Why entrepreneurs should drive old cars

About 10 years ago a friend of mine was starting a new training company. He called me in January asked me to come on a 1-day course on goal-setting the next week, for free; all he wanted was to get some feedback and to actually start his business. I had some free time and promised to attend; a course on goal setting sounded useful too.

The following Wednesday I arrived at the venue, a little early as I’d over-estimated traffic. As I sat there in my car the other attendees started to arrive. A new BMW pulled in, followed by a new Golf GTi and then a Mercedes. All new. More arrived, more very well dressed people with designer sunglasses and the latest mobile phones in new shiny cars. My first thought was that my friend had managed to attract some very successful people to his course: after all, everyone was giving up a full day of productive mid-week time to help a friend, and judging by the cars these were all people who were clearly already well-off. I hoped I could learn something from them.

The course duly began and we spent a very useful day unpacking our ambitions and making them into a single tangible, but stretch goal. At the end of the day we were asked to share our goal with the rest of the class. Here’s the surprise: for over 80% of the class, their single biggest goal was to ‘get out of debt within 5 years’. One guy even cried openly as he realised that he might be able to do this. I was astounded: all these well-dressed, well-bespectacled people in these bling flashy cars were drowning in debt. The worst part – in not one of their ‘plans to achieve’ there goals did any of them mention getting rid of the new car and buying a second hand model. No one mentioned cutting back on his or her addictive lifestyles. Every hope depended on earning more to clear debt. I’m pretty sure they’re still out there now, looking good, driving new cars, drowning in debt and making the auto-dealers and banks very wealthy indeed.

I’ll contrast that quickly with a man I know who voluntarily retired 10 years early (how many people ever really achieve that with financial independence?). This same man never bought bling, he never spent lavishly and he paid off debt while friends (who are still working now) took overseas holidays. When he retired he took over the company car he had driven for 5 years and has driven it for the next 20 years. He remarked to me last week that it’s time to sell the car, which he’s now driven for over 400 thousand km and had for a third of his life. That man is my father. He worked hard to earn money, and he worked hard not to spend it on lifestyle when he was young. He got to retire early and enjoy his retirement.

You can choose to spend money on bling or you can choose to scrimp and save now. Compound interest (a regular theme on this column) will make those choices not seem very different initially, but they make a huge difference in the long-term.

So back to cars: a friend who sells businesses told me that the best businesses he sees are run by people who drive old cars. It’s the first test he has when he visits a prospective customer. He knows that when people spend on their own egos then they’re stripping cash out of the business that could be used instead to accelerate its growth. He knows that when people buy new cars they immediately lose 20% of value in depreciation. He knows that cars are tools – they get us from A to B in comfort and safety but they carry on-going maintenance costs. They carry finance costs, or opportunity costs if you pay in cash. When you sell your old car and buy a new one the value is much higher so insurance costs jump too. The smell of new leather and shine of new paint makes you feel good, no doubt, but how many clients ever see what car you drive?

The right time to buy a new car is never, but if you really can’t resist then at least be aware of the trade-offs you are making. Would you rather spend the money on a depreciating asset or invest it in a well thought-out marketing campaign which has a 200% ROI? Would you rather drive a nice new car now, or bootstrap for a while longer and drive a really nice super car in 5 years time? You can buy the bling and look good now, probably attracting friends and lovers who demand that you maintain that lifestyle and will keep you in that trap until you die. Or, like my father, will you be sad to sell a car you’ve driven for 25 years yet have retired 10 years before your peers? Are you an ideal bank customer or are you an entrepreneur striving every day to build something more impactful and more valuable?

Accountants for entrepreneurs

Entrepreneurship can be a very lonely and harrowing journey – the best entrepreneurs know when to reach out for help and there are few who can help more towards your success than your accountant. Not only do they help you understand the financial side of your business and comply with the regulatory environment, but since entrepreneurs are typically advised by the smaller accounting firms, you accountant is an entrepreneur too and is far more likely to be able to give general business advice than pure accounting-related work.

In this article we take a look at the role of the Accountant in your success and how this industry is organised.

Some background: A Chartered Accountant, or CA (in the USA they are know as Certified Public Accountants) is a highly-qualified individual who has typically studied accounting for 4 years, then written the board exam and done 2 years of practical apprenticeship before being recognised by the association. The CA (SA) qualification is awarded by SAICA, who oversee the quality of the profession at large.

I interviewed Bridgitte Kriel CA(SA) who heads up SAICA’s Small and Medium Practise (SMP) division whose aim is to promote the interests of SMPs and Small and Medium Enterprises within the SAICA strategy. It’s the SMP accountants who deal mostly with entrepreneurs.

