Wednesday 26 December 2012

Are You Creating Wealth From Your Business?


Monday 15 March, 2010
This article looks at the reality in assessing whether you are merely earning an income or actually creating wealth for the future.
After you have been in business for a number of years and have gone beyond the survival stage you hit the next point in the evolution of your business journey. Your strategy and actions at this point generally fall into two basic categories.
The vast majority of businesses fall into the majority that just keep on doing the doing with little change. Sure you've got a business that earns you a living and you live year to year being able to pay for your lifestyle, taxes and the mortgage with life going on. You don't grow much, there's not alot of change and you don't seem to create excess earnings to invest.
The second group of business owners make up a small majority. They not only pay for their lifestyle, taxes and mortgage but do something pivotally different. They do have a wealth creation strategy, they do create excess earnings from which they can invest and they do take action.
It is the second group of business owners that you want to join and which is the focus of this article.

The business is in the cash flow

  • The basics

    The hard facts are that you have to have sufficient income beyond your living expenses to actually save for investment. Start ups have to get past the survival stage. Beyond that, you must earn sufficient earnings to fund your living, mortgage and lifestyle. It's only when you exceed this critical point that excess funds become available that you can actually save.
  • Growth

    It is only through growing your business from inception that allows you to enter the investment arena. The sad truth is that the vast majority of small businesses only provide owners with a living. Money in, money out with nothing left to show after years of operating a business. Don't be one of these businesses that fails to create wealth for your future. We're all going to live longer (so we are told!), so how are you going to fund living the lifestyle you want to live in your later years?
  • The discipline of provisions

    One of the best lessons to learn in business life is the importance of provisions. The ability to allocate each month a provision for tax, GST and savings is a critical skill of wealth creation. Try establishing a separate interest bearing bank account for this sole purpose, with monthly transfers from your business bank account.
  • Budgets and goals

    Remember the need to have future budgets and goals and measure actual performance against these. This discipline is critical in setting up your finances for wealth creation activities.
  • Quarantining savings

    A classic strategy for saving is to 'pay yourself first', which focuses on quarantining a fixed percentage of your profits each month for investment.
  • Research

    Research, whether done independently by you or outsourced to a specialist provider, is critical in the investment process. Assess your skill sets to determine the level of expertise required in considering business investment, share market investment or property investment. This is one area not to go light on.
  • Understanding your investment profile

    In assessing your investment profile, mark yourself on a scale of 1 to 10 in relation to risk. If you are extremely conservative and risk worries you constantly, you may be a 2 or 3. If you relish the thrill of high risk investment activities you may rate yourself a 9 or 10. In any case, you must understand how you deal with risk and what sort of investment profile will sit best with you. Some business people only want to invest in businesses. Others love to own or develop property, some have a passion for the share market. Many business owners like a combination of all. In any case, think deeply about your make up and which asset classes make sense to you, interest you and won't cause you to lose sleep at night.
     
  • Taking action on investment

    Everyone will have heard of the the phrase 'time in the market'. If you never take action you'll never own assets long enough to appreciate the medium to long term growth investment assets return. To create wealth you must take action to start the multiplying effect of compound returns.

Shares

  • Savings levels required

    One of the advantages of shares is that you can buy them at periodic intervals in small parcels from your savings. Unlike property, you don't have to spend up to 20% of the purchase price of a property before entering the market.
  • Entry costs

    If you choose to use a stock broker to buy your shares you'll generally pay a small commission based on the dollar value of the share parcel bought. If you choose to buy shares through an online broker (over the internet), you can pay as little as $20-$30 brokerage per transaction. Entry costs are significantly lower than property.
  • Borrowing

    There are numerous traditional borrowing opportunities available to buy shares. A specific loan product available for borrowing to buy shares is a margin loan facility where the financier holds security over your shares. Margin loans need to be assessed against your risk profile so research here is critical.
  • Debt servicing

    Any borrowing for share acquisition will result in interest being charged on the funds borrowed. You need to consider your ability to service this debt on any borrowings taken out to acquire shares.
  • Maintenance costs / issues

