Source: Samuel K. Burlum takes a look at the most common business expenses and determine whether they are a cost or an investment; explaining the difference.
The Small Business Administration estimates that nearly half of all new businesses fail and disappear in the first five years of operation. One of the key reasons for this unfortunate statistic is that the majority of businesses are underfunded, and do not have enough cash on hand to pay for operational expenses during lean times. If your business is one of the more fortunate stories, congratulations, you survived the statistics; however you might still be operating on a shoe string because cash is limited. I have seen many businesses in this shape, and when they are operating with very limited cash, business owners will usually say, “they cannot afford to spend money,” whether it be on marketing and advertising, new equipment, or even on hiring new employees. Managing cash can be a balancing act. There is the old saying, “you must spend money to make money.” So, when it is safe to spend money as a small business?
When allocating valuable financial resources as a small business, one must ask, “What is my return on investment on spending the money?” First, you must determine whether the business expense is an investment or if it is a cost. Most business costs are either fixed expenses such as rent for a storefront, or cash spent on inventory or labor, all of which may be at risk if the product or service never sells. A business may spend cash on services associated with marketing and/or advertising, which should be viewed as a long term investment because they help generate leads which eventually lead to sales; sales that may have never occurred if the advertising effort was never put to practice.
Let’s take a closer look at some of these factors.
Operational necessities that may not provide a return on investment should be treated as a cost. The basics such as an office or storefront location, phone, and basic website, should be treated as costs. These are expenses that are a must if you provide a service and/or product and depend on foot traffic for sales. If you offer “free delivery” such as a pizza parlor or dry cleaning service, there is a cost in providing the service of the delivery such as the vehicle, a driver, vehicle maintenance, insurance, and fuel cost. Other examples of hard cost which may be indirect to providing your product or services include but not limited to the cost of taxes, cost of licensing and permits, accounting and legal services; all which require a business to spend money.
Some expenses are perceived as costs; but should be categorized as an investment. One of the largest investments any business can make is in its employees. Yes, an investment into people will help grow your business. In the book, Profit at the Bottom of the Ladder; Creating Value by Investing in Your Workforce, the author, Jody Heymann explains how a company benefits by offering additional skills training to employees at the expense of the business.
“These companies have been profitable for their owners and shareholders, not only while being profitable for their employees, but because they have been profitable for their employees,” writes Heymann, “Employees determine 90% of most businesses’ profitability.”
Other studies have found when employers recognize the needs of their employees, employees become less worrisome of their own issues in the workplace and more productive and profitable for the business in which they are employed.
Another area which most small business owners tend not to realize is an investment, is marketing and advertising. Marketing includes the practice of branding, market capability research, choosing the appropriate demographic audience and geographic fit for their business, and lead generation. Most marketing programs will determine the most effective advertising approaches for a business to be noticed by potential customers. A program that employs both a marketing plan and targeted advertising campaign is the best use of cash when trying to get your business noticed. Most small businesses will allocate a very small budget in this area, and expect advertising to instantly provide a return of big dollars in sales, the first ad placement out.
Marketing and advertising is a long term engagement and should be treated as a long term investment. The more consistent and specific the effort, the more effective the return on investment will be. Most successful businesses will spend 20% of all of their working capital on marketing and advertising, however, many small business owners hesitate on spending cash on marketing and advertising, thinking they cannot afford it or it is wasteful. Truth is, you cannot afford not to advertise. People will usually patron a business that is at the top of their mind. If you are not in front of your potential customer, then you do not exist to them.
Most small businesses also hesitate to implement systems or technology that will save them time; processes that may automate business functions. Time is money, and most small businesses in America have less than five employees. It is important to get the most out of an employee’s time. There are many information technologies, software systems, and communication platforms that can help manage staff and tasks, minimizing or even eliminating some cost..
Do you rent, lease, or purchase your location? It depends. In some cases, it is more advantageous to the business owner to rent or lease their location; both which are tax deductible expenses. But when it is more expensive to rent, and cheaper to own the physical location, a business owner may want to consider making the investment into owning the building versus renting it. Owning the business location can be a business in itself and a smart investment. The building might be a multiple unit building that provides rental income which can be valuable for offsetting costs associated with the upkeep of the building. You must also consider the age old reminder, “location, location, location,” in evaluating whether spending your cash on a building is a smart investment. Your location itself is an investment. The closer you are to your ideal clientele, the more probable it is to be noticed by that targeted audience.
Investing into your small business will always be a risk. Risk is limited by having a sound understanding what the possible returns on your risk are. Setting realistic expectations on the desired results will also help develop a discipline on how you spend your cash. The age old saying, “you must spend money to make money,” is truth however you can determine the best use of that cash by having a clear understanding whether the expense is an investment that will help grow the business or if it is a cost that is just a part of doing business. By evaluating your expenses as either a cost or an investment will aid in curbing wasteful spending.
Sam Burlum | Business, Economy, Free Enterprise, Innovation, Small Business, Technology