Chapter 6 / The Formula for Riches / The Difference Between Rich and Poor / by Dr. Hannes Dreyer.

Chapter 6

Although The Formula For Riches applies to business as well as other types of investments, 

it is only in the application of the formula that there is a difference between the entrepreneur and the investor. 

In other words, you need to put the formula to work – not just to measure, but to actively grow your money and minimize your risk

Investing in Business.

You can set up a business in a conventional way, or you can set it up by following The Formula For Riches - I call it the Wealth Creator’s way.

There are three ways to invest in a business. The first is to invest your time, effort in money in setting up a conventional business. The second way is to invest your resources in setting up a Wealth Creator’s type of business and the third way is to invest in an existing business.

In the conventional way to do business, you are going to work for your money and for the business. 

The business is set up around you. If you are not there then the business will suffer or cease to exist. In the conventional way of running a business, you become the slave to your business and the money your business produces.

With a Wealth Creator’s business, you set up the business in such a way that the business and your money work for you. In other words, the business and your money become your slave. With a conventional business, you are a slave. With the Wealth Creator’s type of business, you are free.

In a conventional business, you have to work for your money. We call it active income. In the Wealth Creator’s type of business, you set up the business in such a way that your business or your money works for you. We call the income this produces, passive income. In a conventional business, you work for the business. In the Wealth Creator’s type of business, you work on growing the business.

What we are really after in setting up a business is called passive (also called a residual) income. The only way to do it is to follow the outlines as set out by The Formula For Riches.

The Most Undervalued Asset.

Our gifts, talents, and intelligence are the most overlooked asset which we possess. The moment that we combine our talents and intellect, we can create more wealth than we can dream of.

Ralph Waldo Emerson said it best: "Man was born to be rich by use of his faculties, by the union of thought with nature. Property is an intellectual production. The game requires coolness, logic reasoning, promptness, and patience in the players”.

The greatest investor in the world, Warren Buffet, has used his gifts, talents, and intelligence to build an empire. “He was not born into riches, but he was blessed with extraordinary talents”.

His enduring wealth which he created during his lifetime and which he has structured to benefit future generations was solely developed by intellectual application.

He is cool, rational, decisive, and patient. “The total wealth he created is greater than the gross domestic product (GDP) of Iraq, Ethiopia, and Costa Rica, and greater than the combined GDP of Cuba, North Korea, and Yemen". (Warren Buffet Wealth pg 24)

Why is a conventional business one of the worst investments you can ever make?

Let me explain. Imagine that you borrow $500,000 at the current overdraft interest rates to invest in stock exchange shares, where chances are 96% that you will lose all of your money as well as your home and everything else you have worked for all your life, within the next 10 years.

It doesn’t sound like a great investment, does it? Yet, statistics show, that this is the kind of investment the average business owner makes every time he begins a small business.

I am a passionate promoter of becoming an entrepreneur and even a small business owner, but not in the traditional sense. I believe if you apply The Formula For Riches in setting up or investing in a business it will be a totally different strategy, with a completely different outcome than if you try to conduct business the conventional way.

Why is a conventional business set up for failure?

The biggest mistake is that people do not have the knowledge – they are ignorant. They think because they have money and time they know the business. 

They think 20 years in a particular business is the same thing as experience in running such a business. This is not how it works and a little time spent thinking it through, will reward you and protect you.

Business is a science and an art. 

It requires intelligence and systems.

If you do not invest enough time in understanding the principles which govern conventional business, you are setting yourself up for failure.

• You will have to set up shop and thus find a place to rent.
• The landlord is going to demand a contract and you have to stand surety for the rental amount. If you are going to lease the shop for 5 years at $2,000 per month it means that you start with a shortfall of $120,000 (surety) even before you open shop.
• Now the fun starts because you have to pay salaries, telephone bills, water, electricity and gas bills, and interest on your ever-increasing debt.
• You have to buy stock.
• You have to learn about stock-taking.
• Guarding against theft.
• You will have to find out about marketing, where and how to find clients.
• Customer care.
• Banks
• Record keeping
• Taxes and laws

True Entrepreneurs are Self Reliant.

