlines the route that the business will take to reach its annual and revenue targets.
Drafting a business plan may involve you revisiting some of the questions dealt with in previous chapters.
There are lots of organizations and resources available to small businesses to help with their business plans.
The detail required to draft a business plan becomes apparent in the budgeting and cash flow section in this chapter.
Create a Brand, Logo and Business Design
You need to create a brand, logo and business design so that your customers can find you and your products. I would advise that you start with a blank sheet of paper and think of designs that fit with the business that you are going to operate.
I would also advise that your slogan, if you have one, is clearly understood. One that was misunderstood, to great benefit, is Nike’s ‘Just do it’, which a young Indian man mistook to mean Just do IT (information technology). He went on to form one of India’s major IT companies.
Next, look at brands that you like and see if you can come up with one of your own that is similar, but not so similar that it could be construed as a copy.
Don’t restrict yourself to one design, but come up with a few along a theme, and fine-tune them on your basic software before you hand your initial thoughts over to a professional graphic designer.
Rethink about how your company name will fit with the brand and logo and remember that nothing is set in stone at this stage.
I would advise that you appoint a professional graphic designer to produce the final design, as you will get something that looks professional.
Remember that your customers will associate the brand and logo with you, and if it looks like it’s done on a shoestring they will associate that approach with your business. If it looks cheap, your customers will think you are too.
The graphic designer should be able to advise on the use of colors, how to avoid those that will clash and how your brand will look online and on letterheads. Keep it simple.
Keep an eye out for bad design in others and learn from their mistakes.
Some suggest that you should restrict your brand design to four colors plus black and white, so that it is easy to replicate.
Once you’ve agreed on a design, you can produce what is known as a brand guideline, which typically includes:
■ A copy of the logo
■ An inversion of the logo (black on white/white on black)
■ Your agreed colors
■ Typeface
This design can be adopted on all the business stationary (whether online or actually printed). This guideline is an important document as it will include all the color codes and design parameters to give to printers in the future, as the business develops (i.e., business cards for new employees).
As I am not an artist, nor have I any intention to be one, I have made no effort at this stage to include a design for the sake of this book.
Sole Trader, Limited Company or Partnership?
Now that you have branded your name, you next need to decide which business format you are going to adopt to run your business.
The decision as to which format the business adopts upon setup is dependent upon whether a number of people are involved in the business. If you are planning to run the business on your own and employ anyone you need assistance from, then the sole trader format is for you.
This ensures that you solely will benefit from the business’s success (unless you decide to pay bonuses to the staff from the profits made).
The sole trader approach is flexible, and arrangements can be made to minimize the tax paid and to maximize the proprietor’s pension/retirement plans. You will need to speak to tax advisers in your location as to the options available.
For various reasons (which are apparent in the business plan/finance application in Chapter 12) it has been agreed that JT’s Restaurant be set up as a sole trader format.
A sole trader business is the quickest to set up as there is very little paperwork or formalities. The Tax Authorities only need to be told that you have started running a business. In the UK, this needs to be done by 5 October in your second tax year of trading (I would advise that you take professional advice on this and register as soon as possible so that you do not build up liabilities to tax and national insurance).
The main disadvantage of the sole trader approach is that you are solely liable for the debts of the business should it be unable to clear its liabilities.
Another disadvantage to being a sole trader is that you need to enter into contracts with your employees personally, which means that you will need to pay their salaries even if the business income is nil; in that situation, this could mean that you may be the only one not getting paid!
(You can possibly get round this by offering zero-hours contracts to the staff, which means that as an employer you are not obliged to guarantee any fixed working hours or salaries. Zero-hours contracts are very popular in the ‘gig’ economy we have today, but the morality of utilizing them is questionable [more on this in Chapter 5].)
From a tax and legal perspective, if you are a sole trader, you are treated as earning the income personally and all the assets and liabilities of the business are in your personal name.
In the hypothetical business, JT’s Restaurant, all the liabilities will be mine, as the business has been set up as a sole trader. But given that my involvement is solely to provide security, and I have faith in the business, it is not something that I am worried about.
