As we saw in the last chapter, legal matters and systems have a strong link to the financial elements of your business, and it is of course important that you set everything up correctly and keep them in order as time goes by. But there is another aspect to money, and that is your attitude to it. Almost every case study concerning business success stories says the same thing: businesses established purely to make cash rarely do so. Those with a strong sense of purpose and integrity fare better, and the money flows from those principles. Cash is not an end in its own right.

CONCENTRATE ON THE MONEY

From now on, when you discuss money, it will be not in some abstract way based on a remote budget that was agreed by someone you have never met. It will be a highly personal matter. When you are starting a business, it will be your own money. It has been said that you don’t really appreciate what running your own business means until you have experienced a bad debt, so it is essential that you become comfortable talking about money straight away. If you don’t, you will probably agree to provide unspecified amounts of work or goods over unclear time periods, and in some instances you might not get paid. Alternatively, you may consistently sell products at margins so low that your business will not be viable. Although this sounds obvious, huge numbers of businesspeople pursue a large volume of sales so that they can marvel at the scale of their operation. They may well be proud of their turnover, but frequently they are barely making a profit. There is no merit in rushing around all year generating things to do and creating the impression of success when you aren’t actually making money.

Keep on top of what the money is doing, but don’t obsess over it. Companies do not simply generate money by concentrating on it. They ensure that the business is working properly, and if they are delivering excellent products and services then it is likely that the numbers will take care of themselves. Work out a rough numerical shape of what the business requires, and then get on with implementing the activity that will make it happen. It is important to have a feel for figures without getting bogged down in the minutiae. This skill does of course improve with experience, but it can be acquired more quickly by sketching the overall shape from the outset and then mapping performance against that shape over time. Designing a business with certain products and prices, and then seeing what frequency of purchase will yield a certain monthly sales figure is one way of doing it. But it may not yield the figure you want, so many entrepreneurs prefer to set a figure as a target and shoot for that. Not surprisingly, this ‘finger in the air’ figure is always larger than the scientifically generated figure, but it has the virtue of giving you and your staff and colleagues something more aspirational to aim for.

This shape, albeit very loosely based on mathematics, becomes the template for all operations in the first year of trading. If it is well communicated and understood by partners and colleagues, then running the business becomes significantly easier because everyone knows what they are aiming for, and so pulls in the same direction. If this is left to chance, or not explained at all, then the sales figures for the business are likely to arrive in a much more haphazard fashion.

DEALING WITH YOUR BANK

At the heart of any good financial system is your relationship with your bank. From the beginning, it is important to explain to them what you are planning to do, and what resources you will need. Make sure that you become familiar with all the methods by which you can move money around and stay in touch with your finances. As well as a conventional branch relationship, have a look at telephone banking, internet banking, text alerts and all the electronic versions of possible transactions. Automate as much as possible to save time and the possibility of something being overlooked.

First, consider the nature of the different bank accounts you will need. In a limited company this may be only one, accompanied by a clear bookkeeping system that shows the money coming in and going out. In a complex business, however, several may be needed to deal with different products, services, and subsidiary companies. Talk this through carefully with your bank. Second, you need to establish a very clear distinction between your personal money and that of the business. This is essential to keep everything above board, and provide a crystal clear picture of your income, the company’s income, any tax due on either, and the true financial state at any moment. Third, you may require an account for gaining interest on cash held, for setting aside allowances for future accounts (such as a large tax bill), or as a war chest for future plans for the business. Many current accounts, for example, generate no interest. So, instead of having large amounts of cash sitting in a current account earning no interest, you can set up daily electronic transfers to an interest-bearing account when the cash amount has reached a certain level. If your proposed business has an international dimension, you may well need to send and receive money from abroad. This needn’t be complicated, and the small business adviser at your bank will be able to explain how it all works to keep your charges to a minimum.

Separating pots of money in this way is hugely beneficial to your understanding of how your business is faring. It is important to understand the distinction between cash flow and profit, and to set up the right metrics with which to determine your business health. The cash in your business may be no indication at all of likely profit. To give a simple example, you might proudly look at a bank statement saying that you have £20,000 in the bank. At an initial glance, this appears excellent, and very healthy. However, if you need to pay a supplier or the HM Revenue & Customs £19,000 next week, then the picture is less rosy. So the cash flowing through the business must not be confused with profit. Time lags are a significant danger here. Tax bills in particular come nine months after the event, and must be allowed for to avoid difficulty. This is where separate bank accounts for different purposes can be extremely helpful.

