In Calculating ROI remember don’t confuse Profit & Cash!

Your company is ready to make a big purchase — a fleet of cars, a piece of manufacturing equipment, a new computer system. But before anyone writes a check, you need to calculate the return on investment (ROI) by comparing the expected benefits with the costs. Analyzing ROI isn’t always as simple as it sounds and there’s one mistake that many managers make: confusing cash and profit.

This is an important distinction because if you mistake profit for cash in your ROI calculations, you’re likely to show a far better return that you can expect in reality. So keep in mind: Profit is not the same thing as cash.

Sure, you may know this already, but people who haven’t studied finance often find this statement confusing. If a company earns a \$500,000 profit in a calendar year, shouldn’t it have \$500,000 more in the bank on December 31 than it did on January 1 of that year?

The answer is no, not necessarily. Profit and cash are really two different animals. Profit appears on a company’s income statement. It indicates what is left after all costs and expenses are subtracted from the company’s revenue. But it isn’t directly related to cash.

For example, “revenue” isn’t a cash-based number: A company can record revenue whenever it ships a good or delivers a service to a customer, whether or not the customer has paid the bill. Some of those costs and expenses aren’t cash-based, either. Income statements almost always include an allowance for depreciation of capital assets.

Cash transactions, meanwhile, show up on the cash flow statement. That statement records cash generated by a company’s operations and cash spent on those operations; cash spent on capital assets (and cash generated by the sale of capital assets); and cash received from, or paid to, lenders and shareholders.

A common mistake in ROI analysis is comparing the initial investment, which is always in cash, with returns as measured by profit or (in some cases) revenue. The correct approach is always to use cash flow — the actual amount of cash moving in and out of a business over a period of time.

Let’s look at an example: A midsize manufacturing company wants to know whether to invest in a new \$10 million facility. The plant would generate an additional \$10 million in revenue and \$3 million in profit per year. At first glance the return looks great: 30% every year. But profit is not cash flow. Once the plant starts operating, for instance, you might need to spend an additional \$2 million on inventory. You might also find that your accounts receivable (A/R) — what customers owe you for services rendered or products delivered — rises by \$1 million. These two variables alone would consume the entire \$3 million in profit, so your incremental cash flow in the first year would actually be \$0.

Investments in inventory and A/R are shown on a company’s balance sheet (a “snapshot” of a company’s financial position at a point in time) and are included in working capital — funds used in the operation of a business, often defined as current assets minus current liabilities. Working capital requirements are typically built into an Excel model you’ll use to calculate ROI, so you don’t need to worry about them. But you do need to understand the importance of comparing cash returns with cash outlays. Apples to apples, and all that.

Occasionally companies analyze investments in terms of their effect on revenue. That’s because many young companies focus on hitting certain revenue targets to satisfy their investors. But revenue figures say nothing about profitability, let alone cash flow. True ROI analysis has to convert revenue to profit, and profit to cash.

Once you grasp the cash vs. profit distinction you can better understand the four basic steps of ROI analysis.

1. Determine the initial cash outlay. Usually this is the simplest part of the analysis. You just add up all the costs of the investment. This includes items such as equipment costs, shipping costs, installation costs, start-up costs, training for the people involved, and so on. Everything that goes into getting the project up and running has to be part of your initial cash outlays.

If you’re just buying a new machine, it’s pretty easy to estimate all the costs. A project or initiative that is likely to take several months will be harder.

1. Forecast the cash flows from the investment. This step is the toughest part. You need to estimate the net cash the investment will generate, allowing for variables such as increased working capital, changes in taxes, adjustments for noncash expenses, and so on. Putting the cash flows on a calendar will allow you to estimate returns year by year or even month by month. Most of your time will be spent on this step. It’s where your company’s finance department will ask the toughest questions and scrutinize your estimates and assumptions most carefully.
1. Determine the minimum return required by your company. The minimum rate of return is often called a hurdle rate, and it is determined by your company’s finance department. Companies may have more than one hurdle rate depending on the risk involved in proposed investments. The finance people determine hurdle rates by looking at the company’s cost of capital, at the risk involved in a given project, and at the opportunity cost of forgoing other investments.
1. Evaluate the investment. This is the final step. You can use one or more of four ROI calculation methods: payback, net present value, internal rate of return, and profitability index. The results will tell you whether the proposed investment offers a return more or less than the company’s hurdle rate. Some of the calculations will also help you compare this investment with alternative investment possibilities.

