Ways to Look at a Business

Let’s talk about how you can see your own business and thus the different business goals you might have, and the way that seeing that business imposes different structures and processes.  Now, since most of us are single-owner businesses, when I talk business goals, there’s a lot of cross-over between what the owner wants and the business wants.  As an example – if the owner’s goal is to work 10 hours a week, the business goal becomes to ensure that the owner can work 10 hours a week.

How you structure your business is dependent on the goals you intend to achieve.

Seems self-evident doesn’t it?  Let’s give a few examples:

The Business as a Job – the most common goal, the business is just another job.  You go in, you get paid and if you’re lucky you get to tack on a bit of extra profit.  In this case, hiring is minimal – you have a few part-time employees to help out during busy periods, but for the most part, you are the main employee.  This is probably the most personally profitable method (in the short-term) as you earn both a salary and any profits.  Often, this kind of viewpoint imposes a limit on the growth of the company though – as the owner works in the business rather than on it.

The Business as a Passion – I could also call it, the business as a hobby.  You see this structure more with publishers than you do with retailers, but it’s still possible as a retailer.  Here, the business isn’t run as a business but as an outlet for a passion / hobby – whether it’s publishing games that you designed yourself or a store that is a ‘club’ for regulars, the goal isn’t to make funds so much as achieve the passion.  In cases like this, the focus is less on the bottom-line and more on achieving the business goal, which can be detrimental to the business itself.  A great passion project example would be the Steve Jackson Ogre release.

The Business as a Corporation – This is much more common when you start viewing the business as a separate entity from yourself.  This might be imposed on you (if you have additional shareholders) or as a self-imposed viewpoint, but it forces a more ‘corporate’ viewpoint on goals and structure.  For example, that ‘Manager’ better get paid a regular salary, even if that Manager is yourself.  Neither can you impose random expenses on the business as you have to justify each expense (beyond the Taxman), which can impose a harsher standard.  It is also good training in many ways but less profitable for the company – if you are paying your Manager market-level salaries, your profit is likely to be overall lower but it does allow you to eventually hire someone in for that role.

The Business as an Investment – This is a strange viewpoint but it looks at what you have invested in the company (both real capital and opportunity cost) with an eye at generating a return and the risk of loss.  It reviews the business with an dispassionate eye,  looking for points of failure and final value in the event of a bankruptcy.  Depending on if you see the business as a long-term or a short-term investment, it could dictate how much additional funds you’d be willing to invest in the company.  For example – most game companies are bad investments.  Single point of failure (one industry), quite often with a key employee (you) and almost no assets at bankruptcy (low liquidation value for game stock).   In a case like this, you might view the company as needing to generate profits now so that you can cash out your loans / shares as much as possible.  This imposes cost-cutting procedures through the company and probably hiring freezes.  It’s not a bad viewpoint to occasionally use those; as it forces you to look extremely critically at what you’ve done.

The Profit Mirage

Finally! You broke-even and are now paying yourself a salary. Heck, you’ve got even a little profit.  It’s over, you’re good to go and you can relax now. Right?  Not quite.

What is Profit?

Before we go any further, let me define profit for you.  I’m going to use Profit in the Accounting definition; that is – what you see when companies release their ‘Profit & Loss Statements’ for the year.  I’ve briefly discussed Gross & Net Profit before, but suffice to say that Gross Profit is after you take the Cost of Good sold (i.e. what you bought the game for) away from Revenue and Net Profit is what happens when you take away all other expenses.

However, Profit isn’t cashflow (or cash in bank) as I’ve mentioned before.  Profit really only tells you how much you ‘should’ have extra after you pay all your expenses.  It doesn’t cover the capital expenses you incur (which are treated differently in accounting terms), nor does it deal with repayment of loans.  Capital expenses can include purchasing a vehicle, a building or (most relevantly) more stock.

Making Money Work

When a business generates a ‘profit’, they start having to pay taxes.  If you are a small business in Canada, your tax rate is only 12%.   So set that amount aside.

What can you do with the remainder profit?

  • pay it out to your shareholders (generally as a dividend)
  • invest in capital items (e.g. buying a vehicle).  The amount you paid will be depreciated over-time which will show up in your P&L statement as depreciation in later years.
  • invest in new stock
  • repay loan(s)

The Mirage

All that above sounds good right? Except… if you are continuing to grow, you often have no choice but to invest that amount in stock.  Here’s why:

Let’s start with some simple assumptions – last year, you did $200,000 in sales.  You now are generating $240,000 – with a net profit of 5%.  That means you generated a net profit of $12,000; after tax profit of $10,560.

Let’s further assume, you did that with a turn rate of 4 (i.e. you had $50,000 in goods) last year.  Now, this year if you ‘keep’ to a turn rate of 4, you need $60,000 worth of goods (4 * 60,0000 = $240,000).  So, of that after tax profit of $10,560 you just dedicated nearly all of it ($60k – $50k = $10k) to increasing your inventory to handle the increase in business.

Why increase inventory? Well, if you didn’t your customers start seeing stockouts much more often – items they want are never in, no matter when they arrive.  You miss out on sales on regular bestsellers and on hot new games because you don’t have the inventory to keep up.  This can be the start of a nasty decline.

This is why profit can be a mirage.  Sure, your company is profitable – but if you keep having to dedicate more funds to the business to keep up with its growth, the profits never really end up in your pocket.  It’s why capital is so important, having adequate amounts and having access to other forms of capital (e.g. investors & loans).