Economics for the Busy Entrepreneur

Economics is the study of choice in the face of scarcity, and it has practical uses in every aspect of entrepreneurship. We each have a limited amount of time, money, and resources, and understanding economics can help maximize efficiency for all of them. Unlike finance or accounting, which is primarily concerned with money, the study of economics is a broad field that can create a sharp mindset that changes the way you make every decision in life.

Opportunity Costs and Sunk Costs

“There’s no such thing as free lunch.”

As the maxim of economics, the opportunity cost of any action is the most profitable alternative lost for performing it. For example, if you have twelve lemons that you sell as lemonade, the opportunity cost would be the lemon cake you could have sold from them instead. If the lemon cake is more profitable, you’ve lost the extra profit you could have made. Choices that may seem acceptable or harmless may be a gross misuse of scarce resources when examined fully. The cost of time spent watching TV may be in physical fitness, life expectancy, social life, or professional networking. Make sure you consider your options before closing doors to potentially profitable opportunities, and realize that every decision (or lack thereof) has an opportunity cost.

One of the most common mistakes entrepreneurs make is accounting for sunk costs. A sunk cost is simply a cost that has already occurred and can not be recovered. If you’ve invested a significant amount of time and money into an unprofitable idea, it can be hard to change directions. A sunk cost should not be considered in future decision making. If one thing isn’t working, regardless of how much time, money, or effort you’ve put into it, you need to be able to pivot towards success.

Comparative and Competitive Advantage

If your business can provide a product or service at a lower opportunity cost than other firms, you have a comparative advantage. If you can bill a client at $125/hr for consulting service, but have to spend two hours each day bookkeeping, you may be better off hiring a bookkeeper at $20/hr because their opportunity cost is less than the $105/hr you would be sacrificing to do your own bookkeeping.

Competitive advantages include price advantages and product differentiation. If you have access to natural resources, intellectual property, talent, or experience that allow you to supply goods or services at a lower cost, you have a competitive advantage. For example, you may have software that greatly increases efficiency and allows you to provide better service, or you might have an engineer that is outstanding in their field. Price advantages give you a higher profit margin at the market price and give you the opportunity to decrease your price while achieving the same profit margins as your competitors.

Similarly, if you supply goods or services that are perceived as superior and different from your competition, you will gain a price advantage that allows you to charge a premium. If you differentiate yourself from your peers, you may build an economic moat, or barrier to entry that makes entering the marketing more challenging for competitors.

Signal Theory

Know it. Love it. Understand it. Signal theory studies the way that human beings communicate value to influence decision making. For employers, the sheer amount of available labor requires quick ways to sort candidates, so the labor force invests in degrees, suits, ties, and extra curricular activities to signal a strong work ethic and team spirit. Firms use signal theory in marketing to differentiate themselves from competitors to charge a premium for goods and services. Signals may include a professionally designed website, reviews by third parties, and regularly published material that establishes the leadership as expert authorities in their fields. Marketing and advertising plays an important role in the distribution of goods and services, and superior signalling through marketing communications can give you an advantage over your competitors.

The Bottom Line

Every entrepreneur has to use their time, money, and resources effectively to succeed, and a basic understanding of economics can greatly increase efficiency. Remember that some costs are unrecoverable, and others may be hidden opportunities. Use signal theory to differentiate yourself from your competitors, and press every advantage you can to gain market share and increase profit margins with strategic decision making.

Entrepreneurs need to embrace risk, not money, to achieve success.

The extreme responsibility of ownership is the hallmark of entrepreneurship and its greatest barrier to entry. Although each of us wants to see revenue created from our ideas, it’s important to understand that sales are an outcome — not the focus — of our efforts.

In 2010, I sold my second successful business to new owners that were obsessed with cutting costs — even though many of those “costs” were revenue generating. Efficiency is important, but investment requires risk for reward. The “wealth preservation” mentality that we learn in personal finance can lead to our demise in an open market. Instead, we need to focus on embracing uncertainty to succeed.