While these are the basic steps, there is a lot more to getting it right. You have to account for the time value of money. You have to estimate returns based on cash flow rather than on profit. You must know your company’s hurdle rates, and you must determine which method of calculating ROI is the best one for your project.

For more on calculating ROI, see HBR TOOLS: Return on Investment (ROI).

Joe Knight is a finance and business literacy keynote speaker and trainer, a partner and senior consultant at the Business Literacy Institute, and co-owner and CFO of Setpoint Systems, Inc, a manufacturing company based in Ogden, UT. He is the co-author of Financial Intelligence and the HBR Tool: Return on Investment (ROI).

Yes,Entrepreneurs are different from the rest of us

Entrepreneurs are indeed different from your everyday person in a number of telling ways. Not all these differences are a product of genes however. The impact of nurture is evident especially where the child is exposed to an entrepreneurial parent. Such early development and learning is highly correlated to an entrepreneurial nature. So also experience in problem solving and decision-making. The brain isn’t hard wired, at least not on this issue.

I was watching Tayo Oviosu’s TEDx Lagos talk again and I have to say, this is really one of those things that make you go hmmm. To think that if he had accurately appraised the challenges before setting out he may never have started Paga is beyond scary. Here’s a guy who’s out there executing on his vision and apparently succeeding at it yet he goes and says something like that. Is he maybe winding us up just a little bit? That’s always a possibility but he seemed genuine and sincere. Makes you think.

One thing that’s fairly certain is that even if there’s merely a thin line between bravery and stupidity, there’s one hell of a chasm between those two on the one hand, and conformity on the other. How else would you explain the reality that not everyone is working on a startup? At the very least you’d expect half the crazies in the world to be slaving away on their super idea for a startup. I guess this lack of abundant seed funding has its uses.

People have long suspected that entrepreneurs’ brains were wired differently and now there seems to be scientific proof. Findings from a study by Peter T.Bryant and Elena Ortiz-Terán show that entrepreneurs jump to action quicker than regular people. Additionally, unlike most people, they keep reviewing their actions long after they have made their move. That’s a much more plausible explanation for Tayo’s observations, wouldn’t you agree? Peter and Elena used a test based on the Stroop Effect to highlight these differences.

Here’s one [if it takes you 20 seconds or less to work through it, you’re definitely entrepreneur-material]:

Stroop Test

Name the shapes and their related colors in the 4 x 4 aligned boxes below as fast as you can. The words below the shapes are placed there to throw you off. Do not read them! For example, you might see the words “Blue Square” printed under a red triangles. In all cases you should say “red triangle” instead. Say the colors and shapes as fast as you can. It is not as easy as you might think…

Entrepreneurs are faced with situations where they cannot afford to wait to clear up all ambiguity before taking action. In some cases, even if they had all the time in the world, they still couldn’t clear up ALL ambiguity. As a consequence, entrepreneurs will frequently dive into a situation before fully analysing it. Do not mistake this for mental laziness. Entrepreneurs keep working on problems even after they have taken action; running, refining and re-running experiments with an open mind (as much as is possible) and using the feedback to course-correct.

Lean Startup has really helped codify a lot of that sort of thinking, urging entrepreneurs to conduct experiments around their main failure points and risks. The Lean Startup feedback loop can be approached in two ways, depending on your propensity for action, and tolerance of risk. Entrepreneurs are more likely to build first whereas regular people are more inclined to learn before building.

