End of financial year is coming up for many of us. How do you know if someone you’re hiring or doing business with has any understanding of finance?
It’s amazing how high people can rise in business without much awareness of how all them fancy numbers work. Sometimes it isn’t practical to make them sit a financial literacy test.
One of the biggest leaps of faith you go through as a business owner is entrusting large piles of your cash to someone in another city to do their best with. Most businesses aren’t financial rocket science, you just have to be able to add and do percentages.
But I’ve done a lot of chin-scratching with managers who need to buy extra magenta print cartridges, such is the sea of red ink seeping into their financial statements. As a writer, I’m sensitive to words, and as an investor, I’m sensitive to people losing our money.
Reconcile the two and you notice phrases bad money managers use again and again. Each one is a code red warning that you’re better off putting your precious capital into an amusement arcade claw machine, coin by coin, hoping to pick up a profitable number of fluffy toys. Learn from my pain.
1. ‘You have to spend money to make money’
True. Many businesses fail to make money because they’re run by scrooges who starve their staff of the tools to do their job. You need to spend money, on capex, marketing and the best staff you can get. But the people who do these things successfully never say ‘you have to spend money to make money’.
The people who do say it just like to spend money.
They get a near-sexual buzz from buying things — designer office furniture, domestic business class air travel, prestige cars on novated leases (‘it would actually have been more expensive to keep my old car’) and stupid status credit cards with a four-figure annual fee. As if trying to impress waiters and shop assistants is a measure of achievement.
They have the expense habits of old-school FIFA chairmen, and when you query them, they trot the old faithful phrase out.
Nothing they like to spend money on will actually make your business any money.
2. ‘Tax deductible’
There are many bogus parallels drawn between personal finance and business finance. Plank-thick politicians speak of debt as ‘putting it on the national credit card’, as if worthy nation-building investments at record-low interest rates are the same as drunk-buying a second Nutribullet on your Visa at 23%.
So too the language of the personal tax return sneaks into bad business thinking.
Someone will pitch you an idea that needs money — often it’s sponsorship of their brother’s speedway car — and they’ll finish up with the clincher: ‘… and it’s fully tax-deductible!’
They are convinced that tax-deductibility has some kind of double-bonus multiplier effect that will make everyone wads of cash.
And when you say: ‘You mean it’s an expense?’
They’ll reply: ‘Not just that, it’s tax-deductible.’
If you can’t understand that the more ‘tax-deductible’ things you buy, the lower your profit will be, you are 100% employment deductible.
3. ‘Good for tax losses’
This is a longer-term gambit from the same people who say ‘tax deductible’, as if tax losses are some kind of awesome ongoing business model.
It carries the same secretive multimillionaire imagery as ‘Caymans’ and ‘blind trusts’. Sure you can use tax losses as a consolation for the worst of your screw-ups and failed experiments, but at some point, you need profit to put them against. Many people believe the losses are the main game.
4. ‘I’m doing a bit of day trading’
Not much says unemployable like telling people you’re doing some day trading. Pro traders working for global firms with huge research resources still find it hard to beat the index. People sitting around at home in their underwear, clutching a book ‘n’ DVD kit called ‘Make Million$ Day Trading’ are no different to chronic race track gamblers.
I’ve never seen anyone who admits to dabbling in day trading turn out to be anything but an eternal career drifter, moving from one disappointing scheme to another.
Plus, it shows they prefer hanging at home to working. It’s a clear sign they cannot be trusted to do anything with your money other than lose the lot.
5. ‘A million dollars’ worth’
Occasionally we run the tape measure over an acquisition. You check out the business, which someone has built up over decades of backbreaking effort. Usually, it provides enough cash to keep the owner in a job. An 18-hour a day job. Profit left after their salary: zero.
So you ask them how much they want and they say they’d like $1,000,000 or whatever they need to sit on a banana lounge drinking sav blanc for the rest of their life.
Outside of digital startups, there are only two basic ways to value a business: a multiple of its earnings, or the value of its assets. So, you ask them, given that the multiple of zero profit is, ah, zero, what do you think that warehouse full of equipment is worth?
‘There’s a million dollars’ worth.’
Oh no, there isn’t. You’ve already noticed that much of it is old, weathered and out of date. Some of it has resident possums.
‘Do you mean that over the last 10 years, you’ve paid a total of a million dollars for that stuff? Most of it over five years ago?’
‘That’s right. A million dollars’ worth.’
Here’s what something’s worth, whether it’s a major bank or an autographed football shirt for your kid’s school fundraising auction: the amount someone is actually willing to pay you at the time you want to sell.
It’s amazing how many people are so in love with every object they buy that they can’t imagine it ever being worth a penny less than the day their trembling hands first unpacked it. So, to offer them less than $1,000,000 for their business is a slap in the face to them and the assets they hold dear.
Obviously, they will never sell their business. There’s a strong chance they’ll be entombed like a pharaoh, safe among their precious things: Compaq laptops, outboard CD burners and PalmPilots running Lotus Notes.
This article was first published on Motivation for Sceptics. Read the original article.