If the business is not financially sound or there are risks involved, it may be preferable to incorporate to gain the benefits of limited liability.
Limited Company (Incorporation)
This involves forming a limited liability company, which is a separate legal entity, so that the ownership of assets and the responsibility for debts are not yours, but they stay with the company.
Other than providing security, another major advantage of incorporation is taxation, as the rates of tax and the opportunities to reduce the amount of tax payable are better when a company is used to run the business.
If a business owner transfers his/her business to a limited company that they control, it can be treated as a sale for tax purposes (and a capital taxes liability may arise as a consequence).
If the company has just been set up to take over the business and it is unable to obtain funding, it will not have any cash to pay the business owner. The amount can remain unpaid and a director’s loan (i.e., the company owes the amount to the director) can be set up to account for the amount due.
This amount can be withdrawn over a period of years as a small income to minimize the tax due on it.
From the foregoing information, you can see the opportunity to reduce tax through incorporation, and I would recommend that specialist advice is sought when a business is incorporated.
There are plenty of agents around who can form a company on your behalf, and I would advise that you take this route to ensure that you are compliant with corporate legislation.
When a company is formed, its ownership is determined by the holders of its shares. A company can have as many or as few shares as the business owner decides, but the more shares there are, the more compliance work there is to do.
The system of share ownership provides the opportunity for the business to be shared, that is, 2 shareholders could hold 50% of the shares each, or 10 shareholders could hold 10% each.
As you can see, using the company format provides opportunities to share the ownership of the business, and this can prove useful when deciding upon sharing the profits of the business.
But beware, each holder of a share in a company gets a vote in the running of the business, which is why a large number of business proprietors ensure that they, and their families, always retain more than 50% of the shares. This ensures that they always have control of the company.
The ownership of shares by the proprietor and his family further provides the opportunity to reduce tax by taking profits from the business by way of dividends.
Dividends are payments of a share of the profits from the company to the shareholders.
The payment of dividends has formed the basis of a number of tax saving schemes, whereby a spouse and children receive high levels of dividends, while the proprietor takes a low salary as earnings (more on this in Chapter 6).
The tax treatment of dividends and earnings is different, and this difference is exploited in tax saving schemes.
An example of a tax savings scheme utilizing dividends is provided in Chapter 6.
Incorporation is a complex legal process and advice needs to be taken if it is being considered.
As with all things, there is a catch. It costs more to operate a company as the accounts are more detailed and the company needs to comply with separate tax rules.
For those businesses where more than one person is involved, and the limited company option is deemed to be too complex or expensive, there is the option of partnership.
Partnerships offer the following advantages:
1.Economies of scale can be achieved by working with others, whether it is the ability to jointly purchase a property or the sharing of running costs.
2.Business owners working together can split the management role and assist each other in running the business.
3.A larger business can provide a broader selection of services.
4.A larger business can often attract better staff, and they can assist in the role of succession and ultimately the sale of the business.
5.Customers get more comfort dealing with a larger business as they feel that their consumer rights are more likely to be addressed.
Three basic formats of partnership are available:
■ Basic partnership
■ Expense sharing partnership
■ Limited liability partnership
The basic partnership is very much like the sole trader format of running a business, the only main issue remaining is that of unlimited liability. All partners will be liable for the faults/mistakes of all the other partners, so unless you have full trust in your partners this may not be the best option for you.
In a basic partnership, the partners share profits in an agreed profit sharing ratio with their income and expenses being allocated accordingly.
In these businesses, a single set of accounts is usually prepared, which will show the partners’ individual profit shares and their capital investment in the business.
The basic partnership is required to submit a partnership tax return disclosing each partner’s profit share to the Tax Authorities.
An expense sharing partnership is very much like a normal partnership, but specific streams of income and expenditure are allocated to specific partners. There is still unlimited liability.
Professional practices, for example dentists, often adopt this business model, where they tend to share the costs of the property overheads, but account for individual income and incur separate specific costs related to their individual patients.
Expense sharing partnerships are treated differently for taxation and accounting purposes, as each partner can provide different services and work different hours from the others.
Each partner will draft their own accounts and will submit an individual tax return each year; normally, a partnership return is not submitted.
