Monday, 16 December 2013

Billy's Tenth Law: Don't Buy the Porsche too soon

 Never confuse a tail wind with good management.

Jeff Immelt, CEO General Electric have started your business, survived the first year, did alright in the second year, and thrived in the third year. Congratulations, but beware...the fourth year is often one of the danger years in business development. (Watch for the seven year business cycle, coming up in this blog in early 2014.) 

Sometimes success breeds success, but sometimes success breeds complacency or even arrogance.  I have heard this story, or variations on the theme, dozens of times.  It usually goes like this. 

I started my business on a shoestring, and through hard work and determination, built it into a going concern.  In the early days, there was barely enough money for any extras for myself or for the business.  Now we are successful, and on an upward trajectory.  It's time for a treat so I went out and bought myself a…

You can fill in the blanks with anything you like.  My favourite is the Porsche.  It is a bit of a 'guy thing' but for some people, this is the iconic trapping of success.  The problem is that in any business, things ebb and flow.  There are successful times and there are slower times.  The problem is that we don't know if an upturn in sales & profits represents a long term trend, or a fluctuation in the natural flow of business. 
Entrepreneurs are nothing if not optimistic. When things are going up, then there is no place to go but up.  The problem is that one of two things happens.  Either the entrepreneur commits to higher monthly payments, (on the Porsche) or they deplete the business of cash to pay for the Porsche.  Either way, the business is now more vulnerable to a down turn.

I must confess that I am way too risk-averse to ever make one of those 'bet the company' moves.  (Boeing and 747 come to mind.)  It is one thing, however; to make the big bet with company resources for the company, and quite another to 'buy the Porsche' when you have some excess cash.  I have always been a big fan of retained earnings and contingency funds and I have never been big on borrowing money and increasing cash overheads with lease or loan payments. 

I knew two very successful entrepreneurs who made this kind of mistake.  They had a wildly successful business, and after about five years, started to draw heavily out of the business.  They got hit with two consecutive factors.  Firstly, ice storms in Quebec caused a disruption of supply for their manufacturing.  This cost them six weeks production.  Secondly, they were forced to write off some bad debts made to customers who their factor wouldn't finance. (You should have listened to your factors guys.)  They company had a great income statement, but a weak balance sheet.  They couldn't finance their working capital needs caused by the bad debt and the reduction of production, and as a result went bankrupt as a result.
I am not saying that their problems would have been solved, but, retained earnings, derived by taking less money out of the company, would have provided a cushion that would have helped them withstand the adversity.
So before you buy that Porsche, put away three months cash in a contingency fund. Retain earnings in order to strengthen your Balance Sheet.  It may not be nearly as cool as a Porsche, but it could save your business during a rough patch.  

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