Some Insurance Gambles That Put Your Business at Risk

Much like sunscreen, business insurance is one of those things you don’t realize how important it is until you’ve been burned: A lot of entrepreneurs don’t have it, and those who do, may not be fully covered.

While large corporations have staffers specifically trained to be sure the business is protected adequately, small business owners are often not aware of the risks their business faces.

 “Smaller businesses tend not to get the right amount of coverage,” says Loretta Worters, vice president of the Insurance Information Institute, an industry trade group that aims to educate the public about insurance. “They will get too little or not the right coverage.”

Here, three of the most common mistakes to avoid when deciding on business insurance.

1. You view insurance as one-size-fits-all. Think again. There are four basic types of insurance that all businesses need, according to Worters. Property insurance protects the building that your business is housed in and the inventory, raw materials and computers that you own. Liability insurance protects you against lawsuits. Business vehicle insurance covers any autos owned by the business. Finally, in every state except Texas, a business with employees must have workers compensation insurance should an employee be injured on the job.

In addition, every industry has its own specific risks and your business may require a specialized policy. “You need to get an agent that understands your line of business,” says Worters, noting that you should talk to an agent before just signing up with one. Ask a local business group or association for a recommendation.

2. You think you’re covered by another policy. “The biggest mistake [business owners] make is they assume they don’t need coverage,” says Ted Devine, CEO of Dallas-based Insureon, an online small-business insurance agency. He says business owners often falsely believe their company is covered by their client’s policy or they’re no longer at risk when a client leaves. Not true, according to Devine. A client can come back and sue you years after an event or transaction occurs, he warns.

And don’t think your homeowner’s policy will bail you out, either. Even if you have a home-based business, a homeowner’s policy won’t protect it should you get into any legal issues with employees or business litigation. Whether the homeowners’ policy will protect your business property in your home depends on the policy, says Devine.

3. You think you’re invincible. Worters says many businesses don’t even consider what is called either business income or business interruption insurance. If a natural disaster hits, for example, and your business closes, your revenue can be immediately shut off for an undetermined amount of time, and that can really threaten the life of your business.

Know More About Raise prices to increase profits

I know at first glance this sounds obvious, but it may be worth it for you to think about your prices. At least just for a moment.

How did you decide on your current pricing? Did you conduct market research to understand what prospects would pay? Or did you compare yourself to your competitors and base your price on that? Or was it a crapshoot, and random shot in the dark?

 

These are the ways most people do it, and they are all wrong. Because the price you set for your products and services is more important than you think.

The following few paragraphs are a bit number heavy, but stay with me because this will be really valuable for you to understand.

More Pricing Help
Find more articles on how much to charge for your products and services in our special section on pricing.

Let’s say you sell a high margin product – information products and software are two good examples. Your price is $60, and your costs are $10 – that means your gross margin (selling price – your costs) is $50 each time you sell one unit. Let’s say further that your overhead is $5,000 per month. If you sell 100 units you’ll break even, right?

Now you want to sell more, and decide you can take some business from a competitor by lowering your price – temporarily. You lower it to $40 – a 33% price cut, and not uncommon.

Your costs remain $10 and your overhead is still $5,000, only now your gross margin is $30 – 60% of what it was before. And how many units do you need to break even now? 166! That’s 66% more unit sales required to make up for the 33% price cut!

But what if you’re feeling very aggressive and you cut your price in half (also not unheard of) to $30. Now you have to sell 250 units – just to break even! That’s 2-1/2 times as many as before. How easy do you think that’s going to be?

Let’s use a different example – something that has real manufacturing costs. This time, your product sells for $100, and your cost of goods are $50 per unit, for a gross profit of $50. Same $5000 overhead, same number of units to break even. Now imagine you cut your price 20%, to $80, leaving you with $30 of gross margin. You need to sell 66% more units. Ouch!

What if you cut the price to $70. This 30% price cut means you have to sell 2-1/2 times more units – just to stay even.

Let’s go further…

Competition is really heating up and you think that matching them cut for cut is the way to go. The price for this amazing widget of yours is now a bargain basement $60.

(Shucks, that’s only 40% off your original price. Salespeople and business owners do this every day.)

How many units do you need to break even? 500.

Five hundred? That’s five times your original number.

Do you really think you can sell five times what you did before – at least without significantly raising your overhead and your variable cost of sale?

How many times have you done just this in response to competitive pressures?

How many times have you cut prices because you thought it would help you sell more?

What we’ve just done is a simplified version of what’s called margin analysis, and I hope it gives you a glimmer of what can happen when you mis-price.

For the most part, your price cuts don’t automatically enable you to sell 66% more than you did before, and generally – at least not in this universe – you don’t sell 250% more, and never, ever do you sell 500% more with this kind of price cutting.

But there is some good news – and it’s very good.

Let’s look at what happens when you raise your prices.

Remember your high-margin product. It sells for $60 and costs $10 to make.

