By Maurie Cashman
Is it an investment or an expense? This is an important decision that is often misunderstood in a business and is critical to building and maintaining value in a business. I would contend that this is one of the most critical value drivers that needs to be carefully examined.
In William Shakespeareâ€™s play, Richard III. Here King Richard III yells out loudly this famous phrase, â€œA horse, a horse! My kingdom for a horse!â€ In the middle of a battle, his horse is killed, while the king wanders to find it in the battlefield for hours, killing everything coming into his way with fatalistic rage.
The phrase is repeated ironically, when someone needs some insignificant item. Shakespeare shows that the value and importance of things may change suddenly and simple and unimportant things, like a horse in the battle, could become [more] important than a whole kingdom.
Most business owners fall into this trap at one point or another. An example that I can site from my own business was the transformation that occurred when I outsourced my accounting and tax work. Now this is classified on my financial statements as an expense. However, it is really an investment on my part because prior to that decision I was managing my own taxes and accounting work. It was an expense that I resisted because I was trying to get the business up and running. Once we got to a certain stage it became more clear to me that I could make much more money by focusing on where I can make the best return on my time investment and outsourcing and expensing things that other people can do better. It has had a profound positive impact on my business and my personal life.
A more direct contrast between investment and expense can be drawn from almost every business. For example, it is not at all uncommon to see an owner pull up to their business in a brand new SUV or pickup. When you tour the operation, however, you find that the equipment is twenty years old and may be totally obsolete to the point where the manufacturer does not even support it. I often find information systems that have not been updated since the business startedâ€¦some may even be using paper and pencil for their accounting!
The trap is two-fold. First the owner feels that a nice vehicle is something he is entitled to and it becomes an indirect way of compensation, and an investment that is not subject to taxation. There is some truth to this if it is properly understood and accounted for in analysis of the business. The second is our tax code. Owners are incented to drive new vehicles due to their ability to quickly depreciate them. Many truck and implement dealerships are built on this sole premise and rise and fall with the economy upon which they depend for their sales.
The Key to the Trap
The key is to understand very clearly what adds value to your business and what does not. This is called capital analysis and budgeting in large corporations. It is a fairly simple thing to implement. At its most basic level it involves analyzing each significant expenditure and determining how much return can be derived for the business if the expense is made. Capital proposals are compared to one another to determine which should be made and which can be put off.
For example, would you be better off putting together a strong ownership transition plan that includes finding ways to grow the value of your business significantly or would you be better off paying off the copying machine in the corner that is nearly obsolete if you can shift to a paperless operation? Will the truck that depreciates at least 20% the second you sign the papers generate any return at all for the business as opposed to upgrading your information systems so that you can increase efficiency, operate with less people and have better data security? Which makes the business more attractive to a buyer?
Carefully examining how you spend the limited capital you have to deploy is one of the most important disciplines you can employ to build the value of your business exponentially. Many companies fail due to their inability to get this right. Do you really want to give up the kingdom you have worked so hard to build for a horse?