In yesterday’s post, I introduced Michelle VanAllsburg, who owns a salon, The Hair Co., in Grand Rapids, Mich. In debt and under stress, Ms. VanAllsburg contacted me, hoping I might be able to help her figure out how she could sell her salon. But then we ran the numbers, and much to her surprise, it looked as if she was actually making a profit. “But I don’t have any money!” she responded.
Jay: You should have made a profit of $32,000. The fact that you don’t have the cash means you have a cash flow problem, which is different than not making a profit. Just because you made $32,000 doesn’t mean it is going to be in your checking account. This is where Accounting 101 comes into play. It is the difference between your income statement and your balance sheet. The income statement shows whether you are making money. The balance sheet shows where the money and debt are. We need to find where the $32,000 is hiding. The usual places are in inventory or receivables, which you don’t have. But you do have debt. Have you paid any of it back?
Michelle: Yes. It is down about $60,000 over the last four years.
Jay: Ah ha! Are you paying any interest?
Michelle: Yes. Five percent.
Jay: Have you been paying income tax?
Michelle: I don’t know.
Jay: What does your accountant say about your business?
Michelle: She paints a very dismal picture.
Jay: Is she an accountant, or more of a bookkeeper?
Michelle: More of a bookkeeper.
Jay: Well, here is what is going on. You are making money. Last year, you probably paid down your debt about $15,000, plus you probably paid about $3,000 in interest and about $5,000 in income tax. The business made about $23,000 — if you include the interest you paid. You don’t have any money because this is the difference between profit and cash flow. But something here doesn’t make sense. If the numbers you gave me are right, you should have made about $32,000. We need to reconcile this. Check out these numbers and I’ll talk to you next week. Either way, the business should be worth enough money to sell and pay off your remaining debt.
Michelle: I hope you are right! That would be a relief.
We spoke again a few days later, and I asked Michelle if she had reviewed the numbers.
Michelle: Yes. I gave you the wrong revenue number. It was more like $150,000.
Jay: So that would account for about a $12,000 difference in profit — $30,000 times 40 percent. But you would have paid less income tax, which might make it a $10,000 difference. That means you should have made somewhere near $20,000, which is about how much the debt and interest payments were last year.
Michelle: I know! I feel much better knowing that I am making money. Now that I realize that, I am happy to continue owning the salon, because I know that I am paying off the loans from my family.
Jay: That’s interesting. So what was really stressing you out was the fact that you might not be able to pay back your family — not the stress of running the business.
Michelle: Yes. That’s true. As I told you in my e-mail, I have really good people working for me, and I have many wonderful customers that I enjoy working with.
Jay: Oh, by the way, what did your accountant have to say?
Michelle: After I talked to you, I called her to see if your numbers were right. I asked her, “Did I make any money last year?” She said, “Yes. But the profits are paying down your debt.” I asked her, “Then why were you painting such a dismal picture the last time I talked to you?” She replied, “Oh, sorry. I was having a busy week.”
Michelle is hardly alone. Many people think that they can relegate their accounting responsibilities to an outside accountant. The problem is, it has to be the right outside accountant for them, depending on their needs. And that’s the trap.
Many entrepreneurs don’t know what they need. They view accounting fees as just another expense. But like many things, you get what you pay for. If you recall, she is paying $75 a month for her bookkeeping and accounting. How much advice do you think she should be getting for $75 per month? Right. And that’s about what she got. This is not really the accountant’s fault, and this is not an uncommon situation.
It happens every day to people with more guts than money. The lesson here is that before one starts a business, it can be critical to understand basic accounting. And don’t even think of using the “I am not a numbers person” excuse. I know that’s easy for me to say — I am a numbers person – but, trust me, I have had plenty of other areas that I have struggled to learn.
Business owners do not have the luxury of pleading ignorant to one part of the business, whether it’s accounting, management or marketing. This is at the heart of why the failure rate is so high for start-ups. You seldom, if ever, hear owners say they failed because they didn’t meet the accounting, marketing or management needs of the company. Instead, they usually blame the bank, the government or the stupid partner.
Entrepreneurship, first and foremost, is about accepting responsibility. Which is why I think Michelle’s story has the potential to help a lot of people. I want to thank her for agreeing to let me publish it. She is an entrepreneur, a mother and a good sport.