Entrepreneurs Know Fixed Costs Will Eat Them Alive — number nineteen in a series taken from:
How to Evaluate and Profit from a Business Opportunity – The Entrepreneur’s Guide
By Art Consoli
Fixed costs; those costs which are attributable to commitments for equipment, buildings, employment contracts, notes payable, and other items of this type require payment regardless of sales or profits, or the availability of cash to make the payments. The term is very descriptive and defines a heavy responsibility on the business owner.
The documents that cover such agreements can include language that give the other party very strong rights to payment and the ability to take possession of other property the business might own.
Successful entrepreneurs know that there are many ways to avoid taking on fixed cost obligations but all the alternatives normally come with a higher immediate cost. They know that they can usually get a mortgage on a building at a cheaper monthly cost than they can rent the equivalent space for on a short-term rental agreement (usually defined as less than a year.) But they know it’s better to pay more now and wait to see how secure the business’ cash flow will be.
Successful entrepreneurs also know that it may be better to buy used equipment and have higher monthly maintenance and repair costs than to take on the purchase contract for a new piece of equipment.
Today, thanks to the availability of easier credit (provided you personally agree to repay if the business can’t) it may be difficult to determine which deal or which alternative is best for you. But the lenders are all trying to get your business so it may be possible to define the deal you want and go shopping for the lender that will accommodate you. One of the points I found easiest to negotiate is the percentage of the repayment I would personally agree to make. Lenders were quite willing to accept my offer to guarantee the top twenty or thirty percent of the obligation and then look only to the business for the remainder.
Some business owners escape the fixed cost of equipment by hiring more people. They figure that it may cost a little more to have the work done by hand until the business is doing well enough to buy equipment. I have no problem with this approach if there are other places in the business to use the people afterwards — say another new product that needs some time to become a predictable revenue generator.
But when the business owner uses people as though they were expendable, hire them today, let them go tomorrow, I have a problem.
I believe that people are what make things happen and that good employers attract better people. When I hired somebody, I viewed that decision as making a long-term commitment to that person. I delayed hiring until I was positive that I needed that person for the long haul. I used overtime, with its higher cost and part-time people, with their less than the best dedication to my business until I was very sure I wouldn’t have to let somebody go because the work I thought was coming in — didn’t.
To make the point about avoiding fixed costs in my book I quoted my father, Arthur S. Consoli, Sr. As I was preparing to take my family on our first extended vacation trip, sitting at the kitchen table he said in his colorful Italian; “Take-a-twice as much money as you think an half da stuff. If you gotta da money you can buy more stuff but if you run outa money da stuff gonna be twice as heavy.”
As your business grows, you will have to make many decisions about what to invest in and when. With so much available credit it’s easy to take on fixed costs and it’s easy to rationalize how much better the business will do — right now — even without the additional business. But wait until you have confirmation that the expansion is permanent, not temporary.
In every work-out I was called in to fix, the first thing I saw was excess, idle equipment — most of which was not yet paid for — which was worth less than what was still owed on a note the owner had signed for personally.
Learn more about this topic in Chapter Twenty-nine in my book.
By Art Consoli
Art Consoli held eight corporate positions with Johnson & Johnson before starting his first business. He went on to build over twenty businesses from patents or ideas or from businesses others couldn’t make successful. These ranged from starting a veterinarian drug company to taking over a steel fabricating company to developing the first manufactured home subdivision to qualify for every private and government assisted mortgage program in Arizona. He also did ten workouts for lenders and owners; the last was a $30 million, 300 employee, precision parts manufacturing plant that made parts for the auto industry. Consoli’s unique background and skills allow him to speak and write about how someone with limited experience can do a self-evaluation which will let him decide which business opportunity is best, how to evaluate opportunities and gain control over the one which offers the greatest potential and then manage that business to success. Readers of his book call and write to tell him how much his book has helped their lives and improved their business.
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