    Other than any interest payable on borrowing for share acquisition there are not really any other costs associated with maintaining a direct investment share portfolio independently. If you use a stock broker to manager your funds or a managed fund (or similar pooled fund type investment) you most likely will be charged a percentage of your share portfolio value as a management fee. Review and understand these charges before investing.
  • Capital growth

    In considering capital growth, try and be realistic focusing on the medium to long-term return of top quality stocks. Stay away from volatile stocks with little or poor earnings history. Leading established market performers in the top 20 / 200 are a good place to start on your research.
  • Dividends

    Dividends are often poorly understood by novice investors. Many of the top performers on the Australian share market pay dividends of 3-5%. Not only that, but many of the market leaders pay a fully franked dividend. That means the company tax they've paid on earnings is effectively 'credited' to you resulting in you paying little or no tax (depending on your marginal tax rate) on the dividend income. This results in the grossed up dividend creating an even greater yield in your hands.
  • Liquidity

    It's important to trade in stocks that have reasonable trading volumes that are traded each day. Again, the leading stocks have adequate liquidity. Subject to the share having adequate liquidity, your shares can be sold on any trading day at market price.
  • Diversification

    Diversification is critical in stock market investment. Each stock is a member of an industry sector. By investing in a number of stocks in different industry sectors you effectively diversify your risk. Understanding diversification to mitigate risk is a required part of your research considerations.
  • Volatility

    For most busy business owners it is a good idea to consider volatility in choosing stocks. If you're not going to be in front of a computer screen all day you most likely don't want to trade in a stock that can fall or rise by double digit percentages in any given trading day. This is linked to your risk profile and research.
  • Exit Costs

    Exit costs are similar to entry costs for direct share investment carried out by a stock broker or online broker. If investing in managed funds or similar pooled products read the fine print on exit fees as part of your research before investing. Also consider your exit costs with your accountant in relation to any capital gains tax that may be payable in respect a sales of your shares.

Property

  • Savings levels required

    Savings levels required are generally alot higher for property investment. If you were to by a $500,000 investment property and wished to borrow 80% it would require a $100,000 deposit from you (20% of $500K).
  • Entry costs

    In addition to the deposit required, stamp duties and transaction costs will typically cost approximately 5% of the purchase cost. So using our $500,000 investment property example, this would equate to approximately $25,000 (5% of $500K). Therefore, you could require approximately $125,000 ($100K deposit + $25K duties/charges) in personal funds to acquire a $500K rental property.
  • Buying a property

    There are a number of ways to buy a property including auction, private sale and off the plan. Auction and private sales are typically purchases from a real estate agent acting on behalf of the vendor. Off the plan sales are typically made by acquiring from a developer. Remember that these parties are not acting for you.
  • Borrowing

    Typically borrowing for a real estate purchase is made from a major bank, equity in your existing real estate or through cash savings.
  • Debt servicing

    Any borrowing for property acquisition will result in interest being charged on the funds borrowed. You need to consider your ability to service this debt on any borrowings taken out to acquire property.
  • Maintenance costs / issues

    Maintenance costs for an investment property can include property management provided by a real estate agent (circa 7% of rent) if you choose to outsource this, repairs and maintenance, rates and other owner related charges in respect of the property.
  • Capital growth

    Capital growth can vary depending on the location, nature of the property and occupancy rates. A good quality rental property which is highly sought after can generally enjoy good long term capital growth.
  • Rental income

    Rental income depends on many factors including location, nature of the property, occupancy rates, state of the economy and the ability to have consistency in occupied tenancy.
  • Liquidity

    Liquidity in relation to property investment is subject to your ability to sell the property at a market price that satisfies your expectations.
  • Exit costs

    Typically the exit costs will include real estate agents fees in the event that you appoint an agent to sell your property. Agents commissions are typically 1.5-2% of the sale price so using our example of a $500K property a 2% agents commission would be $10,000. In addition the vendor typically incurs advertising / auction fees that can run into thousands of dollars. 

Source:ceoonline.com

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