What is SAICA? What role does it play and where do you fit in? 

The South African Institute of Chartered Accountants (SAICA), South Africa’s pre-eminent accountancy body, is widely recognised as one of the world’s leading accounting institutes. The Institute provides a wide range of support services to more than 35 000 members who are Chartered Accountants [CAs(SA)] and hold positions as CEOs, MDs, board directors, business owners, chief financial officers, auditors, business advisors and leaders in their spheres of business operation. Most of these members operate in commerce and industry, and play a significant role in the nation’s highly dynamic business sector and economic development.

What size of accounting firm services entrepreneurs?

This can vary greatly from the one man firm to the big corporate practise, however majority of entrepreneurs or small businesses are serviced by the SMP, which includes sole practitioners to a 2 – 5 partner firms. They normally offer a wide range of services and strive to be a “one stop shop” for the small business.

So these Accountants are really entrepreneurs too?

Many SMPs have started their own practise, or gone into practise through similar motivations to those that are experienced by the small business owner/entrepreneur. This also often gives them the edge when servicing entrepreneurs and small business as they not only advise from their wealth of knowledge but can draw on their experience as well, as we all know that the life of an entrepreneur is not an easy one, and thus having an advisor who understands, and has been through the experience and has triumphed, can add a lot of value to any business.

As many entrepreneurs are born through identifying a need, so are SMPs. Many CAs(SA) start their own practises after identifying a need or a specific market segment that requires the use of their specific and specialist skill set.

What are the main issues facing the SMP accountants?

The main challenge facing the SMPs is the pace of regulatory change and this is not uncommon as it is cited as the number one challenge facing accountants worldwide. More recently, the change required to the SMP’s business model due to the new Companies Act requirements regarding audits has posed one of the bigger challenges and opportunities facing the firms. As a result of these changes, many SMPs are refocusing their marketing and sales strategy to service their clientele better.

What impact have the changes to the Companies Act had on the SMP accountants?

The Companies Act brought about change in the requirement of companies to have an audit. Smaller companies now often have a choice as to whether they wish to have an audit, an independent review or only a compilation. This has resulted in a broadening of services provided by the SMP to the SME. However we have found that the majority of SMEs have stuck to the audit, and this is often due to it carrying more weight than independent reviews or compilations.

Are the SMP accountants coping with the transition towards becoming business advisors?

SMPs have always played the role of business advisors but have in the past rolled this into one product as part and parcel of the audit or bookkeeping. As such, this is not a new area of expertise but rather that the challenge has been for the SMPs to re-package their product and to expand the offering of the business advisor services to be able to stand alone as an attractive value offering which businesses are willing to invest in.

What data can you provide that shows the importance of a CA to the entrepreneur?

We have conducted research amongst five big banks and three SME specialist lenders. Some of the stats and comments from the research:

  • Funders agree that financials endorsed by CAs(SA) are more trustworthy for funders than financials produced by companies themselves or by other independent accountants (8.4/10 for total sample, 10/10 for specialist SME lenders)
  • Funders agree that one of the greatest challenges facing small businesses is governance. They agree that the SMP could fill a governance and “non-executive” director’s role for their clients. They indicate that business owners who do this are more fundable
  • Funders agree that SMP CAs(SA) could position themselves as a channel to funders for businesses wishing to fund acquisition, gearing, growth or even exit strategies. Funders all believe that these applications need audits as opposed to reviews or management accounts to support them.
  • Funders agree that even if SMEs opt for reviews, there is good reason for clients to stay with CA(SA) SMP practices. Reviews can be more easily and cheaply upgraded to audits if the provider of the review is a CA(SA). The audit will inevitably be needed when gearing or exit is to be contemplated

Who else operates in this space? (Advising entrepreneurs) 

There are a number of accounting bodies within South Africa, however Entrepreneurs should ensure that their service provider belongs to a body that requires Continuous Professional Education from their members and has a code of conduct which members need to adhere to, as many small businesses have been caught by unscrupulous persons claiming to be accountants, who have cost business in the long run.

How much do accountants typically charge clients for bookkeeping, audit, other work? 

This is a difficult question, as each fee is determined based on size of the company, the state of the companies own record keeping and the work and output required. This is something that needs to be negotiated on a case by case basis. It would also stand to reason that bookkeeping services would be a lower hourly rate than an audit or certain advisory fees due to the level of expertise involved.

How do you suggest an entrepreneur best finds the right accountant for them? Is this word of mouth, or are there directories, reviews etc?