By taking advice from your bank and your accountant, you will be able to set up proper reporting systems that give you the full picture. It is important that you become familiar with what these figures are telling you. Cash flow shows what is in the account at the moment, but gives no indication of what needs to go out. All debts, bills, and other commitments need to be shown alongside the cash figure and offset against this cash income to give a better picture. Profit can be shown as a running percentage or expressed as margin on sales, but in truth is often only fully clear at the end of a year or sales period. Printouts of this information take a little getting used to, but there are some excellent software packages that can make this less daunting.

SECURING FINANCE

Start your business with an appropriate pot of money for what you are trying to achieve. You may need no upfront investment at all, and obviously you shouldn’t borrow if you don’t need to. But if you do, take the time to investigate the implications of having an overdraft, of borrowing, and of securing other finance.

Loans can be fixed or variable, and there are government-backed small loans guarantee schemes that could help. Securing finance can be challenging, and should be approached with care. All the business plan work that took place at the beginning needs to be well packaged and presented to whoever might be providing the funds. Often they will have their own format and detailed questionnaire, so your original format may need to be changed. The lender will need to be completely convinced of the validity of your idea and the likelihood of their being repaid, doubtless with interest.

Take the time to understand the motivations of the lender. Obviously you want the money, but why are they lending it to you and what is in it for them? The time period over which they expect repayment is crucial, and so are the repayment terms. Look hard at the time periods over which the loan must be repaid, and be realistic about the ability of your business to meet the deadline. Punitive interest rates are another pitfall, and have caused problems for many businesses. Even when you have secured an offer of a loan that both you and the lender are happy with, you might want to take legal advice before signing up, or to get a second opinion. Assuming all is fine, put safeguards in place for when the money comes through. Strong discipline is required to make sure that the funds are not spent too fast, or on things for which they were not intended.

Sometimes investment is needed for highly specific items that are critical to your business idea. You might need premises, particular machinery, vehicles, or other hardware that have to be financed if the business is to launch. The banks have experienced most of this before, and usually have particular types of finance schemes to suit. For example, if you need to buy or lease vehicles or premises, they will most likely have products that already fit the bill.

TAX AND PAY

If you are a sole trader, but not a limited company, you will carry on paying tax twice a year in exactly the same way as you do with your personal tax. Bear in mind, though, that the amount the revenue requests in advance in January and July as ‘on account’ will change as earnings increase. So the more successful your business and the more money you take from it, the higher the tax bill. If you set up a limited company you will effectively have three tax bills to take care of – the two personal ones as usual, plus corporation tax once a year. The amount of this will be based on your annual income (which you will have to declare in your report and accounts), and is payable nine months after that year has closed. You can see straight away that this time lag is quite dangerous because the amount of cash in your bank account could make you believe all is well when in fact you have a looming corporation tax bill. It might therefore be wise to set up a separate fund specifically for the tax you know lies around the corner.

If you intend to employ staff, you need to become familiar with payment law, and that means a reasonable working knowledge of National Insurance, Pay-as-you earn (PAYE), employee benefits, your policy with regard to expense claims, pensions and much more. The HM Revenue & Customs website tells you everything you need to know about all of this (hmrc.gov.uk), and there are whole books dedicated to just this subject. At the beginning, it is good to have a clear idea of how you plan to pay salaries and dividends. If you are a sole trader, then you elect when you wish to take a dividend. This could be as regularly as once a month, or as infrequently as once a year. It’s your choice, always assuming that you are not taking out more than the business can truly afford. If you have staff, then they will need to be paid a salary, and your business plan needs to allow for this every month. Depending on their pay level, the correct percentage of income tax needs to be deducted at source and paid to HMRC, along with their National Insurance contribution.

VAT (Value Added Tax) applies to all businesses with income of £60,000 or more. This may change, as does the rate of VAT, which has changed three times in the last three years. In January 2011 it moved to 20%. Once you have registered for VAT, you must add the relevant percentage to your invoices or product prices. You also need to keep a note of your costs and the amount of VAT you have paid out. Once a quarter you reconcile one against the other and pay the revenue. For small businesses, it is worth investigating the Flat Rate VAT Scheme. This enables you to charge your customers at the standard rate, but pay the revenue less using a sliding scale based on the type of business you run. If you are in the scheme you pay this rate regardless and cannot reclaim any VAT. There is a ceiling on the size of business that qualifies for the scheme, currently gross income of £225,000 including VAT. Once again, all the details you need, along with the latest rates, are on the HMRC website.

