I have analyzed hundreds of financial statements of businesses heading towards bankruptcy, and of businesses making low profits. Very soon a pattern emerged. I compiled my research and came up with two common Finance mistakes made in Business.
Let me again explain in layman’s terms. Let us suppose there is a person called Tom and he is walking up the street. Suddenly he sees $1000 lying on the street. Tom takes that $1000 and puts it in his pocket. That $1000 has not cost Tom anything.
Now let us suppose there is a person called Nick, and Nick needs $1000. He approaches Tom and asks if he could borrow $1000 dollars from him. He is ready to pay 10% interest on it. Tom knows that if he keeps the $1000 in his pocket, even after one year it will still be $1000. On the other hand if he accepts the offer of giving the $1000 at the rate of 10%, after one year he would have $1100. @11100 is $1000 plus 10% interest earned by it.
Let us suppose there is another person called Harry. Even Harry needs @1000. Now harry approaches nick and asks if he could borrow $1000 from him. He is ready to pay 5% interest. Do you think Nick would say yes? Definitely he will say no. Now Harry says that he was willing to pay 19% interest. Nick would definitely say No simply because it is costing him 10%. Nick may say yes if Harry offers to pay him 15 – 20% interest.
During my research, it was a very shocking observation made by me. Most of the businesses that were recording low profits or heading towards bankruptcy were actually giving the $1000 for less than 10%. Whenever I share this fact people will ask me – How can people be so stupid? It is not about stupidity but about IGNORANCE.
People are ignorant about how much they have borrowed and how much it is costing them. People are ignorant about numbers. They are mostly dependent on their book-keepers or accountants or other people like business partners in the organization. They completely ignore this aspect. That makes them take decisions based on Assumption. They will assume that they have borrowed $ 500 or $ 800, and may assume that it might be costing them 6% or 8%. Based on these assumptions they will take decisions, which is nothing but guess-work.
If the assumption proves to be right, they are lucky and will make profit. If not then they will be praying that six months later it will bring them some profit.