Earnings > Liabilities

Sep 2015

(Based on an Office Hours)

 

“Because he sacrifices his health in order to make money. Then he sacrifices money to recuperate his health. And then he is so anxious about the future that he does not enjoy the present; the result being that he does not live in the present or the future; he lives as if he is never going to die, and then dies having never really lived.”

– Dalai Lama

 

“One hundred percent of our earnings are reinvested in the company, and a great deal of that goes to research to create newer and better products that generate more earnings. It’s a beautiful cycle.”

– Amar Bose, founder of Bose Corporation

 

Profit is really unsexy in startups. The reason is fairly obvious. Any profit gets taxed by the government and is largely an amount of money that is not being invested to grow faster. So not only is it not being spent to grow faster, a portion of it goes to the government in taxes.

I suspect most governments would even prefer not to tax a business if it was growing quickly because then the business would go out and hire more people. Those peoples personal incomes would then be taxed. The only reason governments have to tax companies is because otherwise businesses would just keep all the money in the company and use it as a tax shelter.

The foundational rule of business is that you win if your earnings are greater than your liabilities. Another way of saying that is your income is greater than your costs. Earn more than you spend. If you always follow this rule, there is no possible way for a company to fail. It just won’t happen. Because it literally can’t. But sticking to this rule requires an immense amount of discipline and is unintuitive.

What it equates to is being fanatically resourceful and frugal. What it also means is that the only time money is spent is when it comes from earnings. For the last 1,000 years of business. This was the norm. A company buys things and pays itself using its earnings. It then reinvests some of these earnings to grow more.

The only time losses are justified is when a business is growing rapidly. If a business isn’t growing rapidly and has a lot of losses then something is very wrong. But regular growth is not enough in this scenario, it has to be exceptional growth.

The reason spending money is enticing is because it is easy and very often makes things seem like they are working when they aren’t. If you spend money and get a commensurate amount of results then that is actually a bad outcome. If you spend X, you should really get some multiple of X as a return for spending X to have been a good idea. You really need to get about 3X.

I tell this to companies all the time. And yet still see them go and spend all their money, when their earnings are nowhere near proportional to their expenditure. It is then sad to see these same companies go under just a year or so later with the founder making a ton of excuses for why they needĀ to spend all their money.

The only exception to this rule is when investor money is involved. In these occasions, the investor money is to be spent getting the company to the point that its earnings are greater than its expenditure. This point is called profitability. The point where earnings are greater than liabilities. If it doesn’t get there, the company collapses and goes bankrupt.

If a company raises $500,000 and then hires 5 people at $50,000 per year. It only has 2 years to get the company to the point it is generating $500,000 per year in revenues and can afford its costs. This is really hard. And if a business doesn’t reach this milestone. It’s dead. It’s very sad to see this happen to companies yet it’s remarkably common.

And there isn’t a lot of sympathy for companies that spend half a million dollars and have nothing to show for it. But this could all have been fixed by one change. Don’t spend your money. Always make sure earnings are greater than liabilities. Make something people want.

It’s a fallacy that founders believe they need to spend tons of money to make something successful. It is in fact the opposite. The only time lots of money should be spent without any return is reactively. If a company is growing so fast that their earnings don’t matter.

You’ll know if this is happening to you because your growth rate will be consistently 1,000% or greater. The growth rate graph will be less a hockey stick and more a large vertical line and if this is happening, don’t bother trying to earn anything until the growth has tapered off.

If your company is growing so quickly that you need to spend huge amounts of money just to keep up and pay for everything. Then just do it. Because this is one of those rare moments where lighting has been caught in a bottle. Just keep up with the growth and great things will follow. It is easier to earn money later from millions of users than it is right now from a few thousand.

But most companies aren’t like this. They are decade long struggles up a giant hill. A very rewarding hill, but a giant one none the less. And all their money should be spent instead just staying alive long enough till they get to the top of it. This can be filtered into the following unintuitive truism that will almost universally result in success in nearly all scenarios.

1. Avoid spending money.
2. Earnings > Liabilities.
3. Make something people want.

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