A colleague had an acquaintance who was looking for funding for his business. My colleague introduced him to a potential investor at lunch. The next day the investor called my colleague and told him that the person was nice but he would never invest in his business. My colleague asked why. The investor said that he had the “Mercedes Benz syndrome”.
“What’s that?” asked my colleague. The investor explained that during the conversation at lunch he found out that this person was funding a $2200 Porsche lease through the business. He appeared interested in having the business pay for his personal lifestyle. The investor explained to my colleague that his money was not going to pay for a car lease. His investments were supposed to help grow the business; not the owner’s personal “finer things of life”. He went on to explain that he called this the “Mercedes Benz syndrome” where the business pays for unnecessary personal assets, i.e. the owner’s “Mercedes Benz”. Investment that is supposed to go towards the business’ needs goes towards the owner’s personal needs.
It struck me that a lot of contractors do this too. I know some. You probably know some. These are the contractors who don’t understand that cash does not mean profits and that having cash does not mean that you have to spend it. These are the contractors who use the business cash to buy boats, have the company pay for expensive trucks and cars, write off vacations, build an expensive home, have a non-working relative on the payroll, etc. Instead of investing in the business, they invest in themselves.
Don’t get me wrong. There is absolutely nothing wrong with enjoying the fruits of your labor. However, you can’t do it at the expense of your business. Our industry is very cyclical and you have to save cash for the downturns. You have to save “for a rainy day”.
Sometimes you have to save for years. A mechanical contractor I know had ten years of 15% or more net profits before taxes. During this time, they did not take a lot of money out of the business. They paid modest bonuses but invested back in the business. This year work decreased dramatically and they had to lay off people. However, they survived this downturn and are seeing an upturn again…nine months later. They had the cash to survive. Ten years of savings gave them the cash they needed to fund operations when it was very slow.
Another mechanical contractor had 10 good years too. The owners of this company took everything out of it they could and spent it…on second homes, expensive vacations, and the finer things of life. The economy tanked in their geographic location too…and they are scrambling. They are on COD everywhere, vendors are calling, their line of credit for several million dollars is tapped, and they barely scrape by to pay payroll each week. The attention that they should be paying to generating additional work is being spent on credit and collections issues. They readily admit that they didn’t invest back in the business and it is now hurting.
So how do you avoid the Mercedes Benz syndrome? You make sure that you are earning enough on your jobs and service work to generate reasonable profits and you save some of the money you generate from collections. You can actually save relatively painlessly. Save 1% of every check that comes in the door. That means if your deposits for the week total $1,000 you write a check into a savings account for $10. You’ll never miss the $10. And, that $10 will start earning interest.
You can also save your service agreement revenues. A contractor I know funded his retirement through service agreement revenues. The company never used them for operating funds. They saved all new and renewal revenues. Over 10 years this added up to hundreds of thousands of dollars.
Neither of these two savings plans is difficult to do. However, they do take discipline to do. If you save service agreement revenues, then whenever a customer pays an invoice which includes service revenues and a new service agreement, you have to have the discipline to write a check to a savings account for the portion of the payment that is service agreement revenues. Many contractors have their bookkeepers perform these activities and check up to ensure that they are done.
How much should you save? This is totally up to you. It depends on whether your company has a line of credit. If you have a line of credit and it isn’t used, that can be a form of emergency cash. However, even with that safety net, many contractors like to have at least two to three months overhead expenses saved. Others have the value of at least six weeks payroll and payroll taxes in the bank at any moment. Their reasoning is that if nothing came in the door in terms of work, then they could at least pay their people for a reasonable time. You’ll need some savings that are fairly liquid, i.e. you can turn them into cash quickly. Other savings could be more long term which probably will earn more interest.
Hopefully you don’t have the “Mercedes Benz syndrome”. Good profits and savings will prevent a financial hardship in years to come.