Differentiating “Good” from “Bad” Business Expenses
Cliché as it is, when you’re an entrepreneur, you really do need to spend money to make money. That said, not all investments are created equal.
You want your workspace to look professional. But should you shell out for expensive furniture? You want your employees to be happy. But what employee perks will make the biggest impact? No bank account is limitless, after all.
One core concept every entrepreneur should understand is operating leverage, says Mitchell Weiss, author of “Business Happens” and small business expert. This describes a company’s ability to earn increasingly higher profit from each incremental dollar of revenue. If you spend a dollar on marketing to bring in a dollar of profit, you’ve netted nothing.
“Every dollar you spend doesn’t equal just a dollar of additional revenues, because what’s the point of that?” Weiss says. “Every incremental dollar should start to deliver $1.10, $1.20, $2.00 of revenues. It’s about leveraging your infrastructure. Let’s say ten employees are producing $1 million in profits each year. If you don’t need additional employees to produce $1.25 million, then you’re leveraging what you already have in place [in order to grow].”
When deciding whether business expenses will really help your business or simply set back your balance sheet, ask yourself these questions:
What’s the Return?
This is vital for business expenses that feel necessary to the growth of your company, like larger space, technology or staff. Turn to your income statement projections for this answer, Weiss says. Look at the cost of the expenses in question and your expectations of how they’ll generate revenue.
Am I Reacting or Anticipating?
Are you spending now in hopes of additional business later, or do you know for sure that the profits are forthcoming? Weiss says. “From my experience, it’s far less stressful to have too much to do versus not having enough. The employee sitting there waiting for the next task is the person worried about getting fired when business falls off. So [in my company] we always took the approach of hiring just in time. We’d wait until we were moving up in revenues and needed additional staff rather than hiring in anticipation.”
Before investing in warehouse space, real estate, upgraded technological platforms or staff, ask yourself: Do you really have the business to support this cost? And if that business isn’t yet in hand, do you have a high level of confidence that it will be shortly?
Will This Aid Employee Retention Meaningfully?
Talent retention is important for small companies, especially since most can’t afford to pay employees exorbitant salaries. The benefits your employees receive includes the general environment, Weiss says, which means benefits like training, mentoring, flexible work schedules and more. Before spending huge sums on perks like snacks in the break room or fancy artwork, think about what will realistically make your employees happier.
“In one of my companies, we had grown to a point where we needed new furniture and had decisions to make: Do we go for higher-end stuff or do we go for what’s presentable and useful but not necessarily high-end?” Weiss says. “The way I pitched it to my staff was, ‘You have a choice: Do you want to be sitting on your money or do you want it in your pocket?’ To the extent we pay up for this fabulous furniture, it will diminish how much income will be delivered to the company’s bottom line and suppress the bonuses we pay.” Weiss gave his employees a choice between nicer office furniture that they could enjoy every day and receiving additional bonuses. Unsurprisingly, they chose the cash.
Is Your Ego Involved?
Are you getting an item for enjoyment’s sake or will it genuinely add value? “I once joked that I’d get everyone T-shirts saying, ‘Just because you can doesn’t mean you should,’” Weiss says. “What’s motivating you to spend discretionarily as opposed to necessarily?” If your business has the cash to spend on wants instead of just needs, that’s great—but these expenditures should also be held up to the microscope of what’s actually useful.
How Does This Stack Up Against My Loans?
If your business has debt, then there’s an added dimension every time you have money to move around. “Think about whether you’ll earn more money by working on your debt and saving on interest, or if you’ll earn more by taking profit dollars to grow your business,” Weiss says.
For example, say you’re paying 15 percent interest on your loan and buying more inventory would increase your profitability by 40 percent. You’d come out ahead by making the purchase instead of paying down debt because profits outweigh the “price” of the cash involved. Meanwhile, if buying inventory would only increase your profitability by 10 percent, you’d do better to simply redirect the funds toward your loan. “Think about probabilities,” Weiss says. “For example, ‘I’m 100 percent sure I can increase my profitability by 20 percent, I’m 50 percent sure I can increase it by 25 percent’ and so on. That gives you a decent projection.”
At the end of the day, every purchase is a judgment call. There’s no magic formula, but going in with the right questions in mind can give your entrepreneurial intuition a serious boost.
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