When you want to become an entrepreneur, it is vital that you learn how to become self-reliant. You must rely only on yourself to make intelligent decisions. It is your money. You can listen to others but you must take full responsibility for your actions.

Entrepreneurs do not blame others for their mistakes; they use their mistakes to learn.

They develop an independent mind. An independent mind is something most people would like to think they have but actually, they don’t. They are completely unaware that their minds are programmed since childhood to follow and obey the system.

Their minds are public thoroughfares, open to the traffic of advertisers, marketers, public relations practitioners, friends, “experts”, colleagues, strangers, and just about everybody who offers an opinion. 

Some of this traffic has an ulterior motive – to make profits from getting you to think what they want you to think (e.g. “experts” and financial institutions).

Some are just as deluded as you (e.g. friends, colleagues, etc.). Either way, your mind is cluttered by traffic that is doing nothing for you. 

Learn to block it out. Start by turning off the TV – yes, even the news.

Understand that when it comes to making and handling money and time, you are on your own. Be careful of the media and the “experts”. 

Make up your own mind. The only way to do this is to apply my first law “Invest in yourself first before you invest a cent in any business or investment.”

Unconditional Trust of the Ever-Present “Experts” and “Gurus”

Trust but verify. Be careful not to react to the advice of so-called “experts” or “gurus” While these people may be bright and articulate and usually have impressive degrees from the best universities, history proves that they are not entrepreneurs or business people.

Experts are trained by and conditioned to follow the system. Their studies are sponsored by Companies with an interest in the field. They need slaves to bring in the profits. 

They are trained by academics who can argue a point with impressive vocational skills. 

The question remains can they do the job? 

Will all this knowledge bring you closer to your objective or will it just confuse the issue?

“Experts” do not like the KISS (Keep It Simple Stupid) principle. They believe complicated is good because you will come back for more and they can bill you for their time and expertise.

Negative Cash Flow.

The biggest priority for any business (start-up or old) is to generate a positive cash flow. People confuse positive cash flow with profits.

Let me take you through the process.

The difference between income and expenses is cash flow. This cash flow can be positive (if I make more than my expenses) or negative (if I spend more than I make). 

Positive cash flow simply means there is more income than expenses for the month.

In my Universal Formula For Riches, this positive cash flow is called a surplus. Note that The Formula For Riches does not state the nature of the surplus.

A surplus can be either income or capital. Let’s look at an income surplus. For simplicity, we are going to call it positive cash flow.

Before we can make a profit we must understand what an expense is. 

An expense is simply all those bills you need to pay in order to run the business effectively:

• Shop rental.
• Staff salaries.
• All government, federal, and state taxes.
• Bank charges.
• Interest in overdrafts and loans.
• Accounting fees to pay for the reconciliations that the government demands.
• Legal costs.
• And all of those other costs associated with running a business but not associated with any individual sale.

So we get income from the sale of products minus expenses and that leaves us with cash flow - either positive or negative. If there is more income than expenses it means that we will have a positive cash flow for the period.

This sounds like profit doesn't it? No, it is not.

It is vital that you understand this concept. This is one of the most important lessons which you can learn.

You can stay in business for years without making one cent of profit as long as you have a positive cash flow. Positive cash flow is the heartbeat of any successful business. The one thing that I monitor on a regular basis (short-term view) is my cash flow.

It is also a lot easier to build passive cash flow than it is to build capital and this I will also explain as we progress.

Let me ask you another question. Is it possible to make good profits and still fail in business in less than a year because of negative cash flow? Absolutely - this is why you must please pay attention and follow what I am going to teach you.

Let’s use an example to explain the difference in terminology. You start a business and you spend $10,000 to get the business started. Because you do not have the money you borrow it on your Visa or Master credit card.

Let’s say that you have made use of their budget facility and you have to pay back $533.72 per month. This means that you are running into a $1 positive cash flow when your business generates $534.72 each month.

In this example, I assume that the payments to the credit card company for the $10,000 that you have borrowed are your only expense. 

It does not include the other expenses that I have already mentioned.

Am I profitable if I have a positive cash flow of $1 per month?

