The Entrepreneurial Madam
Sally was the madam of a Northern Nevada bordello where such a business is legal. She ran a legitimate business and wanted to succeed in a larger sense by becoming an investor.
Since bordellos are largely a cash business (no extended credit or accounts receivable to manage), the temptation to skim some of the cash and under report income is common place. While under reporting income reduces your tax liability, it is a felony.
Also, when you apply to a bank for a loan, the under reported income and related income tax won’t support your ability to repay as large a loan as a higher income would justify. Thus, your ability to borrow and grow your business and invest is hindered even if you don’t end up in prison
Sally knew all this. She not only wanted to run an honest and upright business, she wanted to prove to her banker and to the Internal Revenue Service (IRS) that she did so she could leverage her business success into investments.
We began working together. I had her download MBA-4-Entrepreneurs, one of my do-it-yourself audio workshops at www.theprofitprocess.com for a discussion on managing profitability.
One of the central ideas of this program is the development of Key Performance Indicators or KPIs for activities in a business. KPIs allow you to see and anticipate patterns in a business independently of the financial statements.
Sally took my advice and worked through the MBA-4-Entrepreneurs. With my assistance, she developed a number of KPIs for managing her business and it flourished.
But sure enough, eventually the IRS selected her for an audit. She was apprehensive about the audit, but I assured her that she had the records to prove her case. When the agent pressed her about skimming cash and under reporting income, she told him about her “towel KPI.”
Every business is unique, and so is running a bordello. Each client was required to shower. So Sally kept track of the volume of her business by the number of bath towels processed by her laundry vendor each month.
The agent examined the laundry vendor invoices and corroborated her reported income. He was satisfied that no under reporting of income was going on. He was impressed.
Sally was an apt student and shrewd businesswoman. She successfully managed her bordello for years.
From her profits, she invested in several duplexes and four-plexes. Eventually she arranged a tax-free exchange of her small rental properties and, with a large loan from her banker, she traded her existing equity into a 120-unit apartment complex. The surplus cash flow from the complex went to pay off the bank loan.
When it was free of debt, she sold her bordello to another madam for a fair price based on her legitimate records. She then retired and lived comfortably on the rents generated by her apartment complex.
When small business owners don’t understand the full arc of the growth of a business, they are tempted to cut corners or even cheat on their taxes in the hope of getting ahead in the short-term.
Sally knew this was a poor choice. In order to grow, she knew that she had to know all the facts about her business and not fool either herself or the IRS.
If a business does not represent a compelling value, and is so marginal that the owner has to cheat to survive, it is better to move on to another opportunity. Taking the short cut of skimming cash and under reporting income is one of the oldest tricks around. Tax auditors also know about KPIs and can develop reasonable measures of your income.
Developing KPIs to help run your business is not difficult and will help you produce a legitimate profit and pay your legitimate tax bill. It will also assist you in planning your own business growth path and investment strategy.