Expense sharing partnerships are common where it is easy to identify individual partners’ income and the expense relating to each partner, for example the costs of running separate buildings and specific staff or the cost of running certain fixtures and equipment.
The unlimited liability issue can be dealt with by forming a limited liability partnership. This can be incorporated without any shareholders. What is needed, however, is a detailed partnership agreement, which provides the legal framework that stipulates the duties and general conduct of the company members (partners).
The legal and taxation rules which apply to limited liability partnerships vary and can be more complex than those applicable to normal partnerships.
The partnership agreement of a limited liability partnership has a number of key areas which are mandatory. I would advise any partnership, be it limited liability or unincorporated, to have a detailed agreement to provide for any future disputes.
The core of any partnership is trust between the partners, knowing that each partner has the ability and will work to the best of their ability, for the benefit of the partnership.
Most good commercial lawyers should be able to provide an adequate partnership agreement, as they should have one in place in their own practice.
Now that you have sorted out your name and business format, it’s time to look at whether you’re going to make any money.
As you are setting up the business to earn an income, you should know enough about the finances of your business to be able to produce some kind of budget or forecast before you start. The drafting of a forecast should be the first thing you do, primarily to ascertain whether you are going to make any money!
It is relatively straightforward to do this and numerous computer programs are available which allow businesses to produce detailed financial projections.
It is unlikely that a business will generate sufficient income to cover the business expenditure from day one. It may be a while before the business is generating enough money to match or exceed expenditure, and it is necessary to plan for this deficit upon set up.
The funds to cover the shortfall may need to be borrowed, and in order to convince the lender that the need for their financial support is not open‑ended, it is necessary to show them when the business can afford to begin paying them back.
Ultimately, the business will be set up to provide the proprietor with a living, and it is essential to determine when the business will be able to afford to do this.
Bankers are more keen to lend to businesses that work to budgets and prepare financial forecasts.
A projection is useful to deal with the foregoing points, and a by-product of producing forecasts of expenses is that the first sales targets of the business are set.
Figures 3.1 through 3.3 provide a simple example of a cash flow that reflects the first 3 years of JT’s Restaurant business.
The figures are based on a cash flow produced for an actual startup restaurant I advised.
The schedules have been produced by a computer program called Excel, which is a market leader in the production of cash flows and is relatively easy to use.
The figures in Figure 3.1 show that the restaurant produces a cash flow deficit of £841 in its first year, but then goes on to produce excesses of £22,999 in the second year and £36,689 in the third year (Figures 3.2 and 3.3).
Figure 3.1 JT’s Restaurant 3-year forecast: Year 1.
Figure 3.2 JT’s Restaurant 3-year forecast: Year 2.
Figure 3.3 JT’s Restaurant 3-year forecast: Year 3.
The figures show that the business needs an overdraft of £19,999 in March in the first year, but goes on to generate a cash balance of £58,846 at the end of the 3-year period.
The figures, which I have hijacked for my hypothetical JT’s Restaurant, include an annual salary of £60,000 for the chef as well as the drawings figure, which when added to the final cash balance of £58,846, give a very healthy return from the business.
The combined income figures over the 3-year period drawn by the business team are as follows:
In addition, £58,846 is available for the proprietor to draw (ignoring the tax costs at this stage).
|
Chef’s salary £60,000 for 3 years |
£180,000 |
|
Proprietor’s drawings |
£74,400 |
At this stage, it looks as though the proprietor has gained less from the business than the chef, but the business will have built up a capital value in the period, which would belong solely to the proprietor.
The business which was the inspiration for these figures never went ahead; the chef took a position catering for billionaires on a superyacht.
Financial forecasts form the basis of any business plan and are key in obtaining any finance that is needed. In this instance, the forecasts were shown to a bank manager, and a loan to purchase the business and an overdraft of £20,000 were requested.
The estimates of income and expenses in these forecasts were based on the experience of the chef, and expenses and margins generated by similar businesses.
Forecasts should be reviewed against the actual bank balance each month and any significant differences investigated, as this is what the bank manager will be doing in order to deal with any problems before they happen.
