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?

Be Thankful for What We Have

Several days ago, my wife was sworn in as an U.S. citizen in a ceremony in Chicago. Having dealt with the government bureaucracy throughout, we did not have high hopes for the occasion, but were pleasantly surprised by the ceremony that took place. Along with the 140 other new citizens and several hundred friends and families, we sang the national anthem and recited the pledge of allegiance. We watched a video about immigrants and also a music video with the song, “Proud to be an American”. The new citizens recited the oath to their new country.

For me, the highpoint of the ceremony was when the new citizens came forward to receive their certificate of naturalization. Of course, this is the digital age, so there were several new citizens taking selfie-videos of themselves receiving the certificate.

The person that impressed me the most was a gentleman in his 60’s, who really looked the part of an immigrant; neatly dressed but somewhat grizzled, with the rough hands of one who had done manual labor for many years. When he received his certificate, he held it aloft in both hands as high as he could reach to show it to friends and family across the room, and then began jumping up and down in a dance of sheer joy, a wide smile on his face. This was an important moment in this man’s life!

Of course, bureaucracy was on display that day as well. It took longer to check in the 141 prospective citizens than the actual ceremony. The Bulldog noted several quick changes in process that could have cut the time in less than half, but I kept my peace that day.

Afterwards, my wife told me about a comment that one of the bureaucrats made during the checking in lineup. Seeing the long line waiting to check in, she asked how many were there. When she was told that it was 141, she said, “Wow, why so many? Are they giving something away for free? I want some!” My wife had the right thought, but she did not verbalize at the time. I will now, “Ma’am, you’ve already got it, and you don’t even know!”

What the bureaucrat had was the liberty and blessings of being an American citizen. Unfortunately, at least at that moment, she seemed to have forgotten that fact. Many do, including myself from time to time. The freedom to live as I would like, to be an entrepreneur and build a business that supports my family and my community. The freedom to express myself and my ideas. We often take these things for granted, and often it is immigrants who remind about these freedoms.

To quote Churchill, “”Democracy is the worst form of government, except for all those other forms that have been tried from time to time.” (From a House of Commons speech on Nov. 11, 1947).

 

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.

Genial Relationships and a High Performing Management Team

There comes a time in the life of many small companies when outstanding performance leads to growth. The small company no longer consists of the founder and a handful of employees. At some point, it becomes apparent that the founder cannot manage every aspect of operations, much as they would like. The company now needs a management team.

Forming any management team, let alone a high performing management team, is a challenging task. What follows is not a complete guide to the process of forming a management team, but a few ideas that I believe may be lost along the way. Among them are: a genial relationship among managers and commitment by the managers to each other, and to the company.

In the age of demanding executives, it would seem that the way that people relate to each other is less important than it might have been one time. I don’t have to mention names for anyone to think of one executive or another that is highly demanding with their team and less than cordial when their demands are not met. Despite the fame of these highly successful people, I believe it to be the exception rather than the rule.

In the instance of a small company management team, I believe that a “genial relationship” among the team is a crucial element to be high performing. Now, I don’t expect that a management team will restrict their social circle to the team, nor that every member of the team must be best friends, but I do believe that if any member of the team is not well disposed to every other, then there will be problems. By genial, I do mean that when members know each other, their strengths, weaknesses and style, it is much easier to develop the cohesiveness necessary to be high performing.

That is where commitment comes in. I do not describe commitment as a general feeling that one has towards others, but rather the specific things that each member of the team commits to one another and to the company. For example, the management team members must commit to clear communication with one another. Finding out about problems indirectly can be the cause of dissension on a team, so each member ought to commit to going directly to another team member when there is a problem. When team members know each other well and share a genial relationship, it is possible that communication can concentrate on a problem, rather than a person.

Management team members ought to commit to the company strategy. This does not mean that there should not be discussion or disagreement on the development of the strategy, but that such discussion, disagreement and eventual consensus around strategy should focus on the business, not the relationships among the management team.

Finally, management team members ought to commit to the success of each other and the recognition to each other’s success. Becoming successful by pulling another team member down is rarely the path to long-term success for oneself. Helping another team member that is struggling strengthens the whole team. Success is rarely a one person achievement, so that recognizing the participation of another management team member and their employees in one’s own success will lead to a more sound management team.

DuPont Analysis: A Practical Example

The previous Blogs in this series introduced you to the DuPont Analysis; this offering will take up a practical example of how a DuPont Analysis can help you understand the state of a business. The subject of the analysis is a small company that manufactures medical devices of different sorts.  This study uses financials from 2011, at which time the company was about a $1.6 million company. To view or download the DuPont pyramid with pertinent numbers go to this  LINK.

