We’ve heard stories of penniless immigrants who came to Canada with nothing but a dream, but within a single generation accumulate a lot of wealth. How do they do it?
This is a mystery to the typical person who graduates with a post-secondary education and goes on to work in the labour force as an employee (i.e., most people!). This is because our educational system specifically trains its students to become employees rather than entrepreneurs.
So when we hear about these rags to riches stories, we ask ourselves – “how did they do it?” As someone who grew up in an entrepreneurial household, here is my take on Cracking the Code to Successful Entrepreneurship:
1. In most cases, one will never become truly financially independent working as an employee. Whether you are an entry-level bookkeeper or the CEO of a large organization, you can be unexpectedly fired at a whim by whoever you report to. You are therefore susceptible to financial catastrophe.
2. Therefore, the only way to achieve financial independence is to build and maintain a successful business.
3. There is a “magic formula” that will allow to evaluate a businesses’ odds of success:
[(Sale price of product – Variable cost of product) x Units sold] – Fixed Overhead Costs = Profit
This formula will be very familiar to accountants – it’s called the Contribution Margin Ratio.
Let’s demonstrate this formula using a Bubble Tea business. Wonder why there are so many Bubble Tea shops in Toronto? Because they make a heck of a lot of money with little risk:
· Price per bubble tea drink – $4.00
· Cost to make per drink (water, powder, sugar) – $0.50
· Drink sales per month assuming 100 sold per day – 3,000
· Monthly rent for shop – $3,000
· Assume no labour costs – in the early years, the owners will work the shop themselves
· [($4.00 – $0.50) x 3,000 ] = $10,500 in sales
· Profit after paying rent: $10,500 – $3,000 = $7,500
Once you apply this formula to the multinational soft drink companies to analyze their beverage businesses, you can begin to understand why soft-drinks companies have grown from humble beginnings to global companies they are today.
You can also use this formula to evaluate almost any small business you might be thinking of getting into: restaurant, nail salon, hair salon. You should quickly realize that it’s best to choose businesses with a high profit margin (i.e., high selling price for produce/service and low cost of supplying the product/service) and high customer traffic (i.e., units sold, people serviced).
Seeing the Future – Cash Flow Projection
You want to know if you’ll be making a profit before going any further. If you skip this step, your chances of failing increase significantly.
Investigate your costs to start up and run your business. The most common are:
· Rent – how much will it cost to rent at the location where you want to set up?
· Wages and payroll tax – will you need employees or can your run the business yourself? How much do you need to pay yourself to meet your personal living costs?
· Advertising costs – what types of advertising will you use – TV, radio, internet – and what is their cost versus their potential return on investment?
· Cost of inventory or raw materials – will these be imported? If yes, you’ll need to factor in the impact of exchange rates on your profitability.
· Purchase of equipment – general office equipment like a phone system, computers and IT network, and furniture, as well as specialized equipment for your specific line of business like restaurant equipment (if you’re opening up a restaurant).
· Business liability insurance – to protect yourself from liability if someone is inadvertently harmed by your product or service, or if someone is injured on your premises.
· Pricing – how much will you be able to sell your product or service so that’s it’s competitive with others in your line of business
Once you’ve figured out your monthly costs (i.e., your overhead) and pricing, you’re now in the position to determine how many unit sales you need to make to breakeven – remember the Contribution Margin Ratio that we looked at. Use a spreadsheet to build a cash-flow projection model.
Protecting Yourself – Creditor Proofing
If things don’t work out for your business you could be financially ruined. Therefore, consider the following techniques to protect your personal assets from your business creditors.
1. Incorporate the business. This will provide you with a level of creditor protection – most of a corporation’s obligations are limited to its assets so this structure can provide protection for personal assets. This structure also has income tax benefits, which will not be discussed here.
2. Always pay statutory debt on time, specifically:
· Payroll source deductions;
· Federal and provincial sales tax collected; and
· Employee wages and vacation payable.
Corporate directors can be personally responsible for these debts, notwithstanding that the business is incorporated. In many incorporated small businesses, the shareholder (i.e., the business owner) and director are the same person.
3. If you can, avoid giving personal guarantees of your corporation’s business obligations (e.g., landlord, suppliers) unless it is absolutely necessary.
You will need a financial expert on your team to deal with the issues raised in this article. Therefore, I would strongly advise that you contact a CPA who can help you further.
For all you aspiring entrepreneurs out there, I hope that I’ve helped take out some of the “mystery” behind successful entrepreneurship. Use this tool wisely and never stop dreaming!