This “shoot first ask questions later” approach has its obvious shortcomings. To compensate, most entrepreneurs develop a set of heuristics which they diligently apply whenever they are presented with new opportunities. According to Peter and Elena, entrepreneurs ask the following questions, in no particular order:

• Does the opportunity fit my core strategy?
• Do I already know the market?
• Can I trust the other parties involved?
• What’s my gut saying?
• What’s the doomsday scenario if I fail?

An unsatisfactory answer to any of these questions is reason enough to pass on the opportunity.

If you’re conversant with the origin stories of a few one-time startups which have grown into successful corporate juggrnauts, you’ll notice how so many of them muddled their way through a process very much like the Lean Startup process. All this long before Eric Ries came along and helped the rest of us wrap our heads around the apparent alchemy of building a successful startup with as little waste as possible.

Successful entrepreneurs embrace ambiguous problems more quickly. They don’t try to do too much in one go so they don’t get in too deep a hole before realising what’s going on. They devote significant time and effort to resolving any lingering uncertainty during later stages of execution. It sounds simple, elegant, almost like common sense. Do not be deceived. This is the highest form of observation, risk-taking and execution the world has ever witnessed.
Yes, Boss! Entrepreneurs Are Different From the Rest of You was first published on StartupBlackBox

To Hit Your Goals, Get Help

How to make this partnership work:

1. Tell them your goals. Focus on 1-2 goals, and tell your partners why you think you cannot accomplish those goals on your own. What are your mental roadblocks or resource constraints? What’s holding you back? What do you need that only they can give you?
2. Ask for feedback in a specific area. There might be 1,001 things you need to work on, but knowing everything at once can overwhelm you. Have your partners set one or two priorities for you.
3. Have them catch you in the act. Sometimes when people give us feedback, we don’t get it. But if partners catch us doing something wrong, then it makes it clear what we’re doing wrong. I always prompt readers to tell me when my posts are too long winded, for example. Having concrete examples helps. So if you need help with a presentation, do a run-through for them or at least let them comment on a draft of your speech.
4. Check in regularly. Everyone gets busy, including our accountability partners. Set up a 15-20 minute check-in either once a week or bi-monthly. Use this time to review what is and isn’t working and why. If that’s not possible, then use a feedback form or email exchange.

Now I want to know, who held you accountable in 2014, and what goals were you able to accomplish? Do you have additional techniques you’d like to add to the list above? Let me know in the comments below.

Here are three ways to keep yourself motivated, regardless of the size of your company:

1. Remind yourself of your desire to achieve.

A successful entrepreneur’s number-one asset is perseverance. When I asked around to learn about what keeps entrepreneurs motivated, ambition and perseverance are two words that kept coming up. The need to achieve and succeed prevented them from giving up after every failure and fueled their drive more than any other factor.

If you find it challenging to maintain your morale in the long run, look around you and identify the people who make up your success team. Whether it’s an older mentor who keeps you in line with your goals, or a younger entrepreneur who inspires you and fuels your energy, surrounding yourself with business cheerleaders helps turn every setback into a lesson, not a disappointment.

2. Set realistic goals.

If you are running a startup and your goal is to make a million dollars this year, then you might be setting yourself up for disappointment. Instead, set several smaller, measurable milestones so that you can track your progress.

Related: 5 Reasons Heartbreak Is Good for Entrepreneurs

Create a big-picture strategy for your company, and set realistic business goals on how to achieve them. Everything from creating useful partnerships, networking, marketing, ramping up your social media, or even hiring good employees takes time. Establish a plan and be prepared to tackle it one day at a time.

When you achieve the smaller goals, pat yourself on the back.

3. Take care of yourself.

Yes, having your own business means you’re invested 24/7, but invested and overworked are two different things. There is nothing more daunting than spending your day alone in your home office. Make time to take care of yourself.

Business owner Sharon Middendorf says what keeps her motivated is “ambition, exercise and meditation. This inspires and guides me through the days.”