Referrals are one of the best ways to find an accountant which best services the needs of the business, however there is a directory for SMEs and entrepreneurs to use to find a CA(SA) who operates in their area www.findacasa.co.za

What impact is the rise of cloud accounting (Quicken, Freshbooks, Xero and locally Sage/Pastel) having on the SMP accountants?

The role of the software, has provided accountants with choice. The software and tools at the accountants’ disposal assist them to service clients better by producing accurate and quality information in the shortest possible time. Some businesses may look to providing this function themselves rather than using their accountant for this, but then should look to their accountant for assisting with interpretation of the data and advising them on the opportunities, challenges and risks being highlighted by the said data.

SAICA are doing some innovative stuff with SEFA and SEDA. Can you explain how these projects work, how they’re priced, and what plans are for their future?

SAICA, in partnership with the Economic Development Department, Guarantee Trust, and SEFA, has formed an enterprise development and SME support hub called Enterprisation. This hub seeks to service two main objectives, namely, up skilling unemployed graduates and providing back office support to black entrepreneurs and small businesses. Enterprisation can assist a small business in formalising their back office function in their start-up phase.

This initiative hopes to achieve a domino effect whereby the black entrepreneurs and small businesses are able to provide further employment of individuals within the many differing markets that they operate.  This can only be possible if the SME market in South Africa receives the back-office support that it requires in order for these small businesses to be educated in the day-to-day accounting and reporting requirements that they need in order to become sustainable operations themselves. As these small businesses grow and become sustainable, we hope that they will migrate into the SMP market once they are operationally mature enough to do so.

Are the issues the smaller accountants are facing in South Africa the same as elsewhere in the world? 

Yes, Quarterly there is a survey done by the International Federation of Accountants (IFAC), and consistently the results of the top 5 challenges worldwide reflect those of the South African environment, only the order of priority may vary within the top 5.

What excites you about accounting? and about working with the SMP accountants in general?

Its more than just accounting! It is being able to advise the “Youth” of the business world in their infancy and growing phase, ensuring that they have strong foundations on which to build a sturdy and successful business.

Many times the world of an entrepreneur or business owner can be a lonely place, there is satisfaction in being there to offer a helping hand and see the success of your advice and efforts.

Updates on previous posts

In previous articles we’ve discussed Tesla’s innovative use of financing to help sell its products, and also how Apple have managed to pay an effective tax rate of under 1% on their foreign earnings, both of which are updated below.

Apple goes to congress & the scale of tax minimisation schemes amongst big tech companies:

A few weeks back I described Apple’s use of an innovative corporate structure that allows it to pay very little tax on offshore earnings, as long as the profits aren’t repatriated to the USA. The structure they use to achieve this is a called a ‘Double Irish with a Dutch Sandwich’ which refers to the use of 2 Irish companies and a Dutch offshore company to minimise taxes on foreign and EU earnings. Calculations show that Apple are paying an effective tax rate of <2% on their offshore earnings.

What’s emerged recently is that they’re not the only ones taking advantages of these loopholes. The list of companies that have more than $5B (i.e. ZAR 50,000,000,000) or more kept ‘offshore’ includes Apple, Microsoft, General Electric, Cisco, Google, Oracle, J&J, Pfizer, Amgen, Qualcomm, Coca-Cola, Wal-Mart and many others.

What’s most interesting to me is that these companies typically hold 80-90% of their cash reserves offshore.

If you think about it, what’s really happening here is a power-law in capitalism: the big global companies can afford to invest in such structures. This means that they get to pay far less tax and retain far more earnings than those that don’t. This means they can invest more and grow far faster. With strong balance sheets they can borrow more and pay less for their debt, so they can grow even faster. It’s probably unfair not so much because they avoid taxes, but because by doing so they have such a competitive advantage: it’s easier for them to outspend or simply crush smaller companies that may emerge.

My guess is that congress tolerates this because although these companies pay less tax, the same system has allowed these big American firms to dominate their respective global markets. Congress has probably figured out that removing these loopholes would get them a larger share of a much smaller pie…

Tesla’s battery economics get questioned:

A core concept in strategy consulting is the experience curve. While I’ll get to cover the full workings in a forthcoming article, the core concept is that costs of producing units (or more or less anything) come down as the cumulative number of units produced by the industry goes up. Note: defining the units against which ‘experience’ accumulates is the tricky part. In some industries learning is slow and the prices fall slowly. In other industries the slope of the curve is steep. Competition tends to accelerate the fall in costs. As long as your selling price is above the cost then you’re probably ok. With some analysis, these cost curves become predictable and this allows brave companies to price now based on where costs will be in future. They do this often to win market share that allows them to learn faster than competitors and drive their costs down faster than the industry. For example, when Amazon launched its S3 service (whereby anyone could store data on Amazon’s infrastructure), they priced at a rate many believe was below their actual costs at the time.

