It’s very easy to have a business become an all-consuming lifestyle that you eat, sleep and breathe. Remaining detached from your business can be a challenge, but at the end of the day, your business is an investment and it owes you a return.
The key difference between a business investment and other asset classes is that it consists of two elements — the labor factor (your return on time) and the investment factor (your return on money invested).
Many business owners forget to count one or the other of these. They may view their annual profit and consider it is equal to receiving a good salary, but they forget they also need a return on the money invested. Alternatively, they see their profit as a good return on the investment but forget how much time the business is taking. Few other investments will take the time of a business.
So what should you be earning? First, if you run your store yourself, you need a salary that is commensurate with what you might pay a manager to do your job. Second, you need a profit component equal to the risk/return scenario suitable for your type of business.
Let’s illustrate. Jack is a full-time owner who has invested $500,000 to purchase his jewelry store. Jack knows the market rate to hire a manager in his city is $80,000 per year. His risk/reward scenario means that for his type of business, he would be seeking a return of 25% on his store investment to reflect the risk involved. On this basis, Jack would be looking for $500,000 x 25 percent or $125,000 profit on his investment plus a return of $80,000 to reflect his full-time work. This represents a total of $205,000. Now some of you may view this as high — 25% is a very good return on money after all. The stock market’s long-term yield is only 6-12 percent per annum. The difference is the risk. Would Jack get $500,000 back if he tried to sell his business? Those of you who have tried will know the answer!
Even if it sold, how long would it take? You can sell a share portfolio or withdraw a bank deposit in a matter of minutes. Selling a business can take from months to years. Your bank deposits are also relatively certain to be there tomorrow. Jack’s profitability faces greater uncertainty. He could be wiped out tomorrow by a freak of nature or a competitor’s arrival. He needs a higher return to compensate for this.
Work through your own numbers. Is your business giving you a healthy enough return for your time and money?