In Business school we were taught that the purpose of a business was to make money. This seems like a very fundamental concept but in reality I think that this is overlooked by many businesses. When the thought of making money is discussed I think that it needs to be put into context to understand the real challenge that many restoration professionals struggle with. The first concept is opportunity cost and the second is risk. Opportunity cost is simply the cost of the next best use of your time and money. In this context it refers to the value of the next best investment. The concept of risk simply implies that the greater the risk, the greater the expected return. Both of these are simple concepts that on the surface seem fundamental but when people are caught in day-to-day business strategies this becomes secondary. Often I review company financials, I see that the financial performance to be an after-thought rather than a driver of business activity and management emphasis.
Opportunity cost is difficult because it is not easy to quantify. We make investments in our time and through our resources. This often is done out of perceived need and frequently can be a response to another stimulus. Examples of this include advertising expenses, compensation or staffing. As business owners’ decisions are frequently made off the cuff and often based on historical decisions or even worse based on the actions of our completion – “everyone else is doing it” – or “that’s the way we have always done it.” Through this process overhead escalates and companies become reactive and often struggling to achieve desired levels of profit. Owners of these companies allow themselves to feel comfortable because they are making a reasonable salary and the company squeezes out a 3% net profit. Comfort zones blind these business owners from seeing the real situation. These individuals could often receive a similar salary and have a job with much less risk and certainly a lower level of stress. Maybe this situation is rationalized because there is the perception that they can sell the business one day. However my question is, would someone really want to buy your business? If you are rationalizing your situation then you need to consider the opportunity cost – which is the compensation and also the ability to apply the capital in the business to other ventures or investments. Let’s face it, restoration is a difficult business and the stress can be immense. As the owner of a restoration company you need to be compensated appropriately and secondarily your business should be making at least 10% net profit in exchange for the risk and commitment.
This brings us to the risk factor in owning a business. The rewards in playing the lottery are substantial and the risk of loss is quite high. On the other had the interest paid by a bank very low because the risk of loss is negligible. Similar considerations need to be made when looking at your business. Since the risk of failure is substantially higher than a municipal bond fund you should consider an appropriate risk premium. An investor can earn anywhere between 3% and 6% after tax on municipal bonds and funds, so would you expect to get a commensurate or larger return on your business? I understand that some of the money is leveraged so it is not an exact comparison and there are other spurious factors however I think that a business should expect to make 10% or more in net profit at the end of the year. This appears to be an appropriate return in exchange for the risk and also the time investments in your business.
When you look at your business and the relative success measurements you should consider both of the above factors when putting together your strategic plan. As the owner you need to achieve an appropriate return on your business AND get a reasonable paycheck. I am amazed at the amount of business owners that do not take a consistent paycheck. Make sure that as you put your plan together, plan your compensation and success.
Phillip Rosebrook JR, Certified Restorer is a partner in Business Mentors. He has nearly 30 years of experience in the restoration industry and has helped 100’s of restoration professionals over the past 20 years grow their business and improve profitability. He can be reached at Phillip@businessmentors.net