Finance Does Not Live In Isolation

Finance does not live in isolation, an interesting concept. There are two important ramifications to that concept, first, you cannot look at your company’s numbers just for now, or just for this year. As a matter of fact, not even just for this year and last (unless, of course, you just started last year). Rather, you need to look back at least three years. You do so in order to see the trend lines of how you arrived where you are now. Are you improving or declining? If for example, your cash cycle is 145 days, what was it three years ago, better or worse? If better, work to understand what you have done right. If worse, dig down to find out what is going wrong.

The second ramification of the opening statement above is a question: what is your competition or industry doing? You need to know how you compare to your competition, whether you are a local or national player, dig out information about the rest of the industry. From the example above, what if the industries cash cycle average is 95 days? Can you see how you may have trouble competing in an industry that is far more efficient than you in keeping cash flowing through your organization? A longer cash cycle will mean that you must tie up more cash in working capital, rather than investing in other ways to improve business.

There are any number of online researchers that can provide you with industry information for you to use in viewing how your business stacks up against the competition. I prefer Bizminer, an online research company, because they break down their research in ways that are very useful for a small business. For example, you can do research on a statewide basis, and many of their reports are narrowed down to a small area, such as a county. In addition, their reports are broken out into different revenue categories, allowing you to narrow down your comparative information to your industry sector.

A last word, when comparing your company to your industry, do the comparison over the same timeframe that you are using for your company review. That is, if you are going back three years to see what your trends are, it is important to look at industry trends for the same period, to see if you are trending in the same way. This can give you another important clue on how your financial picture is shaping up.

Never leave your numbers all by themselves!

Filling the Entrepreneur’s Skill Gap

In a past Blog, I have written about making sure that you surround yourself with a team that covers any areas that are not your strong point. As an entrepreneur, you have many skills and the drive to succeed, but rarely do you have it all. Therefore, is crucial to find people to help you with those areas. Many entrepreneurs find this difficult, for different reasons. One reason that is often cited is lack of funds to hire employees.

The reality is that you do not need full time employees to do everything that has to be done, and hiring contractors for critical elements of your business process can work, and often are less expensive than you might think. While it might be a challenge to come up with funds to pay the contractors, it is well worth the effort when you see the outcome.

For example, I am engaging in a sales campaign for another enterprise in which I am involved. We are doing it the old fashioned way, sending out letters with a real ink signature and following up with a telephone call. I do not engage a full time person to do sales for this particular company, at least not yet. How did I find my sales caller? In this case, I used the site Elance and found a person that had the skills that I needed. I then interviewed her by phone (a great test of someone’s phone skills), and finally had her do a few test calls. Based on the results, she has been making sales calls for 9 months now.

Another example would be using a service to make your work look professional. Last year, I conducted a survey in the same industry as the company mentioned above. The results were significant and very interesting, but the resulting white paper looked kind of blah. I then used a graphic artist who took the content and formatted it with typesetting and graphics that brought immediate attention to crucial information and conclusions of the report. I never could have done that on my own.

The lesson taken is that an entrepreneur/small business owner will never have the skills to do it all, so don’t be afraid to hire a contractor to fill in those skill gaps.

Question: do you have any examples of how you used outside help fill in skill gaps. Also, do you have any suggestions on where to find the help you need?

Do You Appear Too Powerful to Your Employees?

A number of years ago, I did some work for a large service corporation, one with over 10,000 employees. While I was there, I got to know a young person who worked there. This was his first job in a large corporation and he was frustrated. He felt that he could not get along with his manager and that his manager did not like him or treat him fairly. From everything I could see, this person was doing a good job and I did not understand why he felt that way.

I made a recommendation: before doing something that could have a significant and possibly negative effect on his career, I recommended that he sit down and talk to his manager, and tell him how he felt. I suppose that there are those who think that my suggestion was foolish, but I had not seen any sign from the manager that he felt this way about the young person.

The conversation took place, and the result surprised the young person. The manager apologized to him for the misperception. The manager’s remedy was also a great one. Starting the following week the manager and the young person would have breakfast together once a week and they would not discuss business. Rather, they would take time to get to know each other better.

The weekly meetings ensued, and in this case, they worked out very well. The manager and his employee actually became good friends, which they remain today. But even more importantly, the young person was able to use the mentoring he received from the manager to make significant growth that I know helped him enhance his career. The young person also learned an important lesson in management.

What is the lesson in this for us? Not that as a manager you need to be every employee’s best friend, but that you be open to understanding how you come across to other people in ways that you may not even realize. In particular, if you are the owner or head of a small business, you may be perceived by employees as being very powerful and hard to approach, in particular among your junior staff. Be aware of this when you are managing people, and be open to listening to your staff, and it will help you grow a business of loyal employees.