HOW TO HAVE A DECENT MARGIN

It is difficult to give general guidelines about how to handle money without distinguishing between service- and product-based businesses. If you produce or sell any form of product, then the basic equation of your business will be based on the cost of making or acquiring it in relation to the amount for which you sell it. That’s your margin or, put another way, ‘materials with mark-up’. Consider this principle in relation to your own business. Ask yourself:

• What level of mark-up will your customers accept?
• What can you do to make what you provide worth more?
• Do you have enough services on offer to increase your average margin?
• Is your pricing appropriate for what you provide?

The price–quality equation states that if they cost a lot, your products or services must be good. It takes confidence to determine your pricing this way, but if what you offer is genuinely high quality, then it makes good sense. What do you deduce about two products of similar type, one of which costs £2,000 and the other £200? The more expensive is probably better made and so of higher quality. It may have a cachet or brand value to which potential buyers aspire. There is nothing wrong with it being more expensive, assuming that there are people who appreciate those qualities and are prepared to pay for them. No matter how disparaging one chooses to be about products and services that are ‘expensive’, one is eventually forced to admit that, one way or another, there must be a market for them otherwise they would not remain in their market.

In which case, what would you deduce about two people, one of whom commands a fee of £2,000 a day, and the other £200? The more expensive is likely to be more experienced and therefore of higher quality. This is self-fulfilling, because if they are not, then in a fairly short space of time they will not generate any repeat business, and will fail as a business reasonably quickly. It may be something of a rhetorical question, but which of these two people would you rather be? Obviously it is a hypothetical example but the principle matters. If you cost a lot, then you must be good. This is the reaction that you should aspire to invoke in your customers and competitors. Clearly, there has to be an appropriate balance between price and delivery but, in the main, you should always place the maximum possible value on what you have to offer. If you are uncertain about what that value is, you need to test your pricing first. One of the helpful things about starting your own business is that you have the power to determine your own pricing. Examine any market and you will find this to be true. People like paying for high quality goods and services. So look carefully at the equation between price and quality, and consider premium prices that are justified. Don’t sell yourself cheap.

Another facet of retaining a healthy margin is to be canny about requests for free or ‘win only’ work. ‘Share in our success or failure’ was one of the more unfortunate traits of the dot com boom in the late 1990s. This is a euphemism for a customer saying ‘I won’t pay for anything unless things have gone really well and I decide that I can afford it’. The main rule here is never to give anything away for free, unless you have an overwhelming reason to do so. When people ask why you won’t do speculative work for free, the best answer is ‘Because I don’t need to’. They really have no response to that.

Although there is usually no reason to give your time away for free, you may reserve the right to charge less or provide free work if you deem that it is appropriate. You will be the best judge of any given state of affairs, and the joy of running your own business is that it is your decision to make. Here are some possible reasons why you might want to provide something free or at a reduced price:

• Because it will lead to repeat business
• Because it will lead to new business
• Because it is part of a much bigger deal
• Because they are a highly-valued customer
• Because you can.

A final thought on free work. If you have had a really good sales period, why not offer to work free for a charity or a worthy cause for a limited period, or give them a one-off delivery of your product? Your expertise may be of significantly greater value than any donation you might ordinarily make, and may even be more useful than cash.

COPING IN A DOWNTURN

Recent world events have caused many to ask whether it is a good idea to start a business during a downturn. The figures actually show that more start-ups succeed when they start in tough times than those that don’t. This may be something to do with starting prudently and keeping things that way in your business, rather than starting with a more relaxed, or even cavalier attitude. Assuming times are at the tougher end of the spectrum, there are certain approaches that start-ups can take to stand a better than average chance of success. Most of it is to do with attitude. It may be tough medicine, but it works. Here are six suggestions.

1. Don’t ‘Do Gloomy’

No one wants to listen to someone moaning. The circumstances might be difficult, but you don’t have to be miserable. If you are, you will probably lose customers fast.