I have discovered that people often feel that financial analysis must be quite complex. Well, yes and no. Large companies with complex business structures can be time consuming to analyze. However, in my experience, small business analysis does not need to be complex at all. As a matter of fact, the problems that a small company may be experiencing are not usually very difficult to pinpoint through financial analysis. The example that follows should give you a feel for the relative simplicity of analysis. Of course, if the numbers themselves are off, so will the analysis, but for the sake of example, the numbers presented in this analysis are accurate.

At the top of the pyramid we have a Return on Equity of 25%. In other words, for every $100 of equity invested in the company, there is a return of $25. Now, how are we to interpret that? There are several aspects to consider. If the company was expecting a 15% return, they are doing quite well. On the other hand, if they were expecting 35%, not so well. The previous year Return on Equity was 26%, which gives you one clue, meaning that the current year is down just a bit. However, the current year’s revenues are up by 16%, so there may be something amiss.

In order to understand better we must go deeper into the pyramid. Return on Capital is 23% with leverage at 1.09, meaning that the small load of debt that the company is carrying is actually improving return on equity (23% X 1.09 = 25%). So the problem is not that the company is over leveraged. As we continue down the left hand side, Net Profit Margin at 23%, Operating Profit margin at 30% and Gross Profit Margin at 72% all seem to indicate that the company has cost under control. On the other hand, perhaps the company could boost returns by increasing leverage. Using debt to increase capital for the purpose of increasing investment might be an option.

When we look at the Total Asset Turnover Ratio (also known as Capital Turnover Ratio), we begin to see the tip of an iceberg peaking above the water. The 1.0 indicates that the company is probably not using capital efficiently. At 1.0, the company is turning each dollar of capital over once a year. So, before the company goes looking for increased debt, they must discover why their use of capital is not more efficient.

We can see that Working Capital Turnover is just over 2, which could be an indication of where the rest of the iceberg is hiding. Working Capital is the amount of investment that is used to keep the company operating. It includes inventory, payables and receivables. Another way that this is expressed is in the Cash Cycle, how many days does it take to circulate a dollar in the process of creating a product, collecting that dollar from clients and paying to vendors.

As we can see, in the pyramid, this company’s cash cycle is 613 days long. Of that cycle, inventory is 554 days. This means that  it takes the company 555 days to circulate a dollar in their production and sales process, including both raw materials and parts purchased from vendors, work in process materials that are unfinished products and inventory both on the company’s shelves waiting to go out  or already on a distributor’s shelf waiting to be sold.

The real problem facing the company is that they are tying up capital in their inventory, making it difficult to deploy that capital for other reasons. For example, if their sales were to create a breakthrough, and they required additional manufacturing capacity, it would be difficult to do without taking on additional loans. But, would they want to take on increased debt when their use of that debt is so inefficient.

The real key is how to shorten their production and sales cycle, so as not to tie up large amounts of capital. The solutions could be improved manufacturing methods such as the use of Just in Time, better forecasting the marketplace for demand and paying closer attention to the inventory on distributor’s shelves. The company would do well to fix this problem before it became an even greater challenge, impeding future growth. In addition to fixing the problem, the company needs to monitor the level of both inventory and working capital closely, to guard against future reoccurrence.

As you can see, understanding the way that financial reports give a vision into the state of a company is not all that difficult. Using the tried and true DuPont Method will afford you that vision into the state of your company, and is well worth the time spent to produce the numbers that “don’t lie”!

The DuPont Method: Activity Ratios

In our last Blog entry, we discussed Profitability Ratios, which can show you how well you are doing at making a profit. As a component of the DuPont pyramid, profitability ratios show you how well you are using your capital to generate sales (click here for an image of the pyramid).

The other component of Return on Capital consists of the activity ratios, which measure how well your company is using capital to support operations. It is often said, “It takes money to make money” and the activity ratios illustrate how well your company is using that money to operate. We should mention, first off, that although we use dollars to calculate ratios, often those dollars refer to non-monetary assets, such as equipment, plants and inventory. The dollar amounts may also denote credit and debt, which we will explain a bit later.

The top activity ratio in the DuPont pyramid is total asset turnover ratio. This ratio tells us how many times a business turns a dollar over during the time period studied. Another way to describe this ratio is to say how many times a dollar’s worth of assets creates a dollar’s worth of sales. The ratio is calculated as follows:

Sales
Average Total Assets

Average total assets is determined by dividing the sum of total assets at the beginning of the time period studied with total assets at the end of the period, divided by two. If a company had total average assets of $100,000 and had sales of $200,000, the Total Asset Turnover Ratio would be 2. In other words, each dollar of assets was “turned” 2 times during the time period. The more times that a dollar of assets is turned, the more efficiently you are using your capital.