A good bank manager will ring you up when he thinks things are going awry, which is better than you trying to build up the nerve to go and tell him that things aren’t going to plan.
By working to financial forecasts, you can pick up problems early and do something about them before they bring the business down. Often, the bank manager, with his experience, can identify the business’s problems and provide solutions.
If income isn’t as high as expected, you can concentrate your efforts on attracting further custom, and if you’re spending too much you can introduce a period of austerity. Achieving the figures in the forecast is key to the success of the business.
A financial forecast should include room for maneuver should things not go to plan, in this case it is the drawings figure (the amount that I am proposing to take from the business).
A proprietor would normally reduce his income to make up for any shortfall in the forecasted profits, because if the business is not making money, where is the income for drawings going to come from?
Although the final figure (£58,846) from the previous example looks healthy, what is not included in the forecasts is the tax that is payable on the profits (at least the cash is still there to pay it!).
Tax can be quite significant, and even at a basic rate, as in the previous example, would account for at least £11,769. This would be in addition to the tax that the chef would need to pay on his £60,000 salary over the 3 years.
A business plan would normally include further details as to how the figures on the forecasts have been calculated, and, ideally, I would have liked to include further details of the figures on these cash flows in the business plan, which can be found in the section ‘Example of a Business Plan/Finance Application’ in Chapter 12.
The foregoing sales and purchases figures have been based on those achieved by the existing business operating from the premises, but they have been adjusted for inflationary factors.
The staff wages were calculated by the chef, based on the number of staff he thought he would need to run the business successfully.
All the other figures are based on historic values, adjusted by the chef for his specific circumstances; they are educated estimates and not pure guesswork.
I don’t need to overstate that the accuracy of forecasts is key to the business’s success as the confidence of lenders can be affected by shortfalls in achieving targets.
It is fundamental for a business to work to financial targets. If you work to targets and monitor your progress (I would suggest monthly), you will have more of a feel for how your business is performing and will not have any nasty surprises.
How much should you sell your product/service for? If you are the only one providing the service and you have no competition, you can set the price as high as you think you can get away with.
Pharmaceutical companies are very good at this; when they bring new drugs to market, they take the opportunity to recoup their substantial research costs by making huge profits on their products while they are still under license.
Interestingly, they can charge more for animal products than they can those used to deal with human medical conditions.
If you haven’t got the luxury of being able to charge what you want, you will have to refer to your costs to ensure that they are being covered, when you calculate your sales price.
While setting your prices, you need to bear in mind the costs that need to be covered by your income.
In the example of JT’s Restaurant, the price of the dishes needs to be enough to cover the cost of the food, the wages and all the overheads, not to mention a little extra to provide a profit for drawings.
In this case, multiplying the cost of the food by two and a half to three times provides sufficient income to cover the costs and provide an income.
Once the chef identifies the prices that he wants to charge, he then needs to compare the amounts with those that his competitors are charging for similar dishes.
You always need to take your competitors’ prices into account when calculating your own, as your customers will.
If you think that you are supplying a premium product, and you think that your customers will be willing to pay extra for it, you will be justified in charging a premium.
Interestingly, customers often perceive that by paying a premium they are getting a better product.
However, consumers are getting wise to the fact that expensive does not always mean better. This has proved true with the success of discount retailers who have taken on premium brands with their own cut-price alternatives.
Conversely, for a number of years the major supermarkets worked on the basis that ‘the perception of being cheaper is more important than actually being cheaper’, by advertising that their products were the cheapest that the consumer could buy, when in fact they weren’t.
Again, the rise in popularity of the discount retailers is indicative that this approach is no longer viable, as consumers can now see through the supermarkets’ deception regarding sales prices.
The lesson that the supermarkets have learned is that the customer is no longer interested in loyalty bonuses or premium products but prefers to get the best product for the cheapest price.
This lesson should not be ignored by the new business owner.
The cut-price airlines initially set up with this premise in mind; however, as time has gone on, in order to maximize the return to shareholders, they have initiated practices to raise prices, which have taken them away from their low-price deals.
We will look at these practices and other methods of maximizing profitability in Chapter 9.