At a certain level business is all about spending money to make money. You spend $100,000 in marketing to make $500,000 in sales. Looking at a business from the sole angle of cutting costs, is a sure fire way to go out of business. Cost cutting is important, but not nearly as important as generating revenue, and bringing in sales.

I’ve had numerous “financial experts” look at my various businesses and say “You're spending way too much on marketing.” The problem was these experts weren’t business owners, they weren’t entrepreneurs. These experts spent their careers crunching numbers, looking at averages, evaluating “models”, but they were never behind the driver seat. 

Security is an Illusion

    People ask me if I’m worried about my future as an entrepreneur. I ask them how much control they have over their own employment. Would you keep your job if your company was acquired? Would you survive if your boss wanted you out?

Entrepreneurs suffer no delusion. We face the reality of an uncertain future every day. It’s our responsibility to generate revenue and create vision — or else we pay the price. Instead of viewing uncertainty as a risk to be minimized, look at the future as a place of opportunity.

Has anyone achieved anything by sitting safely at home and watching TV?

Greatness is achieved by conquering fear, not being controlled by it.

Have a Growth Mindset

    Entrepreneurs face unique challenges, and creating a startup can be intimidating. If you’re afraid to invest in yourself, your enterprise, or your staff, you need to reconsider your profession. If you want a safe routine, you may want a day job instead.

    Entrepreneurs need to pivot when necessary and rapidly shift strategy or tactics to adapt. Starting a business is like growing up as a child — you’re bound to get scrapes and bruises, but it’s getting up that counts.

    Your attitude plays a huge role. “Problems” are just setbacks. “Obstacles” are just challenges to overcome. “Failures” are lessons — hard fought and earned. In education, this is called a growth mindset — I call it grit.

Courage

    Entrepreneurship requires courage. Once you have a model that works, you need to have the courage to spend $5,000 a day, $10,000 a day,or $100,000 a day.  This isn’t easy for a lot of people, they get stuck feeling comfortable. As an employee, you can show up, do the bare minimum, and receive the “effort ribbon” known as a paycheck. As an employee your risks are minimal, but therefore so are your rewards. As a business owner, you are solely responsible for the success and well-being of yourself and others.

    If this makes you uncomfortable, that’s OK. If that discomfort hinders your creativity and hinders progress, then you need to move on. If entrepreneurship was safe and easy, everyone would open a business and become billionaires by tomorrow. Entrepreneurship may require every ounce of cunning and fortitude you have, but your achievements will be uniquely yours.

Conclusion

 Ultimately, determination and courage will be the cornerstones of your success. Finance and economics have their place in business, but even if you’re starting an accounting firm you will need much more. Learn from your experiences in the past and see the future as a place of uncertainty — and opportunity — you create.

The Importance of Financial Statements When Selling Your Company

Reviewed financials, audited financials or compilation reports, what should you have before selling?

Many business owners don't truly understand the importance of keeping well organized books/financials. As a business owner I understand how hard it is to find a good bookkeeper let alone have the time to sit down and look at numbers. As an owner your first concern is usually getting money in the door, paying employees, vendors, rent and keeping the lights on. After having three successful exits, I can tell you keeping well organized financial records from day 1 is as important as bringing money in the door. 

Financials can be difficult to understand. You may think you have a valuable company, but without well-done financial records, your business loses tremendous value over time. The more value your business loses, the more likely it is to fail. However, value sometimes leeches out of companies so slowly that owners don’t realize it until too late. Yearly reviewed financials and audits help you avoid the negative consequences of bad financial records.

Yearly Reviewed or Audited Financials?

The first question to answer is whether you need audits or yearly financial reporting. Yearly reviews are usually less expensive, but may not cover all your business’s factors. Stakeholders, including investors and vendors, use your financial statements to decide if your business is a worthwhile investment. However, yearly reporting may not tell stakeholders everything they need or want to know.