Well, it looks like that but that is not really the case. You will only be profitable when you have paid your debt of $10,000 plus interest to the 

credit card company. This may take some time at $1 per month.

What if you have saved the $10,000 and used that - is the calculation still the same?

Well, you still won’t be profitable until you have paid yourself back. If you want to get technical you will have to pay yourself interest because otherwise, it could have been a better deal to invest the money in the bank without taking any risk.

Another positive outcome if you use your own money is the fact that you have to earn a lot less, to make up for your interest loss, because the bank will pay you less interest than the credit card companies will charge you.

Let’s go back to the example.

If you invested the money at the bank they would give you $50 per month if they give you 6% interest per year. If you can make $51 per month with your business venture, you will have a positive cash flow of $1. So in this example so far, it makes more sense to use your own money.

Does this imply that it is always best to use my own money when I set up a business?

The answer is no. Your personal and each situation will determine what is best and I will teach you how to do the calculations as we progress.

From this example that if you make $1 more, than the repayment to the credit card company you have a $1 per month positive cash flow.

Now, what happens if you make less than $537.72 per month?

To have a negative cash flow does not mean that you are running at a “loss” or that you are “losing” money. 

You can actually make money but still, have a negative cash flow. Is this not amazing?

But how can this be? Let’s say Henry and Harry start the same business on the same day. Henry borrows his money on his “house” (his home loan) at a rate of 9% and wants to pay the loan back in 24 months. If he pays an additional $456.85 per month his additional loan on his house will be paid in 24 months. (Again the interest rates I am using are only to illustrate a point.)

How can he borrow the money for his house?

If he has an access bond of $10,000 then he has access to that money without having to register a second bond. If the interest rate is only 9% then it means that he is effectively paying only 9% interest on the $10,000 that he has borrowed.

Now let us say that Henry’s business produces a revenue of $500 per month which means that he has a positive cash flow of $43.15 per month.

You must also take into consideration that each and every month that he repays his bond he owes less and less on the bond. Twenty-four months from now he will owe nothing on his bond and the $500 becomes positive cash flow.

What about Harry? 

He borrows the money on his credit card and they charge him 25%. He must also repay them over the next 24 months, and his monthly repayment will be $533.72.

Both Henry and Harry are making $500 per month from their businesses.

Henry has a positive cash flow of $43.15 and Harry has a negative cash flow of $33.72 per month but they generate the same income.

If Harry has a negative cash flow of $33 .72 per month where will he find the additional money?

Can you see why positive cash flow is so important?

This is a simple example but it demonstrates a great truth. 

Without positive cash flow, no business or entrepreneur can survive. 

Harry’s business will eventually fail. Not because he is not making a profit, because he is making the same profit as Henry, but because his business is running at a negative cash flow and he did not educate himself in order to find out what would be the best option to finance his business.

A business owner needs the education to understand how a business develops.

The most common mistake that I see that people make is when they become involved in a business and think it is easy. It takes education, effort, and time.

Lack of Training and Convention.

There is something seriously wrong with the way that conventional education teaches business skills and entrepreneurship. If the educators deny this statement can someone please explain why 80%, of all new start-up businesses, fail within the first two years?

Now, why do more than 80% of all new businesses fail within two years?

I think it is because of the conventional syndrome. 

Let me explain. It is not uncommon for people to believe there is nothing wrong when the business runs at a loss (negative cash flow) for the first two or three years.

I have heard many experts saying to their clients that this is perfectly “normal”. Now let me tell you, this is not normal, this is a recipe for disaster. 

From my own experience, I have learned never to start a business that does not have a positive cash flow within the first month.

If you are running on a negative cash flow for the first year or two it means that you must subsidize that business. In other words, it cannot operate on its own. This is where the idea that you need money to make money comes from. It is a stupid idea.

It is my opinion this idea originates from the financial institutions and corporates who have millions to throw into a project. They can do it because it is not their money. It is the money of their shareholders or the taxpayers.

Calculate and Limit the Risk Factor.

Would you say it is wise to invest in a business if you don’t know or understand the risk involved?

This is the difference between entrepreneurs and conventions. They think outside the box. They take responsibility so as to calculate the risk and understand the principles.

