Ever come to the disappointing realization that if you had acted on a problem sooner, you could have saved yourself a lot of time and money?
Or worse yet, if you hadn’t waited to do something, you could have made a lot of money.
We often forget to include the value of time when making our decisions. For example, consider how often consumers travel miles to take advantage of a discount or a special offer. Often the time spent, the cost of fuel, and wear and tear on the car to say nothing of the nerves is more than the value of the discount.
This same rationale can be applied to business decisions. Companies attempt to save money without evaluating the true cost of implementation, which can be significantly greater than the anticipated savings.
The true cost can be staggering when firms fail to take action in a timely manner. The cost doesn’t appear on the company’s profit and loss statement but does result in a decrease in net income. This is called “lost opportunity cost.”
Many people who own and run companies spend a great deal of time inadvertently creating lost opportunity costs. One example is when a young business needs working capital but doesn’t qualify for bank financing. Typically, the business owner spends months going from bank to bank only to be repeatedly turned down.
Many emerging businesses simply cannot meet banks’ lending criteria, such as length of time in business, tangible net worth, profitability, debt to worth, and other financial ratios and assessments. The time spent running from bank to bank (which is time taken away from building the business), and the out-of-pocket expenses are part of lost opportunity costs.
There is also confusion among many established business owners when they identify what kind of capital they need, and what the risks and cost factors are in obtaining that capital. The structure of that capital can take a variety of forms, and the costs of obtaining it are commensurate with risk.
In the process, some business owners become obsessed with the cost of capital and forget what they could do with that money and how much their businesses could benefit.
By way of example, let’s say that a business is doing $1 million a month in sales, and with $1 million in additional working capital, it could increase business by 50 percent. Let’s also assume that it has a 20 S
percent gross profit, and at $1 million a month is just about at a break-even point.
If the company did $500,000 more in sales per month, that’s $6 million per year, for an increased gross profit of $1.2 million. At that level of increase, the business may not incur much more in expenses, perhaps another $500,000. So now it has $700,000 of net profit that it didn’t have before.
Let’s also say that charges for the $1 million in additional working capital are $200,000 for the year. That leaves $500,000 in new, net profit.
The business owner may be able to get the additional capital at a lower cost, but if it takes up to six months to secure, the firm has lost six months of potential profit half of the $500,000, or $250,000. Waiting for a lower rate may actually cost more than it would save.
And that doesn’t count the time the business owner has put in that’s time away from building the business.
In this example, it’s plain to see the magnitude of loss as a result of indecision, and the potential for significant profit when a more timely decision is made, even with an increase in financing costs.
Lost opportunity cost is a soft cost that doesn’t show up on a company’s financial statements. But it can be the difference between just getting by and making a reasonable profit. It may even significantly impact the future success or failure of the business.
How can you eliminate or at least lower lost opportunity costs? You need to become more financially aware not necessarily an expert, just more aware when it comes to business financing issues. The following are some steps to take:
-Talk with your banker to understand the parameters and limitations under which banks operate. If one or two banks can’t or won’t provide the financing you need, running around to other banks probably won’t get you the results you’re looking for.
-Understand alternate financing avenues and under what circumstances you would use them. Alternatives include venture capital, factoring and asset-based lending.
-Align yourself with experts, CPAs, attorneys and business consultants who can refer you to the right people when you need them.
-Keep the proper perspective when evaluating your options and financing proposals. Remember, the cost of funds is not necessarily the most important consideration.
Once you feel comfortable with your options and how to evaluate them, make timely decisions and act on them quickly. This will allow you to turn your company’s dilemmas into opportunities.
Bron D. Hafner is chief executive of Celtic Capital Corp. He can be reached at [email protected].
Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.