Set regular times during the week to unplug, hang out with family and friends, sign up for a gym, take walks, read or watch TV. If possible, take a vacation! This gives your brain time to rest, recalibrate and be ready to run a successful business.

5 Powerful Rules for Women Entrepreneurs to Live By

1. Quit seeking validation and embrace your crazy.

This is your business. It’s yours because no one else has had the vision you did to start it. Stop seeking validation before you launch a new product, program or idea. The most successful people are those who were once believed to be crazy.

2. Celebrate even the smallest of wins.

To maintain a go-getter attitude requires positive reinforcement. Have you worked up the courage to make that call you’ve been putting off? Finally gotten through that stack of paperwork? Kick up your heels and celebrate! That energy will carry you forward.

3. Get specific.

Now that you’re trusting your own instincts and celebrating along the way, challenge yourself to break down your vision into smaller chunks. With the freedom to do what you want during the day comes the increased need to stick to a plan. What do you want to achieve this month — and what do you need to do this week to reach your goals? As we know, writing your goals down significantly increases your chances of success.

4. Know that making money is like making broccoli.

A mentor once told me that making money is like making broccoli: You’re not afraid of using up the broccoli in your fridge, are you? You know you can always get more.

Similarly, if you’re committed to growing your business, you can’t be afraid to invest in your growth or do the things that excite you. Rather than worry about the money you’re spending, focus on making each investment worthwhile.

5. Decide to be grateful.

My dad used to say that no matter how good or bad you have it, there’s always someone who has it better than you and someone who has it worse than you. Comparison is the root of despair. Every day, we get to choose to be grateful for what we have, regardless of where we want to be.

“At the end of the day, I work for myself, and you can’t put a price tag on that,” Sherwood tells me. “I also can’t put a value on the lessons that I am teaching my children as they watch me build my company.”

Like anything worthwhile, being an entrepreneur isn’t easy. All of us, however, can be grateful for the opportunity to pursue meaningful work and build a life we love. What more could we ask for?

Startup 101: Finding the right business partner

If you have a good business idea, you may ask, do you really need a partner in the first place? Just like in dating and life, it all depends on your reasons.

The entrepreneurial path is stressful, expensive, and a little bit lonely. It’s only natural to want to team up with someone so you don’t have to shoulder everything alone. That may seem like a solid enough reason to seek out a co-founder, but is it really worth giving up half your equity and control?

Giving up equity may not seem like a big deal when you are just starting out, but if/when your business succeeds, you’ll discover just how much it really costs. Of course, without the right team and talent, your great idea may never get off the ground in the first place.

My advice is to do some soul-searching and think about why you’re looking for a partner. Is it just because you want someone to talk to every day or is there a true business need?

In most cases, the best reason to bring in a co-founder is to fill some major gaps in your own background and skills. In the tech world, the typical partnership formula is: one builds and one sells.

For example, you might have the idea and business skills to run a company, but no experience in hardware or software. Or, you’ve got deep technical skills but no clue on how to sell a product. In these cases, you’re looking for help either with building and running a business, or building and running the technology.

Beyond experience and skill set, the best partner is going to complement, if not challenge, your personality. If you’re detail oriented and run your life through a series of lists and spreadsheets, you’ll need some help with the big picture and vision.

Where to find Mr. or Ms. Right

Conventional wisdom advises against teaming up with family and friends, since money and control issues can wreak havoc on a relationship and you can end up losing both a business partner and a best friend at once. However, I launched my first business with my boyfriend. Twenty years later, we’re still together in business and marriage, so it can be done.

If you don’t already have a specific person in mind, you’ll need to start the hunt. It’s best to start with your own network: identify your needs and see if anyone comes to mind. If there’s no one in your first degree of connections, chat with a few well-connected friends and colleagues to see if they can make an intro.

To get beyond your current network, attend industry conferences and events to meet your right match. If you’re looking for a developer or engineer, look in a tech-savvy place like hackathons, startup weekends, or startup schools.

