I was having lunch with a client and he posed the question “Why don’t most small businesses make real money?” After talking for a while, we came up with some good ideas.
Before I tell you those ideas, let’s define what real money means. Real money is when the owner is paid the market rate for his or her services AND earns a healthy return on his or her investment. Assuming the owner of a particular company serves as CEO, the CEO/owner should earn a competitive salary for his or her service to the company. The actual salary depends on the company size, industry, etc. The CEO/owner should also receive some form of profit distribution relative to the performance of the company. Again, the actual profit distribution is contingent upon the specific characteristics of the business (e.g. industry, company size, etc.) If the CEO/owner does not receive both a competitive salary and an adequate return on investment, he or she may want to reconsider his or her employment and investment decisions.
Why don’t most small businesses make real money? Here are some thoughts:
1. Unwillingness to act like an investor: Just as an investor expects a certain return on investment (ROI), a business owner should also expect a return above and beyond what he or she receives as compensation. If this return is inadequate, the owner needs to evaluate whether or not the business is structured to earn an acceptable return on investment. If it is not structured properly, hard decisions may need to be made (layoffs, selling the business, etc.)
2. Failure to reinvest: Business owners need to continue investing in order to remain competitive (equipment, technology, training, etc.) Although this can be financially painful short term, reinvestment positions the business to continue making money in the future.
3. Not hiring key personnel: Not all management teams are created equal. Even though a marketing manager might do a great job at a $5 million company, that individual may not be capable of growing the business to a $50 million. Hiring the right key personnel is essential to achieving growth and profitability goals.
4. Lack of vision: A small business will always be a small business without a vision of being more. This requires management commitment, careful planning, and exceptional execution.
5.Lack of financial sophistication: Business planning without meaningful financial projections is a waste of time. In addition, it is critical to you subject to financial data to evaluate both company and employee performance. Without a certain level financial sophistication, management teams cannot be sure where they are at today or where they’re headed.
Addressing these issues early and often can help you avoid not making real money in your business.
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