As an entrepreneur, it’s difficult to stay optimistic about new opportunities while preparing for risks that may destroy a business. In my CPA firm, I have studied the financial details of innumerable clients over the past 20 years. I am convinced the businesses that are recession-proof are those that take advantage of the opportunities in good times and bad.
The following represents the three key building blocks that we have seen help our clients survive and thrive in any market:
Key #1 – Set shareholder wages to a market wage
This may seem like an odd starting point, but this has proven time and again to be the most critical. Most entrepreneurs actually set their own salaries too low. Many business owners have fallen into the tax game of setting their personal salaries low in order to avoid payroll taxes; in turn, they take distributions to meet their living needs. The major problem with this approach is that it distorts the reality of business performance and sets the profit target too low. Once we get shareholders to set their own wages to reflect what they would pay someone else to do their job—the “market” wage—they invariably hit their profit target.
Key #2 – Get profitable with the current flow of sales
The one story I have heard over and over is: “I am not profitable right now! I need to hire one more key person and then we will be profitable.” Sounds like a good plan on paper, but in my experience, it has some serious flaws. If anyone has ever succeeded in doing this, it is because they got lucky, found the right person quickly and produced quick cash flow results. That is highly unlikely in business.
If a business owner is in need of new key talent, he or she must first eliminate other salaries to make room for the new hire. The same holds true for staff reductions in a downturn. The businesses who survive are the ones who make the cuts and adjustments early and do it to for profit, not just to break even.
Key #3 – Get cash flow priorities right
If an entrepreneur is trying to take distributions out of the company while it still has debt, needs working capital and owes taxes, he or she is heading down a road of hard times. We tell clients that once they apply the first two keys for profit, their cash flow should flow as follows:
- Pay taxes
- Pay debt
- Build working capital to core target
- Take profit distributions
I know this is not the order most entrepreneurs want to hear, but of our clients who have fared well during the recent downturn all have followed this process. All in all, my experience has proven these concepts to be the most reliable building blocks for entrepreneurial success.