Through good product positioning and excellent marketing you raise the price to $70. That’s only a 15% increase. Now you only have to sell 83 units to break even, and if you sell the same 100 units, your profits go from $0 to $1000. Nice increase…

And that “hard” product – the one with $50 of costs? Raise the price tag 20% to $120, your margins increase to $70, and now your breakeven drops 71, and you make $2000 if you sell the same number of them.

See how this works?

You can do this same analysis in a bit more sophisticated way, considering your marketing costs, sales or affiliate commissions, travel expenses if you have them, and so on. You can see the actual pricing effect varies quite a bit depending on these details.

If you have a high-leverage, pay-only-for-results affiliate model, a very high gross margin and almost no fixed overhead, you have a lot of price flexibility. You can cut the price 25% and only need to sell 15% more! That’s not too bad at all.

But only in that type of model. If you have a office, some staff, and a physical product – in other words, fixed overhead – lower prices can kill you – and you won’t even see it coming.

And higher prices?

They can make you rich.

By now you are starting to see the tragic effects of mis-pricing on the downside, and the marvelously enriching possibilities of raising your prices

Some Tests to Qualify for a Small Business Loan

Want to get a small business loan? Banks and other lenders are really only concerned about one thing; getting repaid. After all, that is how they still make the bulk of their revenue; making loans and getting repaid both interest and principal. Thus, to qualify for a business loan, you simply have to demonstrate that your business can service the loan request – meaning being able to make the loan payments for the life of the loan.

Most lenders will perform the following three analysis calculations to determine if your business has the cash flow to service the proposed new loan.

1) Spread The Financials:

Banks / lenders will require three years of past financial statements at a minimum.  The reason is to see if your business could have serviced the loan over the last three years.  If it passes this test, then your business should be able to service the loan for the next three years.

Thus, they use your past business performance to determine what your future performance should be.

To spread your financial, most lenders will do the following for each past period that your business provided financial statements:

  • Take your net income (that is your net profits after all operating costs, taxes and interest payments).
  • Add back any non-cash accounting items like depreciation (deprecation is not an ongoing cash expenses but an accounting anomaly to reduce taxable income for tax reporting purposes only).
  • Add back any one-time charges or expenses – expenses that are not expected to reoccur in the future.
  • Then subtract out the interest charges for the proposed loan – only the interest portion at this stage as interest payments are considered regular business expenses.
This results in the true net positive (hopefully positive) cash flow of the business – cash flow that will be used to pay the principal portion of the business loan.

Now, if your business’s cash flow at this point can cover the principal portion of the loan, you have almost passed this test.

Most lenders will not just want to see if your business’s cash flow meets the minimum principal portion of the proposed loan but would like it to cover 25% or even 50% more.  The reason is that should your business have a slow period and revenues decline by say 25% or 50%, your business’s cash flow would still be sufficient to make the loan payment.

Example:  Your business requests a $100,000 loan for three years with a monthly payment of $3,227 – broken down as interest of $449 and principal of $2,778. Therefore, your monthly cash flow should not only cover the $2,778 in principal but say 1.25 times more or $3,473.

Also, keep in mind that this cash flow figure should not only cover the proposed loan’s principal but the principal payments of all the business loans the company has.

Principal payments are not income statement items and are not accounted for based on normal operating income and expenses but are balance sheet items and are paid out of net income (after all operating expenses). Interest charges from loans are an operating expense and accounted for when the financials are spread. Financials could be spread monthly, quarterly or even annually – depending on the types of financial statements requested or the policies of the lending institution.

If you can pass this test via your past business performance, then it is highly expected that your business will do the same in the near future.

2) What If Scenarios:

Here, the lender will perform a series of “what if” scenarios on your financial statements.

For example, they may take your total revenue per period and reduce it by 10% or 20% – keeping all other items (your expenses) the same. Then, spread those numbers again to see if your business could still service the proposed loan, i.e., still have the cash flow to make the payments. Again, reassuring the bank or lender that your business would still be able to repay them should your business hit a slow period.

3) Debt-to-Equity Ratio:

Lastly, while your business may be able to service the proposed loan’s payments, banks also want to ensure that your business is not over leveraged – meaning that your business does not have too much debt in comparison to its equity.

Let’s say that the entire market declines or crashes and your revenues fall so low that you are forced to shut down the business.  In this situation, would you still be able to repay all your lenders – including this proposed loan? Thus, lenders look to a safety measure known as the debt-to-equity ratio.

Measuring your debt-to-equity is simply taking your Total Liabilities and dividing them by your company’s total equity. The higher this ratio, the more risk the business has as it is relying on too much outside debt financing. A ratio over 3 (meaning that the business has three times the debt as it does equity) is too much risk for most lenders to feel comfortable with. Most businesses will have a debt-to-equity ratio between 1.5 to 2 and are considered safe to their prospective lender.

Now, if your business does not pass all these tests with flying colors and you still need a small business loan to grow, then it is up to you (the business owner) to manage your company in such a way to bring your business in line with these tests.

It all starts with your understanding of your business and the measures it has to pass to qualify.