There are many small businesses that start out producing a product, and of necessity, sell their product in small quantities directly to consumers. This is the bootstrapping phase of a (hopefully) growing business. If the product catches on, there is a phase where growth is rapid, and the business may begin to acquire customers that want larger quantities, or even better, want to distribute the product themselves.
The small business may struggle to keep up with providing the product to all that want it. In particular, if the product is at all customized, it may be difficult to keep up with all the customizations that need to be made for individual customers while trying to ramp up larger scale production for large customers and redistributors. The question is, how do you decide where to put your energies and capital as you expand?
What some small businesses fail to do is consider the finances of the situation in order make a better, more informed decision. Other small businesses cannot consider the finances of a situation, because they do not adequately track cost properly. If you fall in to the latter group, you may want to look at a Blog that I wrote concerning cost, by clicking here.
For those that are tracking costs sufficiently, one way to consider the situation is by reviewing capital turnover. Capital turnover is calculated as sales divided by total capital. Capital Turnover is an activity ratio that will tell you how well you are utilizing your capital. For example, if a company had $100,000 in assets and $200,000 in sales, the calculation is:
$200,000/$100,000 = 2
In other words, 1 dollar of capital produced 2 dollars in sales. To use the vocabulary of the ratio, every dollar of capital was “turned” 2 times.
Once the company has established their overall capital turnover, they can use their knowledge of their costs to make an estimate of what portion of their capital is involved in the sales to different customers. Let’s say that they believe that roughly half of their resources are dedicated to each segment of the customers, small customers and large customers. However, the ratio of sales to each segment is not, with $150,000 going to the large customers and redistributors and $50,000 to the others. We could then do 2 calculations:
$150,000/$50,000 = 3
$50,000/$50,000 = 1
In this case, the large customer and redistributor segment is “turning” dollars at three times the rate of the small customers, therefore is using capital more efficiently. Now, this seems pretty obvious in this example, and working out the numbers is often more complex than this example.
In this case, the small business needs to consider ways to move towards putting more resources into the large customer segment and away from the small. Now, that brings up m=other questions, such as how to do so without alienating one set of customers. That would be the topic of another Blog. The important conclusion here is that having made this analysis, the small business now knows how well they are using resources and where they need to change to become more efficient and productive.