Archive | November, 2013

The Compounding Effect In A Business

11 Nov

Compounding is the reinvesting of any profit, interest, dividends, effort, time, etc. back into an investment so over time the annual return on your investment is far greater than what you originally put in.  We have looked at how earning interest at reasonable rates can make you a millionaire over 30 – 40 years by only investing £2.73 a day.  We did a similar chart with dividends and saw exponential growth over a shorter term.  Finally we looked at the effect of compounding growth on property and how it can double in value on average every 10 years.  In the last of our compounding series we look at business.

Business offers a great potential for compounding growth.  When the business formula is right the return can far outweigh the effort.  But how do you use compounding principles in business?

When a business is started it is usual to start as a one man band.  You have an idea or hobby you enjoy and so your business starts.  You put the hours in building the business and if successful you get to a stage where you can’t possibly do any more with the business unless you hire staff.  So you employ a person and you can then grow your business a bit more.  The cycle continues hire more staff and grow the business a bit more.  You are reinvesting in your business by employing staff and in doing so, the value of your business increases.  You benefit from the efforts of the staff working for you.  Richard Branson (Virgin founder) is a billionaire and the last I heard had around 300 companies.  It would be impossible for him to work all these businesses himself.  He employs thousands of people. By employing all these people the value of his business grows way beyond what he could achieve on his own.  He has compounded his time and effort to create a brand worth billions.

Another business model is franchising.  Probably one of the most recognised franchises in the world is McDonalds.  Ray Kroc the founder of McDonalds obtained the rights to sell a burger.  Setting up a successful burger bar the idea was sold to thousands of other business minded people who in turn set up their own burger bar under the McDonalds name.  Today McDonalds is said to be worth around $19 billion.  Ray Kroc used other people’s time, effort and money (they paid for the franchise) to build a business worth billions.

Network Marketing is another type of business that offers enormous rewards.  Most people fail to grasp the power of this much misunderstood business model.  With network marketing you have a product to sell which earns you commission and by introducing other people to the business you duplicate your effort and earn commission from that as well.  In effect, you are selling a product and franchising your time.  10 years ago a friend of mine injured his back.  As a result he had to give up the job he loved. Then someone introduced him to network marketing. Not sure about it but willing to give anything a go he started his business.  At first he earned very little and almost gave up but as he says thankfully he didn’t. Today he earns a monthly income circa £37,000 a month.  He now spends most of his time teaching other people how to build a business like he has.  In return his business continues to grow every month and along with it his income.

All of these businesses have compounded the profit and time in their businesses in different ways.  One owns the businesses and employs staff, the second sells duplicate businesses under a trade name and the third combines both product and franchising.

What do you think these businesses will be worth in another 10 years?

Compounding is a very powerful investment tool.  Once you fully understand the concepts and can apply it to your investments you are virtually guaranteed success.

Karen Newton is an entrepreneur and angel investor.  She also invests in property, shares and commodities. If you are interested in buying a franchise or starting a network marketing business you can obtain more information from http://www.karennewton.co.uk

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