Owning or buying a business creates tax advantages that employees do not have, for operating costs can be deducted from pre-tax income, thus lowering the business’s taxable income.
Businesses can generate positive cash flow, be taken public with an IPO, or sold.
“The S-business owner owns a job, the B-business owner owns a system.”
B and I quadrant types face great risks and responsibilities. Not only their money and livelihoods but also other people’s are usually at stake. And starting or owning a business requires a strong mission, a good team, and leadership.
Types of businesses.
• Franchising. When a corporation sells a franchise, it typically grants the buyer the exclusive right to sell its goods or services in a specified area. In exchange for a fee and usually a share of the profits, the company or franchisor provides the buyer or franchisee with its product or service, the use of its name, a business system, and sometimes training as well as advertising and marketing services.
• Network marketing. Also called direct-distribution systems, network marketing companies provide the investor or distributor with proven business systems. As with a franchise, the distributor buys the rights to distribute an existing product line but for a much lower fee.
• Buying a business. Businesses are always coming on the market. For the investor who is financially literate, buying a pre-existing business that has positive cash flow, sound operating systems, and good name recognition can save the time and worry associated with starting a business from scratch.
• Starting a business. For those who have the drive and the start-up capital, or the connections to raise it, developing a business can be the ultimate investing experience. A business can take any number of forms offering different levels of investor/owner control and varying potential for gain. More than any other investment, starting a business requires an expert team of advisors.
How to analyze a business investment. To evaluate whether to buy, or buy into, a business, an investor must learn how to calculate the economic indicators below or hire an expert to do so, for they are windows into the financial strength or weakness of a firm. Even the investor who never makes it into the B quadrant can use these indicators to assess companies being considered for a portfolio of paper securities.
• Gross margin percentage. This indicates the percentage of sales left after deducting the cost of goods sold
gross margin percentage = | sales – cost of goods sold |
sales |
• Net operating margin percentage. This reflects the net profitability of a business before taxes and interest on debt are deducted. The higher the net operating margin, the stronger the company.
net operating margin percentage = | earnings before interest and taxes |
sales |
• Operating leverage. This tells whether a business has enough revenue to pay fixed costs.
operating leverage = | contribution |
fixed costs |
• Financial leverage. Together with operating leverage, this figure helps determine the total risk a company carries.
financial leverage = | total capital employed (debt + equity) |
shareholders’ equity |
• Total leverage. This is the company’s level of risk and indicates what effect a given change will have on equity owners.
total leverage = operating leverage x financial leverage
• Debt-to-equity ratio. This measures the portion of the business financed by outsiders and the portion financed by insiders.
debt-to-equity ratio = | total liabilities (outsiders) |
total equity (insiders) |
• Quick or current ratios. This indicates whether the company has enough liquid assets to pay its liabilities in the coming year.
quick ratio = | liquid assets |
current liabilities |
current ratio = | current assets |
current liabilities |
• Return on equity. Perhaps the most important ratio, this indicates the return a company is making on a shareholder’s investment.
return on equity = | net income |
average shareholder’s equity |
“Business is a team sport.”
The more you know, and the more advice you receive from your advisors, the better prepared you will be for making an investment decision.
“Disability and death have sent more than one business and financial empire crashing down. Insurance buffers the fall.”
INVESTOR SAFETY NETS
• Health. In this country, medical bills are the leading cause of personal bankruptcy. No one can anticipate a major illness or surgery, yet the wise investor plans for it.
• Disability. This replaces wages lost when someone becomes too disabled to work. Anyone who relies on earned income to meet expenses should have coverage of at least 60 to 70 percent of monthly pay. Unlike workman’s compensation, disability insurance covers a person on and off the job.
• Life. Term is bought for a set period, from one to thirty years, and renewed periodically. It is the most affordable insurance for those starting out, yet it has no cash value and premiums increase at the end of each term, so it can get costly. Whole-life insurance charges a fixed premium for guaranteed lifetime protection and a death benefit. It builds cash value, which the insured can borrow against, and usually pays dividends, which are used to pay premiums or buy extra insurance. Variable universal life is part life insurance, part investment vehicle. If premiums are too low and investments do poorly, the death benefit may be reduced.
THE CHOICE IS YOURS
Whether you invest to be secure, comfortable, or rich, you should have a plan. Financial literacy is vitally important in the information age, a time of lightning-quick change, fewer guarantees, and more opportunities.
“There are two kinds of money problems, not enough money and too much money. Which one do you want?”
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