Practise walking the plank

Investors will do better if they focus on the goal, rather than the risk

If I asked you to walk across a 10m long, 20cm wide plank that is 10cm above the ground, I’m sure you would have no trouble doing it. No one falls off at 10cm. Raise it to 1m and likely this will still be simple enough. Raise it to 2m and you’ll probably start feeling shaky. Raise it to 10m and you’ll probably say, “Thanks, but no thanks.”

This seems rational – it’s too risky, right? Or is it? The risk of falling hasn’t actually changed, only the consequences of falling. You’ve already proven that you can walk the plank at lower heights without falling, so why should the increased height make any difference?

The consequence of, and our fear of, failure has significantly increased. Most people when faced with this increased height focus on the consequence of failure rather than the goal. And as humans the more we focus on negative consequence, the more likely we are to realise that as our reality. No one falls off at 10cm, but most people would stumble or baulk at 10m, even though the task is the same and should carry no additional risk.

Anyone who was brought up on country roads knows that when you pass a big rig at night you never look at the oncoming headlights, you look at the black space next to the truck where the road is. This is because you are more likely to drift towards the thing you are focusing on. Focusing on the truck to avoid it increases the likelihood of having an accident. Focus on where you want to go, not what you want to avoid.

Back to the plank. Even if you did walk across it at a 10m height, a watching crowd may not give you great adulation for your efforts. If you want love (returns) from the crowd (market) for your effort (investment), you need to increase the risk.

No risk, no reward.

Say we decide to add something risky to our plank walk, like a back flip, where the consequence for failure is large at the 10m height (a sizeable investment). To do this for the first time at 10m is almost certain to end in tears.

So, the seasoned performer practises the risky manoeuvre on the ground until it comes as naturally as walking, then raises the consequence to 30cm, 1m and then, finally, 10m. This is where they will receive the greatest adulation, and many happy returns.

Know the difference between risk and consequence. Doing things with higher consequence but lower risk (such as putting most of your life savings into blue-chip shares) is unlikely to give you great short-term returns if that is your goal. Conversely, if you are crippled with the fear of losing everything, you are likely to panic at some point and become your own self-fulfilling prophecy.

But don’t forget that jumping straight into high-risk investments without any practice or experience is also a sure-fire way to devastate your finances. When you start, you may make some silly mistakes. This is okay. For most of us it is the only real way to learn. Practise with small investments first. Find a manoeuvre or industry that you understand and that works for you, then slowly raise the stakes.

Even the most experienced of plank walkers fails every now and then, which is where the safety net of a balanced portfolio is critical for those times when unexpected wind gusts blow you off balance.

People start businesses for myriad reasons. It could be that they are following a passion or wish to take control of their lifestyles and schedules. Perhaps there’s a level of demand for their products or services.

Also, unlike working for a boss, you are not dependent on others to either run the show or pay you for your efforts. At the same time, you have the flexibility to decide how much effort you’ll put into your business and, hopefully, how much you’ll earn.

Still, the primary contention many owners face is the size of the pay packet they can take out of the business.

Unfortunately, it appears many SME owners aren’t paying themselves enough, according to business coach Suz Chadwick. Through her research, Chadwick has discovered that around 45% of the small business owners fail to pay themselves enough – if anything at all.

She says the reasons owners aren’t paying themselves a decent wage varies from “I’m not earning enough to pay myself regularly” or “My client load changes, so I pay myself what I can.”

Others, according to Chadwick, fail to pay themselves because of fluctuating cash flow. Ironically, 74% of the owners she surveyed consider that they oversee profitable business – so go figure.

Business adviser Craig West, CEO of Succession Plus, says business owners often fail to pay themselves, either first or at all, for various reasons. “The most obvious is cash flow. When times are tough, they pay suppliers, rent and bills and then find there’s not enough money to pay themselves at the end of the month.

“Sometimes it’s tax-driven, where they need to pay themselves a low amount to stay under a certain tax threshold. And sometimes it’s simply a desire to reinvest in the business to help drive its growth.”

Anne Nalder, founder and CEO of the Small Business Association of Australia, says SME owners generally don’t pay themselves because they can’t afford it. “Also, some take drawings when money is available rather than reporting it as a wage.”

Small business is doing it particularly tough in lockdown locations, notes Nalder. “Owners are trying to survive and therefore struggling to pay themselves. Their fears are well-founded as there is uncertainty with little clarity.

“Australia is being run as eight separate countries. The fear is genuine and consists of health, including mental health issues, lack of incoming revenue, the possibility of losing their homes or failing to comply with regulation due to their business barely surviving.”

Impact on the value

Regardless of why SME owners may decide against taking a pay packet, this has severe consequences for the value of the business, warns West. “If you are not paying yourself a market salary, then a buyer will expect this money to be added back when they determine what your business is realistically worth. In many cases, businesses that look profitable but rely on the owner and often their family as free labour are not profitable at all.”

West says it is critical to treat the owner as an employee and separate ownership, or equity, from employment, or income.

“For example, when you do the monthly pay run, the owner should be included at a market salary, the same as every other employee. If this is not achievable, then something is fundamentally wrong with the business’s financial performance and needs its cash flow to be addressed first.”

Using accounting software and professional advice to predict and manage cash flow is also valuable, says West. “Xero, for example, has recently released a module to help businesses see their forward cash flow and hopefully avoid issues like not being able to pay the owner an income.”

The accounting platform’s short-term cash flow tool takes all the relevant data from your bank accounts, bills and invoices to give you an up-to-date view of your cash flow in one place. Using this data, Xero estimates your bank balance 30 days into the future. The tool can also show you the impact of existing bills and invoices if you pay them on time.

Using Xero’s tool, an SME owner can determine which invoices should be chased up and how cash flow changes if you pay a bill this week or postpone it for a period of time. This strategy might also help free some cash to make sure there’s money to cover your next pay packet.