Audited financials focus on best business practices more than yearly reviews do. With audited financials, you are providing potential buyers or investors the most assurances possible on your financial statements. This is an outside CPA firm stating your financials are free of material misrepresentations and are presented in according to GAP.  The outside CPA firm will also analyze your financials independenetly and identify any risks or problems they see currently or in the future. Having Audited financial statements adds tremendous value to your company and gives buyers and investors a good piece of mind.

Additionally, you can catch and fix financial issues earlier. A small monthly issue is less likely to become an overall business issue that impedes cash flow and scares away investors. Audited financials also give you more time to do your due diligence when it comes to performance, sales, or program modification.

Is Auditing Worth the Money?

Many small businesses don’t use audits to save money. An audit does require significant time and research on the part of a CPA, so you may not want one if your business is just starting out. However, an audit can mean the difference between getting a loan or not. It could positively influence your interest rates. Having audited financials also creates tremendous value when you go to sell your company, investors and buyers LOVE seeing audited financials.

If your business accepts money from state or federal governments, or is in a regulated industry like franchising or securities then audits are required. If you don’t yet have the money for an audit, ask your banker or other financial adviser the best way to go about getting it. As a new business with no investment capital you can and should get at least Reviewed financials.

Reviewed Financials

Reviewed financials are one level below audited financials, they are done by an outside CPA firm and provide limited assurances on your financial statements. The main benefit of reviewed financials for the business owner is mainly the cost and time associated. Reviewed financials are much less expensive then an audit and don't require nearly as much time as an audit. One big difference as it relates to selling your company is reviewed statements don't include an investigation into the entity's internal control system of it's risk of fraud. This can be extremely important to banks that could be lending a buyer of your business money. Many banks will be satisfied with reviewed financial statements, but if you have the resources and audit will get you more value.

Should You Get a Compilation?

Some business owners opt for a compilation instead of an audit or review. In a compilation, your CPA or other accounting expert helps you prepare financial statements. He or she does not offer opinions on best business practices, whether your company complies with accepted accounting principles, or whether your business is a good investment. A compilation is a more “common sense” approach to your financial status.

During a compilation, your CPA will read your statements and ensure they’re free of obvious errors. Footnote disclosures, such as statements regarding your cash flow or income tax, may be omitted as long as you have not intentionally misled your CPA or any potential report readers. Your CPA will add a paragraph to his or her report, explaining you have chosen to omit this information.

Yearly reviews, compilations are inexpensive and often easier for small businesses to take on than audits. But the lack of professional opinions and comprehensive reviewing may hurt your business in the long run.

It really comes down to what stage of of your business you are in, at a minimum I recommend a compilation or preferably reviewed financial statements. 

How to Properly Value Your Internet Company

One of the earliest considerations you face when deciding whether to sell your Internet company is its objective value. To gather the appropriate data on the relevant valuation drivers requires that you understand and use proper valuation techniques, gather the correct information, and understand the “big picture” regarding your industry, the economy and other external factors.

Here are some of the most critical factors to be considered when evaluating your company:

·         Domain appraisal: Unfortunately, too many companies rely on so-called “website valuation tools” to value their domains. These online tools offer quick answers to complex problems, ignoring items like financial analysis, hard data and human judgement. Instead, these tools massage publicly available information to extrapolate advertising revenue and other financial information. We suggest you avoid automated tools – the results are inconsistent and undependable. 

·         Traffic valuation: A technique popular with sites that have significant traffic but have not yet been monetized is the traffic valuation method. This involves researching the most popular key phrases that drive the bulk of search traffic to your site. Next, identify each keyword’s cost per click (CPC). For example, if you find three keywords that drive almost all of your traffic, use Google AdWords or something similar to assign CPCs and then multiply each by the number of visitors stemming from each keyword. This is a good proxy for the traffic value of your site. However, if your revenues are not traffic-driven (for example, a software-as-a-service site), this method will substantially undervalue your website.

