The One Man Corporation - Part 2
Expanding the Business
Last time we showed how we could take a simple business, and use it to start making money.
We also saw how even though we were getting cash into our accounts, we were still losing money overall due to non-cash charges related to depreciation and amortization.
Today we’re going to see how the company progresses in the next few months, what we can do to make it profitable, and what needs to be done to turn this startup into a sustainable business.
The problem that we saw last week was that even though we had positive Free Cash flow, that is, we had more cash in the bank at the end of the month than at the beginning of the month, when we accounted for non-cash costs we were actually losing money.
Let’s have a look at what happens in the next couple of months
Each month we are selling more and more logs, and since the depreciation remains the same, while the amount of income coming in is increasing, we go from losing money, to making money.
This is normal for a new business, we’re just getting started and getting clients and improving the efficiency of our sales and wood chopping results in greater profits.
That said, while it’s interesting to have a look at the income on a month to month basis, it’s also a lot of numbers.
Let’s group up all this into just 2 tables, one showing the balance sheet at the beginning of the first month, and one at the end of the 6 months.
Now this looks simpler!
What happened here?
Well the goods sold were turned, first into Accounts Receivable, and then into Cash and Cash Equivalents. That cash was then used to pay off the Outstanding Land Payment (the second half of the Tree Rights), and the ongoing personnel costs.
Right now we have $150 in the bank, $200 on their way from clients, and we still need to pay $100 to our employee for last months wages.
Overall in these 6 months we made a slight loss of $70, however like we saw before as long as we can turnover $180 worth of logs every month we should be profitable, and we have done that for the past 2 months.
Ending the Year
If we follow this through, assuming that we stabilize our revenue at $200 per month for the next 6 months, we get the following:
Overall the numbers look OK.
We started the year with $1000 in equity in the business, and now have $1010 worth of equity in it.
All of those gains are shown in the balance sheet in the “Retained Earnings” section. We can see that we started with zero, went negative 6 months in, but managed to bring that back up to a positive number by year end thanks to our increased profitability.
In total our yearly per share earnings were only 10 cents, however if we annualize the last 6 months we would have made $1.60 per share, for a total earnings of $160.
That’s a profit margin of around 6% (and without paying taxes!) which is quite low, but you’re sure that you’ll be able to bring that up further as you gain more clients, and improve your processes.
So now you have to decide what you’re going to do with the 10 cents per share you made throughout the year.
You have a few options here, you can buy back shares, you can issue a dividend, or finally you can keep it in the company and reinvest it back into the business.
In this case, let’s just keep it in the company so that we can re-invest in it.
Expanding the Company
The company is profitable as is, but for a business like ours there are things we can do to increase its profitability.
And if we can make more money, why shouldn’t we?
The first thing we need to come up with, is a clear idea of what we need to do to increase our earnings. Remember, you’re hired on by this company (that you happen to own) to be not just its wood chopper and salesman, but also its CEO.
It’s your job to see where the company is lacking, and figure out what you can do to improve its business so that its shareholders are happy and profitable.
One thing you noticed is that your current method of walking around town carrying a load of wood to sell door to door is very time consuming and not very efficient at all.
If you think about it, if you were to have a bicycle with a trailer, not only would you be able to carry along more wood with you while you’re out selling it (letting you sell more), but it would also be a lot easier and faster to travel around town. Who knows, it might even allow you to go across town to find clients that would otherwise be too far for you to sell to!
The good news is that you now have a clear idea as to what you need to do to make the company more profitable.
The bad news is that the bicycle and trailer you need to do it is expensive, a whole $1600!
Now you may have $750 in the bank, and an additional $200 coming in, but not only is that not enough, you also have other expenses to pay! If you use all of that up you’re not going to be able to buy the Tree Rights you need!
What you need to do is to raise capital, that is, you need to get some cash in your companies bank account, so that you can afford to buy the Bicycle and Trailer, while still having enough to spare to buy the Tree Rights and pay your employees.
There are 3 ways companies raise capital:
They can work for it
They can borrow it
They can sell equity
Working for it simply means the company bites the bullet and waits a few years until its accumulated earnings are enough to buy the bicycle outright. This is possible, but given that we are making $160 a year, it would take 10 years to do it… Too slow.
Borrowing it can be done in a number of ways, but essentially what it means is you find a lender and “rent” that cash for some time, paying interest while doing it. Once the time is up you return the cash.
Unfortunately your company is very new, and the rates of interest you’d have to pay would be quite high.
What your one man corporation is going to do, is go with the third option, selling equity.
Selling equity is the same as the company selling part of itself in return for some cash. This is a common occurrence, and can be both good an bad.
In this case, it’s good because it will allow the company to buy the bicycle and trailer which will improve its earnings… And its bad because the existing shareholders (you) will have to share the earnings with new partners.
These new partners don’t have to take an active role in the business, in fact you’d rather they didn’t. But there does need to be something in it for them, otherwise why would they do it?
You decide that you’re going to begin paying a dividend next year, this way your future partners will get some return on their investment (and so will you).
So you prepare your presentation, your business plan, and your future plans, and you go to your friend and pitch him your company.
The corporation offers to issue and sell him 30 shares for $53.33 each. This would raise the $1600 cash you need, and make him the owner of around 23% of the company.
$53.33 is a steep price for these shares (a whopping 533 PE, with a forward PE of 33!), but your friend has bought wood from you, and knows it is good quality.
He also knows you’re honest and hard working, and he was convinced by your plan to raise earnings.
He’s not too sure about the need for the dividend, but he’d be happy to get it as well, or better yet, to have his shares bought back by the company in the future at a good price.
He accepts, and your One Man Corporation has grown up and is now a Two Man Corporation!
The Second Year
Let’s see how the year went:
Not too bad!
The bicycle let us sell twice as many logs, and we even managed to increase the price we sold them for! This was enough to bump up the earnings per share from an estimated $1.60 to $2.55!
This means our new silent partner effectively who bought his shares at a 500+ PE now owns them at a 21 PE. Still a bit pricey, but hopefully we can increase profitability even further in the future.
As agreed though, the company decides to issue a 10 cent dividend for the year, paying a total of $13.
$10 of those dollars go to you, as owner of 100 shares, and $3 go to your partner.
What we missed
This series was a simplified view of how companies work, and because it was simplified there’s many things we didn’t discuss.
The elephant in the room here is taxes, companies generally have to pay taxes on their income, and in addition there are consumption taxes like VAT which are collected by companies in the name of the state.
The tax system around corporations is complex, and I don’t feel I would be able to accurately explain it, especially since it changes from country to country and even company to company.
We will leave our One Man Corporation here, as a profitable partnership with room to grow.
Let me know what you think, and comment down below, or tweet at me. I am always open to listening to other views.
I’ll see you next time when we will go over a new company!