2. Don’t Invoke a Higher Power

Bad performers often use the context of a recession to claim that their company’s poor performance is nothing to do with them – it’s the economy, apparently. This isn’t always true.

3. You Only Need One Girlfriend

Complaining that there is no work is like a man saying there are no women in his town. You only need one girlfriend or piece of work, so go and find it.

4. Good Companies Do the Right Things All the Time

There is no difference between the things your business should do in a recession versus what you should be doing in any other circumstances. If you have to ask what to do differently in a recession, then it may actually be too late.

5. Sometimes Things Go Up, and Sometimes They Go Down

Economies go up and down. You still need to earn a living, so you need to believe that your success is entirely in your own hands, and go for it.

6. Nip into the Gap

You need to be dexterous enough to nip into the gaps that other businesses might have missed by being too cautious. Be flexible and keep coming up with new ideas.

LOOKING AHEAD TO AVOID A CRISIS

Looking back can help you to look forward, and often the experience gained can help avoid a crisis at some point in the future. Being retrospective doesn’t mean losing perspective. Considering the past doesn’t necessarily mean indulging in nostalgia. In fact, many people who run their own businesses repeat their mistakes precisely because they don’t review the past and learn anything from it.

Even in the earliest days of your business – perhaps in a test market – it pays to look back at all the customers you have had and what products or services you have provided for them. The frequency with which you do this rather depends on the nature of your business. In a fast-moving business that involves many customer transactions a day, this might be as often as weekly. Fashion retailers look at their sales figures every Monday, and adjust pricing and product mix immediately to rectify problems or capitalize on opportunities. You may be able to do the same.

Reviewing the past objectively can give you some fantastic ideas and insights, based on what you have already done. Large organizations have data and records to draw on, but when you run your own business you may only have a very limited amount of information. In fact, a lot of it might even be in your head. Start by jotting down the overall shape of your business:

• What was your total income last week or month?
• What were your costs?
• What was your profit?
• How many customers did you have?
• How many jobs or transactions did you complete?
• What was the highest value transaction?
• What was the lowest?
• What was the average?
• What was the average value of a customer?
• Is the trend going up or down?
• Is the customer mix right?
• Are the number of transactions per customer appropriate?
• Is the level of repeat purchase acceptable?
• Is the cost per job viable?
• Is the value per customer adequate?
• What are the important things that need to change?

Anyone who runs their own business needs to have a firm and up-to-date grip on these matters. As a rough rule of thumb, if you aren’t broadly aware of the answers to these types of questions, then you may not be sufficiently on top of your business. Equally, if something you offer proves to be very popular, it is vital that you work out why. Differentiate between the types of products that you have sold, and group them along the lines of what you sold most, what you sold the least, what the different types of product are, their viability, their enjoyment and satisfaction for you and your staff, and so on. Looking at these questions could help you to re-engineer your business on your own terms. If the things you enjoy most make the most money, then you are in luck (or you are a master of balancing work and pleasure). If not, consider whether you can change the proportion of less enjoyable and lower margin jobs for ones that make better economic and satisfaction sense. You really do owe this to yourself, and should be able to arrange the money–enjoyment balance more to your liking.

Naturally, if something you offer doesn’t generate enough profit, then you need to work out why as fast as possible. So the flip side of this exercise is to identify things that you sell or do that actually don’t make enough money. Many businesses produce huge quantities of work or products in a particular area only to conclude that they are neither viable nor that enjoyable to provide. This is why regular reviews are important, otherwise you could be spending your time on something that you don’t necessarily like doing, and which doesn’t even bring in worthwhile money. Asking tough questions now will help avoid problems in the future. Be honest with yourself, and if something you offer doesn’t make enough money, work out why and make the necessary decisions.

• What would happen if you stopped doing that thing?
• Would the business suffer in any way?
• Would more time be released for you to do more enjoyable or profitable things?
• Would anyone notice or care?
• Would the quality of your working life improve?
• Would the quality of your personal life improve?

This level of questioning summarizes the type of quizzical approach you should always adopt in relation to the financial aspects of your business. It represents the heart of whether it will be a success or not. But do not turn money matters into a permanent obsession. It is far better to concentrate on running the business well, and the likelihood is that the money will flow as a result. Keep an eye on which products represent the greatest margin opportunity, and examine regularly whether this needs adjustment. A deep understanding of what has proved popular and viable before will inform your decisions about what to do next.