·         Revenue and earnings: A popular method used to help evaluate Internet companies is to employ methods that center on earnings multiples. The basic idea is to multiply the site’s discretionary cashflow – pre-tax earnings before non-cash expenses, owner’s compensation, interest income or expense, as well as non-business related and one-time expenses and income – by an appropriate multiple. The rub, of course, is arriving at the correct multiple, and this takes experience and lots of data, including:

o   Length of time in business

o   Annual income trends and anomalies

o   Transferability of revenue streams

o   Stability of CPMs and their reliance on a particular owner

o   Traffic, discussed above

o   Many more factors – this is a huge topic that requires additional blogs

·         Assets: The presence of physical assets and inventory certainly affects a site’s value. Also consider licensing requirements, intangibles like patents and trademarks, and specific regional factors. 

   Before selling your company it's important to get a professional valuation done. You may be sitting on hidden value in your company. When hiring someone to put a value on your business make sure they have experience with internet businesses.

7 Ways You May be Sabotaging Your Sales Team

Is your sales team struggling? It’s possible that you made a bunch of bad hiring decisions—but it’s not likely. If morale is low and every member of the sales team is struggling to meet quota then you might need to look in the mirror to find the source of the problem.

1. Your only advice is “sell, sell, sell.”

Sales representatives already know they need to sell, sell, sell. That’s the definition of their jobs, after all. Walking down the halls breezily shouting this mantra doesn’t help. You should also avoid its close and equally odious cousin “ABC” (always be selling).

Your sales team needs concrete advice. They need to know the best way to approach leads—the unique way that works specifically for your business. They need to know which words will get them in the door, and which words will close the sale. They need to specific insights on overcoming their specific obstacles. They do not need platitudes.

2. Your inspire desperation instead of inspiration.

Sales representatives don’t thrive in a culture of fear. Obviously you’ve set some expectations and you want them to live up to them, but you need them focused on the positives. Their own inner emotional world and attitudes can have a massive impact on their ability to do good work for you.

Help them see the road ahead. Help them see the money they can make. Keep the culture in your office positive. Brow beating your sales reps won’t make them produce. It’ll just tank their close rate.

3. Your training is non-existent. 

You cannot throw a flipbook at a sales rep and say “go get ‘em, Tiger!”. It doesn’t matter how experienced the rep is. It doesn’t matter how simple the flipbook looks to you. Your rep needs to learn the full presentation. Your rep needs to learn the ins and outs of all of your products. Your rep needs to know exactly how things work on the back end—how orders get processed, scheduled, and sent out. 

You need a formal training program to make all of those pieces fit together in a way that will allow your rep to be a polished, focused expert who does a good job of presenting the benefits of your company to the rest of the world.

4. You don’t have a CMS.

Nothing makes a sales rep feel more unsure of himself than the thought that he or she is about to look stupid. Sales reps need access to real-time customer data. It needs to be something they can access when they’re working. That way, your rep is never sitting there wondering whether or not he’s about to try to sell something to an existing customer.

And yes, it’s happened before when offices did not maintain good customer data.

5. You’ve set unrealistic expectations.

You need to know the numbers that drive your sales activity down to the last percentage. You need to know how many calls generate appointments and how many appointments generate sales. Then, and only then, can you set realistic quotas. If it takes 80 appointments a month to reach your current quota, and there’s only time for a reasonable rep to run 60 of them, then you’re setting your reps up for failure. 

Make sure you evaluate your compensation plan too—a reasonable quota should allow reps to make a reasonable living. It should also allow reps time to exceed that quota, and to make even more money.

6. You think blitz and rah-rah will motivate them.

That big sales contest which will send someone to Hawaii might generate a burst of activity in the short term, but it’s really only going to be effective in a sales department that was healthy already. Short term feel-good hits can’t sustain a demoralized, exhausted, and depressed sales team.

Focus on building a positive, energized environment first. Then you can break out the scoreboards.

7. You haven’t caught up to the current century.

Cold calling is getting less and less effective, and in most industries it’s going to be unreasonable to expect your sales team to generate business that way. Your marketing team needs to be generating a steady stream of warm inbound leads instead. Your sales team needs to stay active on social media to generate a few more of those leads. Most people don’t answer their phones anymore.

Thus, you must find a way to make customers call you.