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The Balancing Act of a New Business—
Folding Under Financial Irresponsibility
by Stuart Daw
(Originally appeared in Canadian
Vending, Sept. 1996)
Why do many new, small operators seem to last
for a while, then sell out? Good question! Let’s look at one possible
scenario.
Young man gets job selling for a coffee
service. Good salesman, does good work, gets well paid, has a nice car, nice
home. Doesn’t know squat about accounting — thinks a balance sheet is
something a butcher puts on a scale before the meat gets weighed; thinks gross
profit minus his wage equals net profit. Thinks boss has the really good life.
Young man gets Napoleonic complex, thinks he’ll
go into business for himself. Boss trusted him; no non-compete agreement.
Salesman has lots of customers who are "good friends" that he knows
will buy from him. Arranges equipment leases through manufacturer. Gets 30-day
credit line from coffee company.
Attempts to put out machines, finds he doesn’t
have as many friends as he thought. Surprised he has to cut prices and furious
that old boss keeps cutting right beside him. Annoyed that "friends"
seem willing to stay with old boss, and the ones that do change want upgraded
coffee machines. Very expensive.
Gets a few locations at low price. After all,
he knows where all the high volume accounts are. But he has to spend more time
servicing accounts — special deliveries, equipment repairs, something called
collections. Competitors won’t leave him alone — he forgot other people were
also in the business. Finds the wide range of allied products needed to compete
with others are not that easy to buy — takes time, too. Wife going to have a
baby. Roof seems to be falling in.
Runs out of money. Can’t understand why.
After all, he had borrowed $5,000 from his father-in-law as the capital needed
to run a business — should have been enough. Goes to the bank. Gets bad vibes.
Stunned to hear bank manager saying negative, hurtful things. Finally has to go
through trauma of mortgaging his home.
Personality subtly changes. Not a nice man
like he used to be — his mother tells him so. "What happened to my
carefree little boy?" Doesn’t sleep so well at night either. Looks tired,
haggard. In old selling job had his work day down to four hours on the road,
actually two hours of effective production. Now does twelve hours a day at
least, even slugs it out on weekends. Gets business up to 240 locations Decides
to bail out.
What happened? At the risk of being a bit
simplistic, this is the likely story. In any business, assets are needed to
support sales. Some assets in one form or another have to be there before a sale
can take place. A listing of them is what we see on the left hand side of that
thing called a balance sheet. In coffee service, one will find there is a fairly
constant relationship between assets and sales, perhaps between 40 and 50 cents
in assets for every annual sales dollar, e.g. $500,000 in assets for sales of
$1-million. The exact ratio will be dictated primarily by average account size,
how well receivables are collected, and the care with which equipment is handed
out.
Now, what about the numbers on the right hand
side of the balance sheet? And why does there seem to be two basic categories
there, while there’s only one on the left side? Well, those assets on the left
side didn’t fall out of the blue. They had to be financed, either by money
that the owner(s) injected into the business or by borrowing from others such as
creditors, banks, relatives, leasing companies, etc. The former is known as
equity, the latter, liabilities (debt). The more of the former the better.
By the time the young man cited above got a
few machines on location, his equity was negative and there was a lot of debt.
At first he and his wife had to be very frugal with the household money. But as
sales grew, and even though he was stringing his suppliers out well beyond 30
days, they began spending more. In fact, they spent all the seemingly available
cash from the business on personal consumption. After all, they had
"sacrificed" so much in the early days. That bigger car they bought
was nice, too.
Equipment lease payments piled up. The balance
sheet still balanced, but only through a "balancing act" involving a
towering debt and still no equity (the father in law wants his money back some
day, too, it seems). Breathing strength into an exhausted balance sheet through
leaving some money there in the form of retained earnings was a foreign idea to
the young man. He begged at the bank, only to hear the manager mutter something
about debt-to-equity ratios, and that his was terrible. And liquidity? What the
heck was that? The bank told him it should be two to one, and pointed out that
the young man’s ratio of one to 10 just wouldn’t cut it.
A mild recession hits. Average per-machine
sales drop 15%, and the young man realizes he’s in deep trouble. If he is
lucky, a large coffee service operator will appear over the horizon waving his
checkbook. But he may have to seek out a buyer, usually from a group of
competitors who can afford to be laid back about his predicament. Finally he
says "to hell with it," and the business goes the way of all flesh,
sold to another service.
This was the big "come and get it
day" he dreamed would take place some time, but much later and for much
more money. He and his wife calculated the extra hours he had worked compared to
the old job, and the money made before and after he left that job. They found
that by dividing the extra hours worked into the money gained by the sale, his
per hour "wage" was lower than when he worked for the old boss.
Indeed, if he had stayed with and worked as hard for the old boss as he did for
himself, he would be a well to do young man instead of a somewhat older, wiser
one.
© 1996 Stuart Daw
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