There are also plenty of matchmaking services and events specifically designed to bring together startup founders (like CofoundersLab, Startup Weekend, Founder2Be, and FounderDating to name a few).

Don’t get hitched right away

Once you have found the right person, you will want to spend some time getting to know each other before making anything official. While you can never really know someone until you have worked with them for several years, there are certain things you can do to predict the likelihood that you’ll be able to spend time and build a business together.

Startups are stressful, so ideally you’ll want to simulate this climate. For example try out the partnership at a startup weekend where there’s lots of intensity and decision-making. Meet each other’s friends, get together for mega planning sessions, even work on a small project first.

Through it all, don’t let the excitement of starting a business blind you to any red flags. You’ll want to consider how this person works, thinks, resolves conflicts, makes decisions, seeks input, and collaborates.

Hash it out up front

Entering into a business partnership should never be taken lightly. Try to have as many “hard conversations” as possible early on.

Many startups fail because the co-founders end up having completely divergent life goals and priorities.

Many startups fail because the co-founders end up having completely divergent life goals and priorities.For example, discuss when you want to start paying yourselves vs. investing in the company. How many hours should you put in during the average week? What are the specific roles and responsibilities? Is anyone keeping their “day” job and how will that fit into the startup picture? Who will be the public face of the company and take the lead at events?  What’s the dream exit? What happens if you get an acquisition offer, but one of you isn’t interested? How will big (and small) decisions get made?

Drawing up a legal document and seeking legal advice is also a great way to force yourself to deal with the sticky matters upfront and potentially avoid major conflicts down the road.

The search for a perfect co-founder isn’t easy. But when you are lucky enough to find the right match, the rewards can be great.

Get Help to Build A Business of Significance

Get  busy building your dreams or some one will employ you to build theirs .

Thinking of forming a Limited Liability Company? You are not alone. The LLC has grown in popularity as more and more entrepreneurs discover its benefits and flexibility. Sign up with me Coach RNC and learn what it takes to start and run your own business.

Americans love the idea of entrepreneurship, and small businesses are a major part of the U.S. economy. According to the Small Business Administration’s Office of Advocacy, in 2008 there were more than 29 million small businesses in the country, and half of all American workers were employed by small businesses. Every year, hundreds of thousands of Americans start a business doing something they love. Here are three important tips for starting your own business.

1. Plan Everything

Ask any small business owner about launching a business and he or she will tell you to plan as much as possible. Start by creating a business plan-it’s essential. In the business plan, you will need to outline your overall approach to starting a business, as well as information on your competitors and the business’s financial needs and expectations.

Will you be a corporation or LLC? Where will you get the money to launch and run your business? In addition to helping get the basics together for yourself, a business plan comes in handy when pitching your idea to potential investors.

Be sure to take some time and think about why you want to start a business. Are you willing to risk losing everything you own? While you gain a lot of freedom when you’re the boss, there is also the responsibility of building steady streams of revenue.

2. Lay the Groundwork

Once you have a solid business plan and the financial backing to support it, your work really begins. Everything-from the name and location of the business to the staffing needs and day-to-day processes-gets determined by you. The great thing about this is that you get to choose how you want to run things. The challenge, of course, is that you have your work cut out for you. Be sure to reach out to family and friends for assistance in getting your idea off the ground.

3. You’re the Boss

After you’ve laid down the groundwork and poured countless amounts of time, energy and money into your business, the next step is to start running things. It starts with a grand opening and, hopefully, flourishes throughout the years as a reward for your hard work. Challenges will be aplenty, but at the end of the day you’ll find satisfaction knowing you report only to yourself.

While the idea of starting a business is exciting, make sure you do your homework. According to the SBA, only about half of all new businesses survive five years. It’s good to be ambitious, but it’s important to be realistic as well.

March is National Start Your Business Month. Will this be the year you finally take the leap and realize your dreams of being your own boss?