More Efficient and Productive

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.

On the Origin of the Bulldog

My mother passed away several weeks ago at the age of 93. I spoke at her funeral, and as I thought about the stories I might tell, I reminded myself that my mother was the original Bulldog. This story illustrates the point quite well.

My mother drove well into her 80’s, and one day she was driving in the town south of where she lived when she was pulled over by a young policeman. It turns out that she had failed to mail in her registration renewal and it had expired. She accepted the ticket from the police officer, and then told him that she would drive straight home without any stops. He said that, unfortunately, she would have to have the car towed.

So, my mother pulled out her auto club card and started to dial to get a tow. This time, the policeman pointed out that she would have to be towed by the company that the town selected, at her expense. They waited together for almost (a silent) hour until the tow truck came. It was a massive tow truck, and this matters because my mother, at her tallest, barely brushed 4’ 11. I digress on this point for a moment. Lately, there has been a lot of talk about Google’s driverless car. Thirty years ago there was a whole group of drivers that were convinced that there was a driverless car already; they had driven behind my mother!

As my mother’s car was hooked up to the tow truck, she said to the police officer, “I can’t get into that truck, the steps are too high!” That was when the officer made his crucial mistake. He picked my mother up like a doll and placed her on the front seat of the tow truck. If looks could kill, I am sure the officer would have been struck dead on the site. My mother and car made their way home, and somehow, the driver helped her descend from the truck.

That was just the start! My mother began calling her friends and telling them what happened, eliciting much sympathy. The storm gathered and by the time it hit, there were articles in the newspaper, and even one of the state’s senators entered in the fray. When the court summons arrived for the violation, she pleaded not guilty, “I am going to tell the judge what he did to me!”

My mother attempted to talk to the chief of police in the town, but he would not take her call. She then began working on the mayor. After she finally spoke to the mayor, he called the chief and suggested that he take my mother’s call. During that conversation, my mother opened up on him with both barrels, forcefully asking the question, “Would you want your mother to be treated like that? Assuming of course, that you had a mother!” The chief assured her that the young officer would be counseled on his mistake. And, in the interest of peace, the ticket was cancelled.

My Uncle Bernie provided the perfect denouement to the affair, “There’s a police officer in that town that is very, very sorry he ever pulled over Ida Callahan.

Worn Down by Your Business? Beat a drum!

I originally wrote this Blog one year ago, after taking a long-needed vacation during which I attended a seminar on the bodhran, a type of drum played with traditional Irish music. Last year, that meant a few days in Milwaukee. Little did I now where that would lead. On the suggestion of my current music teacher, this year I attended a one week international school for the bodhran, held on the island of Inisheer in Ireland’s Aran Islands.

The school, known as Craiceann, hosted 70 bodhran payers from around the world.When 70 drummers get together, different things may happen such the Gathering Concerto, as seen  on YouTube. Also, here is a link to that concert, as seen on Irish television news. The piece will also give you a taste of the Gaelic language.

I am writing this on Sunday morning of the first vacation I have taken in 2 years. There is so much to do that I don’t know how I can take a vacation right now. I am sure that many if not most entrepreneurs and small business owners often feel this way. Yet, if I allow myself to be completely burned out, my business will suffer. So, here is an idea to help you sustain yourself during busy times. Beat a drum!

Well, maybe not literally, although in my case I do mean so. Several years ago I attended a fund-raiser for a friend’s dance company (Chicago Dance Inc., if you are in or near Chicago, it would be well worth it to catch a performance). I bought tickets for a raffle, and won a free class at the Old Town School of Folk Music. Being of Irish descent, I have long been interested in Irish and in particular the bodhran, a Celtic drum. I enjoyed the class and took another. After the second class, I decided to try my hand drumming at an Irish music session in a pub, where I met my current teacher, John Williams.

I now spend a half an hour practicing every day and 3 hours on Sundays playing the bodhran at a pub. The physical exertion of playing the drum has helped to reduce my stress levels and be more relaxed. The camaraderie of the other members of the music “session” and our common love of Irish music has given me an outlet for conversation that has nothing to do with business, so that I am able to focus on something completely different. As well, playing music in a session is just plain fun! How many of us small business owners and entrepreneurs ever do something just for fun?

Now, I don’t think that every entrepreneur in the world needs to play a drum, but taking up a hobby of some sort, even for a few minutes a day, will help you increase your energy and clear your mind so that when you return to your business you will do so with new enthusiasm. My Irish mother in law used to have a saying, “A change is as good as a break!”, meaning that it can be just as restful to do something different as to do nothing at all. I highly recommend it.

