Evaluate the Forest, not each Tree
Warren Buffett has a way of communicating financial principles in ways that hit home, and this year’s annual letter to shareholders is no exception. He’s managed Berkshire Hathaway since 1965, growing the company into a $500 billion conglomerate that owns and operates 66 different businesses generating $225 billion in sales.
In this article, I will discuss what I call the first guiding principle for managing wealth:
Make your balance sheet, cash flow, and portfolio your friend
There is a critical distinction between possessing a high net worth and having a strong balance sheet, cash flow, and portfolio. Problems in these three areas can give rise to huge frustrations and mistakes. The predicament of a gentleman I’ll call “Harry” illustrates this point.
In terms of net worth, Harry was in an excellent position, with total assets valued at somewhere north of $60 million. I would have thought it safe to assume that his balance sheet, cash flow, and portfolio were spectacular, but that was not the case. A very high percentage of his assets was locked up in a private company he owned, or in his homes and other personal property. In fact, when I first met him, his liquid and semi-liquid assets were not sufficient to sustain his rate of spending for much longer. Though he had a $3 million portfolio, he was beginning to tap it at an unsustainable rate. Harry was wealthy and he felt wealthy, but he was heading toward an inevitable cash crunch.
Part of Harry’s problem was that he needed to be more cost conscious. A lot of his cash flow problems came down to over-paying for various goods and services. His mortgage payments were much higher than they needed to be. He was bleeding cash in the form of high brokerage fees. He was paying far too much for financial advice and services that were focusing on the 85% Trap and missing the Essential 15%.
When successful business owners start the planning process of selling their business, in many cases the largest asset that person owns, many are looking at things such as; what multiple of my EBITDA is reasonable, what business broker or investment banker should I be using, etc.? The first step in the process really starts with the question “how much do I need to realize from the sale of the business to fund my family’s lifestyle for the remainder of our lives? I like to equate this process to building a home, if your foundation (or in this case accumulation needed), is not thoughtfully and carefully calculated and executed the rest of the process is built on shaky ground.