They know it is better to start with nothing because then they have nothing to lose. Convention dictates that the ordinary investor needs money to invest - only to find out afterward that he has an 80% chance of losing it all within two years. If the idea is not right then no amount of money will save you.

Here is the irony. It has nothing to do with how much you invest. It is about the growth your investment will give you. The more you invest the bigger the risk becomes. From a logical point of view, it is better to risk $1,000 than $1,000,000.

Be creative! Why don’t you structure the transaction so that it will cost you only $100 instead of $1000? By doing it that way you are limiting the risk to only $100 – you are making it 10 times smaller.

Most people do not think this way. They think that you must invest money to make money. First, invest in yourself. The Formula For Riches comes into action again.

If you know what you are doing you can make more money by investing only $100 as the alternative to throwing hundreds of thousands of dollars into an investment that you don’t understand.

What if you can do it for $1? Then you can take 1000 “chances” before you have lost the $1,000. Even Newton needed fewer chances than that!

If you understand what I just explained you understand more about risk and how to eliminate risk than many “experts” who think they understand it all.

Negative Gearing.

It is interesting to see how governments can get away with wasting money. They have no need to run at a profit because everything is subsidized by taxes. They don’t take responsibility for their actions.

Bureaucrats are not entrepreneurs they get their pay no matter what happens, therefore there is no incentive to run the government as a profit-making business. 

What they are well equipped to do is to drain the taxpayers’ money and make life very difficult for an entrepreneur. It is absolutely possible to run most government projects at a profit.

Part of the reason why corporations run into big losses when they start up a new business is that they can create tax breaks. Many “experts” will tell you this is a good thing. They even have a fancy word for this - it is called negative gearing.

Personally, I believe that if a business is not feasible within the first month you are sitting on a sick horse and that horse is going to die while you are on it.

Statistics tell us that the chances are greater than 80% that if you start a new business today the business will close its doors within the next two years. The chances are 96% that the business will not be in operation within the next ten years.

Ignorance is the Main Reason why most Businesses Fail.

There is an old proverb which says that “You don't know what you don't know!”

I think ignorance is the main reason why most businesses fail. People do not want to invest in themselves. They do not want to take the time to find out how things really work and how to minimize risk and how to avoid unnecessary problems. They simply rush in and in the process destroy their lives.

Phantom Profit.

I want you to learn a new term which you will not find in any handbook. It is called a “phantom profit”. You think it is a profit, it is shown as a profit but, it is a ghost profit because it only exists in your financial statements and in the minds of the “experts”.

Negative cash flow is the biggest destroyer of businesses? Let me try to explain this principle.

A business with a good turnover does not necessarily make a profit and if it makes a profit, it does not mean that it is running on a positive cash flow.

When I buy an item for $1 and I sell it for $2. It means that I have a turnover or income of $2 and I made a profit of $1 on that specific item, not so?

But what if my expenses are 75 cents? Then my income is still $2 but I have a $0.25 profit. In this case, my profit after expenses is 25 cents and my positive cash flow is also 25 cents on the transaction. I hope you are still with me. If not reread the section, please. It is important that you understand this. Now let’s make it more interesting.

What if I sell the item on credit? 

Now I have a “phantom income” because I sold something but did not receive any money for it. I sold it in the “hope” of collecting money at a future date. 

On my “books” it shows that I have sold an item for $2 (but I do not have the $2 - my debtor owes it to me). I had to pay $1 for the item out of my own pocket and I also had to pay for the other expense of 75 cents out of my own pocket.

On this deal, I have made 25 cents profit - not bad - but in reality, I am running at a $1.75 negative cash flow. Is this not strange? I make a profit of 25 cents but I run into a negative cash flow of $1.75. No wonder so many profitable businesses close their doors. They simply do not understand this principle.

Remember how I got to $1.75 negative cash flow? I had to buy an item for $1 and pay an extra 75 cents for my expenses, in order to sell the item for $2. Money which I still don’t have in my pocket, because someone (called a debtor) still owes me.

I must show this in my financial statements with special journal entries! Can you see why some “experts” tell you it is OK to do business this way? We call it job creation; someone must be paid to keep the financial records.