If by chance, you would like to hear some great Irish music, stop by Tommy Nevins Pub in Evanston, Illinois any Sunday between 3:00 and 6:00 PM. You might even spy the Bulldog beating on a drum!

Sustaining Growth – A Practical Example

In last week‘s posting (Sustaining Growth), I introduced a model that would allow a small business owner to understand how fast their company may grow without external financial inputs. In other words, how quickly can your business grow without running out of cash and without infusing new cash from equity or loans. In addition, the model also allows a small business owner to see how other changes and improvements might

The Allowable Growth Rate model that I introduced last week is:

AGR = Net Profit Margin x Rate of Retention x Asset Turnover x Leverage

Let’s take a look at an example: a small business has sales of $900,000, with Cost of Goods Sold (COGS) of $350,000, Sales and General Administration (SG&A) costs of $400,000 for a Net Profit of $150,000. In addition, the company’ owner pays a dividends $100,000 to investors. The business has Capital of $450,000, of which $300,000 is debt and the rest equity.

 AGR   =   16.7%    x    33.3%   x   2   x   2   =  22.2%

AGR     =     $900,000     x     22.2%     =     $200,000

Simply put, with retained earnings of $50,000 (after dividends), the company turns assets over 2 times a year, and has leverage of 2, meaning that internal operations will allow the company to turn the $50,000 of retained earnings into $200,000 of new sales without external funds.

Supposing, however, that the product or service that the company sells has made a hit in the marketplace, and sales could grow much more quickly than that. If the company expands more rapidly, they will be pinched by a lack of capital to sustain the growth.

If it is possible to make improvements internally, you should try. For example, if the company can decrease Cost of Goods Sold, Sales or General Administration Expenses, each dollar saved would be another dollar to be reinvested into the business, all things being equal. For example, a decrease in COGS and SG&A of just 5% would increase Net Profit and AGR as follows

AGR   =   20.8%   x   46.7%   x   2   x   2   =   38.9%

AGR     =     $900,000     x     38.9%     =     $350,000

You could also analyze other operations. What if the company could use its assets more efficiently, thus increasing capital turnover? This would allow them to create more sales with the same assets, thus increasing AGR, again without external financial inputs. The following example assumes that the company is able to increase asset turnover from 2 to 3, increasing revenue to $1,350,000. We also assume that COGS and SG&A will increase by roughly 1/3, as would dividends. The resulting equation for AGR is

AGR   =   27.8%   x   65.3%    x   3   x   2   =   108.9%

AGR     =     $900,000     x     108.9%     =     $1,470,000

Of course, not every company is simply going to increase asset turnover by 50%, but this illustrates how internal change can have a significant effect on financial performance. In reality, you would always want to look at improvement in internal operations as a way to increase AGR, before looking at external financial inputs, such as debt or equity. If you were to seek external financing, a good investor or bank partner is going to want to look at improvements anyway.

 

Sustaining Growth

Every business owner wants to be successful; or at least all of the business owners I know do. However, there are a significant number of businesses that do not succeed in the long term because of how well they succeed in the short run. Most often, this is because the business grows more quickly than their cash flow allows (see Its Cash That Counts and A Simple Tool to Calculate and Track Cash Flow). Adequate cash flow is vital to the success of any business, and it is possible to analyze your company’s financials in order to predict the rate of growth that your cash flow allows.

Allowable Growth Rate will tell you how fast your company may grow without changing any external financial inputs, such as increasing equity financing or loans. The lesson here is to know what your company’s allowable growth rate is without such financial adjustments and then be ready to apply the adjustments when needed. Negotiate the additional equity or loan before you need it!

This posting will look at the Allowable Growth Rate Formula, and next week will follow with a practical example. Here is the formula for Allowable Growth Rate:

AGR = Net Profit Margin  X  Rate of Retention  X  Asset Turnover  X  Leverage

Net Profit Margin: The first term of the formula is simply the percentage of your net profit, which is Net Income divided by Revenues. The formula presumes that the first source of operating cash is your company’s profits. Recall that I mentioned above that this formula addresses the allowable growth rate without external financial inputs. If your company does not yet have net profit, you will automatically need external financial inputs in order to operate at all, let alone grow.

Retention Rate: Retention rate refers to the amount of Net Profit that is retained within the company. For example, the company may be obligated to pay a dividend out of profits, or as the owner, you do not take any personal salary until after all other expenses are met. The retention rate is calculated by dividing the amount of profit retained in the company by the total of net profit.

