There Is No Such Thing As A Business Expense

  • June 20, 2023
  • 4 min read

“What is your budget?” “How much can you afford to spend?”

These are questions often asked by sales representatives when presenting your business with a product or service. How should you answer those? If you look first (or only) at your free cash or your net profit as a guide to a purchase budget, there may be a better way to evaluate an offering.

If your company buys a new product or service using existing net profit money or balance sheet asset money, you are simply erasing previous hard work results purely on speculation.

If the purchase decision is made with the intention that all new “expenses” are not “business expenses” but are pursuits of more revenue, then the purchase is not simply burning cash and even becomes less speculative. Every expense is put through the wringer of a requirement to pay for itself and then some.

Certainly, all businesses have some nod to “ROI” for an expense. But what should that return be? One way to evaluate a purchase is to start by dividing it by the profit margin percentage. For a business with a 20% profit margin, it takes $5000 of sales revenue to retain $1000 in earned cash. So a new “expense” of $1000 for something would need to generate $5000 in new, fresh, original sales just to break even, or a 5X multiple ROI. But that is just to end up right back where you started, so that is no good. So maybe a 7X or 8X would make sense to have a positive cash result on the “expense.” If you spend $1000 on some new widget, marketing, employee, or app, and you sell $8000 of new sales revenue, you keep 20% / $1600, so you are $600 ahead of the game. Good.

But remember, not all “new expenses” pay off; some end up with no results. Even with good instinct, evaluation, and best-laid plans, all new expenses are speculative by nature. So maybe a 10X expectation is appropriate to make up for the “non-winners.”

Now, you can communicate with the sales team of the new offering and ask them to give you the best information to demonstrate how the product/service will help generate a new original $10,000 in sales. While it is not their job to make those sales happen, having them show a clear pathway will make it easier for you to close the deal with them.

Now you and your staff can evaluate the probability that this new thing will actually help generate those sales and that you have all of the other pieces needed to process and fulfill the business. Remember not to fall into the trap of “Just one sale of $1000, and it pays for itself…” No, it doesn’t, because you as a business do not keep all of the revenue, just the net profit after all those pesky line items on your P&L. You might think that since those are already paid for, any new business is gravy, and you keep it all. Well, maybe at first, but if you add more revenue activity, you will eventually need more of everything. (Payroll, insurance, etc.) If you do not bake that cost of sale into each new purchase decision, eventually, the margin will go from 20% to 14%, to 11%, even as top-line sales increase, and you will not be able to see what happened.

This type of buying process is a win-win, helping weed out the “business expense” drag on profitability for the buyer and helping the seller retain business and not burn through acquisition costs to come up with new sales leads for when you stop buying when their thing is not profitable for you.

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