Real entrepreneurs don’t make profits, and for good reasons. Huge oil companies make excess profits, sure. Smart entrepreneurs don’t.
And I don’t mean just the land-grab web companies like Facebook and Twitter don’t make profits. Growing companies don’t make profits. Can you be more successful than amazon.com and Jeff Bezos? Amazon didn’t make profits until relatively recently. No, I mean small business everywhere.
Ideally, you do want enough in profits to support an increase in working capital, which would be a single-digit percent of sales. But that’s rare in growing companies.
Where do profits come from? Money you take in as sales that you don’t spend in cost of sales or expenses. And if you want to grow, then money that might have been profits goes right back into expenses as more product development, more marketing, more smart people on payroll.
When Palo Alto Software was growing at double-digit rates during its teenage years, I made the order of priorities as clear as I could: cash flow break-even first (we didn’t have outside investors); growth second; profits third.
This is a rewrite of an older post, but it seems like a good one to repeat. You don’t have to be an accountant or an MBA to do a business plan, but you will be better off with a basic understanding of these six essential financial terms. Otherwise, you’re doomed to either having somebody else develop and explain your numbers, or not having your numbers correct.
Sales: exchanging goods or services for money. Most people understand sales already, but the timing of sales is important. Technically, the sale happens when the goods or services are delivered, whether or not there is immediate payment, and regardless of how long ago you paid for what you’re selling.
Cost of Sales (also called Cost of Goods Sold (COGS), Direct Costs, and Unit Costs): the raw materials and assembly costs, the cost of finished goods that are then resold, the direct cost of delivering the service. This is what the bookstore paid for the book you buy, it’s the gasoline and maintenance costs of a taxi ride, it’s the cost of printing and binding and royalties when a publisher sells a book to a store for resale. And timing is important for this one too: it gets into the books at the same time that the sale is made, regardless of when you bought it or paid for it.
Expenses (usually called operating expenses): office rent, administrative and marketing and development payroll, telephone bills, Internet access, all those things a business pays for but doesn’t resell. Tax and interest are also expenses. And the timing is supposed to be when you are committed to the expense, regardless of when you pay for it.
Profits (also called Income): Sales less cost of sales less expenses. Expenses in this case includes depreciation, amortization, interest, and taxes. And if you don’t know what depreciation or amortization are, don’t sweat it, neither one of them belongs in my list of six essential terms.
Sure, you can spend a lifetime analyzing and getting to know the ins and outs of it, but these are basics every business owner and entrepreneur should know. In my opinion.
Question: I’m in the process of writing an Internet startup business plan to present to prospective investors. The site isn’t live so I don’t even have a basis for speculation with respect to the financials. I would essentially be pulling numbers out of the air. Being that the Internet business as it pertains to advertising revenues is so mercurial, is it feasible to present the plan without having the financials included? If not, how can I make more realistic financial assumptions?
My answer: No, you won’t get anywhere presenting a business plan to investors without financials. I’m glad you asked me instead of just moving ahead with that idea.
Every new business, including a website business, has to be able to present a reasonable forecast if it’s going to hope to get an approval from outside investors. And it can never be “pulling numbers out of the air.” The assumption is that before you start a new business you have some idea how it’s going to work, based on some experience. If you have no idea, no investor wants to even share the same elevator with you.
In this case, the website business, you need somebody on your team who can project website traffic and sales based on real experience with search terms, search engine optimization, Google ad words and its competitors, conversion rates, and so on. Your traffic doesn’t get pulled out of the air, it’s a function of what you plan to do and what you plan to spend. Know your key search words and the traffic those words and phrases get for others, right now. Know reasonable conversion rates. Make estimates based on real assumptions about real variables.
How could I know? (from the Plan-As-You-Go Business Plan online site).
I was in an airport recently, not wanting to eavesdrop, just sitting near the gate waiting to board. I was trying to concentrate on my own work on my own laptop in fact, but these people were loud and completely unconcerned about bothering anybody else. So I heard their conversation.
They were salespeople bragging about what I consider the opposite of good selling—making bad deals for things people didn’t want, selling to people who didn’t want to buy, getting the order regardless. You know the cliche: selling iceboxes in Alaska, etc.
Doesn’t this almost always end up with an unhappy customer? How is this good for business? Why are they proud of it? And, if this is you, why are you proud of it?
We all forget too easily: the best startup funding is sales. Sure, angel investment, friends and family, SBA loans, all of those options are necessary for most startups. But sales is better.
If you can, find the early customers. Give them a deal, make them important, work with them to optimize their needs; but make a sale.
Even if you need to go out and find investment — and I speak now as an actual angel investor — there’s almost nothing as convincing as actual sales. People are spending money. It makes a new business proposal far more credible.
True, not all businesses can do that. But a lot of them can. And, as we write about business plans and seeking investment and all, we forget the real sweet spot: finance growth by making the sales.
You know who you are. You hate selling, but here you are, making your way as entrepreneur, having to sell or sink.
Me? I’m a terrible salesperson. I’m also bad at networking, cocktail parties, and small talk with people I don’t know. Do I seem stuck up, aloof? Not really, just awkward.
I’m probably still scarred from my miserable failure at selling encyclopedias when I was in high school. I spent all summer, never made a sale, never managed to convince even a single person that I was really conducting an educational survey, and not selling encyclopedias. That miserable summer might have been what led me to hippiedom, way back when … but that’s a separate story.
And yet, hating to sell or not, I sold myself to business clients well enough to support a big family on my business plan consulting for 15 or so years, while simultaneously starting to build Palo Alto Software as a product business.
I never learned anything while talking.
There’s no way to avoid it: you have to actually feel what this other person is feeling. Jump into their skin, or into their head, and look out from inside their head at the rest of the world. My mother used to call it putting yourself into the other person’s shoes. My sister-in-law used to say “borrow my eyes and see through them for a while.” See if you can imagine how he or she feels and he or she sees it. What experiences have they had which led to that point of view?
There’s no substitute for empathy. It’s the most important quality in business.
Lies come out, in the short term or long. Even plausible lies are time bombs.
When asked questions you shouldn’t answer — it happens; in the software business, for example, some questions about platforms and programming code and such — just tell the truth, and say you don’t feel comfortable answering that question. Explain why not.
When asked questions about weak points or flaws, answer them. You’ll gain some credibility and avoid the long-term loss you risk if you lie and your customer finds out later.
Your credibility, which is inseparable from your integrity, is the key to long-term relationships.
And I would end up giving them the toll-free number of a competitor. There was great satisfaction in that. And, in the long term, it’s good for the business. People see that you realize what your product is good at, and that other products might be better at different things.
I’ve seen our best salespeople do it over and over: they listen, empathize, and solve the other person’s problem either with our own product or by suggesting something else, that isn’t ours, that will solve the problem. We’re dealing with humans here; not everybody is a potential sale. Some of those people whose problems we can’t solve now will come back to us later, when they have a problem we can solve.
The first person who ever worked for Palo Alto Software as a full-time salesperson was amazingly persistent. He would leave voice messages for key gatekeeper people once a day for months, without ever getting a returned phone call. And, at least in several key accounts, those months of unanswered phone calls eventually got him — and our product — in the door.
Yes, I know, it’s somewhat contradictory to include empathy and thick skin in the same post. If you really empathized with the people who ignore messages, you might not persist in calling back. But business and life is full of paradox. I can’t resolve this one.