Asset Turnover: Asset turnover refers to the number of times in a year that your company uses a dollar to move its operations forward. It is calculated by dividing the company’s Total Assets from the Balance Sheet by Revenues. Asset Turnover is a way of looking at how efficient your company is with its resources. This is important for determining your company’s growth rate: the more efficient that your company uses its resources, the greater the allowable growth rate.

Leverage: Although not everyone agrees with me when I state it like this, but Leverage basically tells us who owns what in a company (see DuPont Analysis: Capital, Debt and Equity). If the total capital in a company is $150,000, and the owner’s equity is $100,000, then that means that there is also $50,000 in debt (belonging to the bank or other individual or entity). In this case, capital divided by equity equals 1.5. Debt is used as a lever to increase the amount of capital available to operate the company. In many small companies, there is no leverage because the company has not taken on debt.

Next week, a practical application of the formula.

Effective, Efficient, Repeatable Processes

There are times, when dealing with different situations in business, when I remind myself that patience is a virtue. I ran into one of those times recently, though I will not release any names in order to protect the guilty! In this case, not only is patience a virtue, but the creation and maintenance of effective, efficient, repeatable and most of all, documented processes could have saved a large amount of virtue expended on my part!

Whether your business is large or small, when you reinvent the wheel with every new business opportunity, you are wasting precious resources. Even worse, when process is informal and undocumented, you could be wasting the precious time of a client or a vendor. This is essentially what happened to me. Had I known what was expected of me when interacting with this vendor, we could have been much more efficient. Imagine what might have happened if vendor employees had known what to do as well.

The first quality of a good business process is to be effective. In other words, the process is intended to accomplish something specific and is designed to do so. Forgive the old adage, but if you don’t know where you are going, you are very likely to wind up there! When designing process, always begin with the end in mind, and be certain through testing that the process actually accomplishes what is intended.

The second quality of a good business process is to be efficient. This means that the process should only include only those inputs, outputs and steps that are absolutely necessary to accomplish the end in mind. Many of us have a natural tendency towards complexity and we must resist at all costs. When you are creating business process, ask at each step along the way, “Is this really necessary?”  Think of the other person, be they client or vendor, carrying out the process; will they be muttering under their breath as to why they must perform this action?

The third quality of a good business process is to be repeatable. As mentioned above, the height of inefficiency is to do the same thing a different way every time (or was that insanity?). A process that is repeatable will gradually build up a body of experience that will help to increase efficiency and reduce performance time.

The fourth quality of a good business process is to be documented. What others don’t know they cannot follow! If a process lives only in someone’s mind, then there will be a constant battle to get the process done well. Of course, there are those who would like to preserve their position by keeping control, but that rarely works in the long run.

A final lesson here: a truly agile business will also have a process that handles exceptions to the rule. When an effective, efficient, repeatable and documented process produces an unexpected result, business agility requires that another process be available to handle the exception.

These simple, common sense ideas can keep all of us from expending too much of the virtue of patience!

Kafka Revisited (Or How Not to Give Good Customer service)

Over the last couple of months, I have been dealing with a government agency that will remain unnamed. Over the course of my dealings with the agency, I began to feel like Josef K. the main character of Kafka’s novel, The Trial. Josef K. had been arrested, but all during the legal process, nobody ever told him why, or what was going on.

After each call with a Customer Service Representative of the agency, I, like Josef K., have felt more confused and frustrated than before. Based on this experience, I would like to give you some rules on how not to give good customer service.

  • Give incomplete or misleading information. Never give a customer the complete set of information that they need to know, although it is all right to let them believe that they do have that information at the end of the call. If you are a big company, chances are when they call back they will speak to someone else.
  • Berate the customer. Tell the customer that they should have known that information already. Make them feel that they are stupid for not knowing the information in the first place and should not have called (forget that if all the customers did know already, you might not have a job!).
  • Send the customer in circles. Tell the customer that you are not in the correct department to help. Be sure to send them to a department that cannot help them, and will insist that they call your department back.
  • Keep the customer waiting. Put the customer on hold for long periods of time with awful music and the occasional announcement that “Your call is important to us!” Hang up on the customer from time to time.
  • Don’t call back. When the customer asks for your supervisor, tell them that your supervisor is busy, but will call them back in a few minutes if the customer will leave a name and number. Be sure to lose the name and number immediately after you hang up.
  • Play on the customer’s emotions. Always tell the customer that you understand why they may be upset then do everything you can to aggravate them further.

There is an old saying, “Those that don’t know history are doomed to repeat it.”  I would like to make a modification of that saying to, “Those that don’t know literature are doomed to repeat it.” For the last few weeks I have asked each customer service representative at this agency if they had ever heard of Franz Kafka. Not a single one did!