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How Money LIES

A little over a year ago I sat with a friend who extolled the virtues of his company.  He spoke of how profitable it was, all the great success they were having and how easy it was to make that profit.  He was working very little.  I’d previously given him the assessment that the business model was poor and unsustainable/unscalable.  Here we learn a valuable lesson of how money lies.

It was difficult for him, sitting with profits in his pocket to believe me, the money provided a sort of credibility, a sense of proof that it worked.  Six months later, looking over the financial position of the company he discovered something very different and though not all the factors had remained consistent during that period the basic truths behind the company, the same root causes of disaster, were dooming the venture.

The company and his assessment of the company and its prospects failed on two fronts:

  1. There was no repeat business – it was a one-time capital purchase with no related products the consequence being even if they could manage to sell the product profitably during a given period of time their lead cost and consequently customer acquisition cost would inevitably rise and ultimately erode the margins, which is exactly the opposite of what needs to happen in a sustainable business.
  2. Lying about expenses – the only expenses they were accounting for were the cost of goods sold and the advertising, they didn’t factor in cost of product storage, the cost of money to carry what amounted to huge amounts of inventory, didn’t account for the cost of excess inventory, the cost of product defect replacements, the cost of sales staff, accounting, merchant processing, legal, rent, etc. By lying about the expenses not to me but to himself he was creating the illusion of profit where none would exist in a comparable model at scale.

What needed to happen to make the business sustainable was to turn it from an organization that sold a product to a brand with relationships with clients to provide them with many products on a repetitive basis in order to grow those clients into long term profits.  It also required being honest about the expenses to plan scale and efficiency into the model, but it was only later when demands for capital in other areas forced a detailed review of the actual finances during the subsequent months and as sales began to fall as the market reached a saturation point that these factors became apparent and by then there was trouble.

It’s often said that when you have every reason to be proud and arrogant is the most important time to remind yourself to be humble, to ask the question “what am I missing?  What am I not seeing?”  Money in our pocket especially seemingly easy money flowing can mislead us in these cases.  It is very often that easy money shows up in a bit of a short term torrent and causes us to believe we are better than we are, it is why consistency in results over a long period of time are king.  Don’t be deceived by the short term wins someone experiences, keep in mind the fundamentals, diligence will pay off in the long term every time.

If you’ve got questions about the soundness or long term viability of a business model or any other business, investing, or wealth building question contact us by clicking “Ask a Business Question” in the lower right corner of the screen.  We’ll be happy to help.