Without the financial records, I cannot apply for credit. I will have to prove to the bank that I can make 25 cents per transaction on the condition that they give me an overdraft. I desperately need the credit otherwise I cannot replace the original item and if I can’t replace it I cannot trade. 

See how the bank is in on the deal as well.

Thus far you have the bank and the “expert” as your partners. The only problem is they do not stand surety and they have nothing to lose.

The Effect of Inflation.

Ah, but this is not the end of it, there is a tiny little bit of a problem, let’s call it inflation. The item you have to replace now costs $1.05 because of inflation. Your clients are under the impression that you make so much money and the competition does not increase their prices. While you evaluate your options you realize you cannot increase your prices at this point in time.

At this stage, you are becoming an “expert” yourself because you have learned how to juggle all the balls at the same time without one of them falling. When month-end comes, you juggle a bit faster because you are getting good at this thing called a business. If one of your big debtors does not pay on time, chaos is imminent.

Remember your debtors? That is a fancy word for those who owe you money. Please don’t forget you are also a debtor; remember the money you have borrowed from the bank.

But let’s get back to the debtor who owes you money. He is also a juggler and one of his debtors did not pay him so he cannot pay you. He explains that to you and promises to pay whenever he gets paid.

In the meantime, you are developing a headache. You see, this is your best client and he is responsible for a lot of your “profits”. So you decide to go to the bank and ask for more money. But the bank wants to see financial statements, and so it goes on and on, you walk on the edge all the time and so the story of being a conventional business person has only just begun!

Professional Jargon.

Two months later you are getting worried. Promises do not place money in the till. So the one “expert” advises you to see another expert” in order to help you to deal with the problem.

The only other problem this will cause is that your debtor is also trying to survive, so he will call on his “experts” and now the “experts” are going to talk to each other.

You see the “experts” even have an ad campaign that you are funding and that is “Don’t talk to me talk to my expert”! The only problem is that while they are talking to one another, they are getting paid by you and your debtor. Although you are doing the paying, you are not necessarily invited to join the conversation.

Sometimes I see “entrepreneurs” who want to listen to the “experts” because they are paying for the conversation, but when they enter the conversation, they find out the “experts” are talking in a different language.

We call that language “professional jargon” Now this is a difficult language to learn - it is the exclusive domain of the intellectuals. They teach you the basics at university. 

This is to make sure that you are really interested and are willing to pay a lot of money, that you are desperate enough to work for peanuts when you have completed your studies (and starting to do your articles or internship) so that one day you can become one of “them”.

Does Government really want Small Business People to Succeed?

The question remains can a small businessman or entrepreneur in South Africa afford the staff needed to read, analyze and comply with the laws of FAIS, FICA, PAIA, CIPRO, and who knows what else.

On top of this, they want entrepreneurs and small business people to comply with every one of 140 PLUS pieces of legislation, regulating small business owners. They need to stay on top of the tax laws - Income-tax, Value added tax, Donation tax, Estate duties, Import and Export Duties, Capital Gains Tax, and the list just goes on and on and on.

Don’t forget the Companies act, the Close Corporations act, and even an act relating to trusts. We must know the insolvency act and labor legislation. This can be complicated and confusing and then the business owner must still find the time to actually run the business - sell, take stock, buy and keep his customers happy.

The bottom line is; that you are running at a negative cash flow of $1.75, but the government says that you have made a profit of 25 cents. Depending on the entity, it means that you may pay up to 40% tax on the 25 cents. This is an additional 10 cents. This means your negative cash flow is now $1.85.

Withdrawing more than the Business can Generate.

If your standard of living is more than the profits and cash flow that the business can generate, the business will not survive. It is that simple, even if it is the best business in the world.

Business owners must live within their means. Many businesses fail because their owners never give them a chance to survive because they take the cash flow out of the business.

No wonder 80% of all new business owners see their businesses fail within two years. They never stood a chance.

What happens if your debtor can’t pay? Well, the “experts” get paid no matter what. The bank has its surety no matter what. And guess what? You must sell four more items (that you must finance) just.

For more information on the Formula for Riches book;