Yesterday I started answering the question I am often asked "How much profit should I make from my business?" by looking at the issues surrounding profit expectations and I introduced you to the lower profit expectations trap in Business Owners & Managers - Profit Expectations.
Today I am going to consider how much an entrepreneur should earn from working in and owning a business.
Do You Unbderstand Your Role In the Business?
Business owners think they have a job.
Michael Gerber covers this issue extensively in his book, the E Myth Revisited when he revealed that too often entrepreneurs create a job for themselves working IN the business rather than focusing on creating a profitable business which can be sold by working ON the business.
Michael Gerber went further by splitting the business owner into three different roles, the technician (who does the work of the business), the manager (who manages other people doing the work) and the entrepreneur (who builds the business).
What Does An Entrepreneur Bring To A Business?
I have moved this section to a separate article.
Competitor Benchmarking - How Does Your Performance Compare?
Would you recognise that there are issues that you can and must deal with if you want to earn more?
The Principles Of Opportunity Cost and Alternative Cost
My views on how much you should earn from your business as the entrepreneur or business owner are based on the cost of opportunities and alternatives.
The opportunity cost of doing A is usually defined as the gain you have foregone from the next best alternative.
The alternative cost is the cost of providing the same product or service from a different source.
So how does this work?
Well if you are working 60 hours a week on your business but you could go out and get a job which would pay you £60k per year then if you follow the opportunity cost principle, you need to be thinking of your business generating more than £60k.
Even if you appreciate the fringe benefits of "being your own boss" you should start putting values on how much you are "prepared to pay.
Next is the alternative cost approach and the acceptance of the 80/20 rule. In virtually all situations 80% of the results come from 20% of the efforts.
Entrepreneurs should focus on what they are good at and do more of that and delegate/outsource the routine tasks that clutter up the day.
So if you are doing your own invoicing and book-keeping but it's taking 10 hours of those 60 hours per week you work then you have a choice.
You can spend about £8k per year and release those 10 hours, either to give you a better work life balance or reinvest them in your sales and marketing.
Or if you keep doing those 10 hours of book-keeping, you have to accept that you don't deserve to be paid any more than the £8k alternative cost.
These principles ripple through the other areas as well.
In the money section, you can use your own money, borrow from a bank or if the business is seen as too risky, raise it through a business angel. But these alternative sources give you an alternative cost to include in your own expectations.
You can hire a manager to build the business but you have to be prepared to pay for the right quality, you can hire a business coach and commit the personal time to develop your business building skills or you can accept that your business will be limited by your own management skills.
In essence you need to be setting the target of earnings based on:
- A return as an employee for the technical tasks that you haven't out sourced or delegated
- A return as a manager for the time spent managing your team and the business
- A return on the money invested and the risk you have taken based on what it would cost you to raise that finance elsewhere
- Your entrepreneurial premium or discount
And bounded by your own opportunity cost of what you can earn elsewhere.
The challenge then is whether you have a business which can meet these earnings targets, how you are going to improve the business so that it does and what you will do if the business is unlikely to meet the target.
It could be that you have to accept that your current business is wrong for you.
There Is No Substitute For Good Ideas
The true making of an entrepreneur and the element that is difficult to put a value on is the premium for seeing the good idea and having the courage to take advantage of the opportunity.
It doesn't take a great idea to build a reasonable business. There are many "me too" businesses that have little differentiation from their competitors but are just that little bit better in the important areas. A little better at building relationships and closing sales. A little bit more efficient. A little but ahead of the main market in anticipating new trends.
But it takes a great idea to build a great business. It is the ability to come up with ideas which create new areas of customer value and commit to their implementation which turns entrepreneurs into millionaires and billionaires
Everything else can be bought in but there is no substitute for the ideas. Tomorrow I will look at how you can find ideas to create a business that is differentiated.