Protect your normal income generating assets against your own greed. Mwangi runs a hardware shop on Ngong Road. His clients are mostly people doing small scale construction. He is very good with relationships and most of his clients are repeat customers who keep sending referrals his way. Mwangi is a simple guy and by just looking at him or his shop, you will underestimate how much money he actually makes. His shop turns over millions every month and is profitable. Not just profit on paper but actual cash. In other words, money comes in, money is paid out and he still has more than enough left over at the end of the month. Even in slow seasons, like the present one, where many people stopped spending because of the elections, his profit is roughly about half a million shillings. Not bad by any standard for a slow month. It shows you the sustainability his business benefits from. He has had months, like earlier this year where profit can be between one to two million shillings. This is when a very simple mistake was made. A mistake that many businesses make and indeed many investors. Let’s illustrate it with cows.
Imagine you had a cow that was producing milk regularly and faithfully. And then somebody came along and wanted to sell you another cow. Maybe it has an exotic breed and at some unspecified point in the future, if fed, fattened, and cared for properly, it would also produce milk. You buy into the aspirational narrative that comes with the cow. You slaughter your current cow for meat to get the money to buy this exotic cow. However, you forget one thing. Your old cow was giving you regular milk hence regular money. This new fancy cow will take some time before it can hopefully produce milk. In the meantime, you have no money.
Mwangi saw a new dazzling cow in his line of work. He felt the natural progression was to enter construction. After all he supplies so many people in this industry and he has seen what they have built. He bought some land in Dagoretti and started developing a commercial building. He has partly borrowed for this project and he is also using funds from the operations of the business. Because of this new project he is slowly slaughtering the cow that has been feeding him. The combination of loan repayments and construction expenses is taking at least one million shillings from him every month. At the moment construction has even stalled because he wasn’t able to make some payments on time. He also hasn’t paid some suppliers of his store. This construction is slaughtering the hardware business. The business is suffering from funding a project that has fundamentally nothing to do with the actual business. Before money would flow in and out depending on the needs of the business. Remember before this project, Mwangi would only remove money from the business if it made profit. He could also make the decision to reinvest funds back if need be. Money is now being forced out of the business before it has a chance to turn into profit and is not available to be reinvested. That’s why basic operations like paying suppliers has become a problem. Mwangi let his ego get in the way. He just wanted to own a building. He made some erroneous assumptions and did not do the math. Had he done that he might have seen that the returns from his business are higher than what the building can ever give him and maybe the way to grow was to identify another location for another hardware store. Leave the exotic cow and instead get another normal, milk producing cow.
Mwangi’s mistakes are not uncommon. When a business or certain investment has done well for a time we can get overconfident with our actions and believe that somehow things will work out. We lay down the same survival instincts that got us this far and we chase an expensive and irrational dream. Some people have killed their business by removing funds to buy a house. Some have even done this with a car. Some have expanded into a product or area that does not make sense. Does this mean Mwangi should never have done the building or you should not try and do something different? Not necessarily. It just means that Mwangi should have separated the funding of it from his business and so should you. He can use profits that are paid to him personally. Borrow based on the project rationale itself not the current business finances. Maybe even look for partners to co –invest with him. Separate financial operations of his current business from the construction.
We make this mistake in investments as well. Some people have sold their income producing apartments to buy exotic land, only to realise that they have no money to fund the equally exotic plans to build. They should have just continued to collect rent until they are clear on how it will all work out. Taking calculated risk means that you have done the calculations (Click to Tweet this thought). Mwangi did not. Learn from him and do yours. What are his options now? If he continues to squeeze himself like this, he will destroy the hardware shop which is his true source of livelihood. It’s worth letting go of the building to keep his normal business afloat. He needs to stop sinking more money in. Give up the building owner aspiration for now and sell the project to someone whose version of the normal cow is this type of construction. Bigger (or looking bigger) does not necessarily mean more profitable. Hang on to your normal cow. It’s worth it.
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