Something just like this is going on in the Electric car industry, where Toyota, Nissan and Tesla seem to make all the headlines. Its important to note that Toyota and Nissan have sold far more of the Prius or the Leaf than Tesla – they are much further down the curve (and these 3 companies are further down the curve than the rest of the industry combined).

Tesla shares have done well lately. So it’s worth noting that while Tesla has a stated aim to slash the cost of their cars by half by 2016, the core cost of these cars is their battery. If you think about, electric cars differ from petrol cars only really in their motor and their fuel source. Electric motors have been around for years and are unlikely to suddenly get more efficient. Batteries are the single place where technologies have to advance to make the cars more affordable and more useful – their limited range is the biggest issue at the moment.  The problem for Tesla is that few experts believe the cost of the battery will drop by more than 30% in this time. So Elon Musk needs to take care that his cost curve (which falls at only 30%) doesn’t end up higher than his price curve (which he wants to fall at 50%). The bottom line is that savvy analysts are urging caution about the bet on falling battery prices that Tesla shares represent…

Very long-term interest rates

At Finweek and ValuationUp.com were big fans of compound interest. It’s quite simply the most powerful concept to understand in finance and underpins everything from the interest on debt to valuation. So it’s interesting to see just how old and universal this concept is: it turns out that the idea that loans can be made, and periodic interest payments can be accrue on those loans has been with us since we took the first steps to becoming agricultural.

A move to an agricultural society implies property rights: if you are to invest in preparing soil by clearing forests, removing rocks, digging up the earth, planting seeds and then caring for your crop you need to know that it will be yours to reap when its ready. Agriculture has always required large capital investment, but the returns can literally accrue for several generations, if not centuries. What’s interesting is that seed is a form of currency. Say you take 100 seeds, plant and care for them. If all goes well you should have 100 plants that each produce 100 of their own seed. So within a season you could take 100 seeds and make that 10,000. Now if you’re a farmer starting out you need seed. So very early on, there’s proof that people were buying seed and paying back out of future ‘capital’ growth. Animals were also loaned in a similar way – with payback in terms of a share of progeny. Investing seed or animal capital to share in the growth of the pool (the gene pool, if you think about it), is what we do today, just money was invented in-between. The invention of money meant that you could lend someone seed and be paid back in Silver, which could then be exchanged for something else. There is evidence that around 3000BC Interest rates in Sumeria were about 20% on these deals.

Compound interest was viewed as being morally suspect for a long time, and was derided as usury. This in part driven by a speculative credit boom that coincided with Silver mines in German and the Christian invasion of Islamic Spain. The ‘shaming’ of compound interest forced capital providers to invest in such a way that they could make a collective profit from what people did with their money…and so the venture capital business was born. It as no longer a sin to profit from the money one lent to an agent. However people who made a lot of money this way still felt guilty – its been suggested that wealth which 14th century banks accumulated in Italy lead so the banks owners investing in philanthropy as a way to ‘give back’. This investment allowed the Italian renaissance and pulled Europe out of the dark ages.

Religion has never been far from money and although ‘taking from the poor’ via interest wasn’t initially popular, the rise of Protestantism and its associated work ethic lead to increased tolerances from religious leaders that in turn allowed the middle class to accumulate capital. The Calvinists saw business as something you could pursue while caring for morals at the same time. Thus it was in the 16th century that compound interest became mainstream and acceptable again. In 1545 England passed laws allowing annual interest rates of up to 10%. Rather like taxing prostitution or drug trades this legitimised and regulated the trade that until then had been the domain of loan sharks (the micro-lenders of their time). Bear in mind though, that at this time if you wanted the farm land someone else had invested their life into getting ready, it was quite possible that you’d just fight them for it, so capital was still at risk.

In 1613 Richard Witt published ‘Arithmetical Questions’ – a landmark book that included tables of compound interest and formula for their practical application in merchants and traders. The book laid the framework for the English banking system, which remains fairly central to global financial trade.

The other side of the coin is that Karl Marx viewed compound interest as an evil force that allowed capitalists to have far more control than their proportional share of the assets they actually owned. It would be hard to argue against this today, even though communism clearly hasn’t been the answer to the problem.

Compound interest remains at the heart of the financial system. If you eat food its production has been financed by compound interest. It’s the same with your house, car, education and most likely the business where you earn your living. Interest rates vary widely – our systems are far more complex now and we also have a far more granular understanding of risk. Capitalism remains the dominant economic model and that is entirely due to compound interest. My guess is things will stay in the 10%-20% for a long time to come…