Fixed Asset Turnover is especially important to those that have large investments in fixed assets such as plants, machines, trucks and other equipment. The Fixed Asset turnover ratio will tell you how well your company is using these assets. It is calculated:

Sales
Average Fixed Assets

If your company has $50,000 in fixed assets and $200,000 in sales, your Fixed Asset ratio would be 4. In other words each dollar of these assets was turned 4 times. The importance of this ratio is not only in how well you use your assets internally, but also in comparison to your competition. If your ratio is 4, and your competition is at 8, then you are much less efficient, and will find it hard to compete. If your competition is that much more efficient, they could lower prices to be more competitive.

The final activity ratio that we will look at is Working Capital Turnover. As you may recall, working capital represents the assets and cash that you need to keep your company operating. In previous Blog entries, I have often explained that a fast-growing company that is not well financed may run of cash and go out of business, despite success at selling a product or service. This ratio is also referred to as the cash cycle, in other words, how long does it take for a dollar to be create a product or service, and then be received back as payment.

Monitoring Working Capital Turnover will help you avoid that pitfall. There are three components to this ratio:

  • Inventory Days: the number of days it would take to sell the inventory that you have on hand at your current sales rate.
  • Receivable Days: the number of days, on average, that it takes you to collect a dollar of receivables. In essence, this ratio lets you know how much “interest free” credit you extend to your clients.
  • Payable Days: The number of days, on average, that you take to pay a dollar of payables, the interest free credit that your vendors extend you.

The ratio is calculated:

Inventory Days X Receivable Days X Payable Days

If for example, your Working Capital ratio was 45, meaning that it takes 45 days to use a dollar to create a product or service (including paying for suppliers) and collect that dollar back in receivables. Many manufacturers and distributors keep too much capital tied up in inventory. Small manufacturers’ that find themselves in a cash crunch need to look at inventory, including Work In Progress, to be sure that they do not have too much on hand.

All businesses need to pay attention to receivables and payables, which are nothing more than credit that businesses extend to each other. Many a small business has gotten in trouble by purchasing goods and services at Net 60 and selling at Net 90. You must keep payables and receivable in balance in order not to have large amounts of cash tied up in this type of “loan” to your customers.

Now that we have covered the basics of a DuPont Analysis, the next Blog posting will be a practical application of a DuPont Analysis.

The DuPont Method: Profitability Ratios

As I first mentioned in this Blog two weeks ago, a good financial analysis can lead you directly to the source of most problems within your business. Yet, many small business owners and entrepreneurs don’t spend a lot of time on financial analysis, or only do so superficially. The series of Blog posts on the DuPont Method of analyzing financial performance will give the small business owner and entrepreneur an excellent set of tools to begin doing financial analysis on their business. For a diagram of the DuPoint Method, click here.

Net profit is a good thing, although it should never be confused with positive cash flow (see the Blog It’s Cash That Counts).  When your net profit is not where you want it to be, digging deeper into the profitability ratios can help you understand why.  Let’s start with Net Profit Margin which shows the percentage of each dollar of sales remaining after all costs and taxes are paid. The Net Profit Margin formula is pretty straightforward:

Net Profit
Sales

The key to remember here is that the Net Profit Margin is an indicator of how your business is doing, financially, but it does not tell us much about the details. Underneath Net profit Margin are two other ratios that can lead you to understand why you have the net profit that you do. On the one hand, you have direct expenses that your business incurs to create the product or service that you sell, and on the other hand you have operating expenses that your company incurs to support the production of that product or service. If either one is out of line your bottom line will be affected.

Examples of direct expense could be the cost of materials in manufacturing, or the wholesale price of a product that a company distributes. For a service company, the cost of consultants or other employees that create and provide the service is often the largest direct expense. Operating expense might be rent, utilities, and internal company services such as human resources or accounting. Now, there are eternal arguments on what constitutes a direct or operating expense; I am not going to take that up here because it is really the topic for a dozen other Blog postings!

When we decompose Net Profit Margin into its’ constituent parts we are able to see two things clearly, how well the business is operating and how much tax is paid to the government:

Operating Profit Margin X Tax Rate

I will leave it to the lawyers and accountants to take up tax rates, but Operating Profit Margin is the key to understanding how profitable your company is. The constituent parts of this ratio will reveal to you how well your company is doing both with direct expense and operating expense with this formula:

Operating Profit Margin = Gross Profit Margin X Operating Expense Margin

Gross Profit Margin represents the percentage of each dollar amount that remains after paying for the direct expenses. Its formula is:

Gross Profit
Sales

Gross Profit Margin represents the percentage of each dollar of sales that remains after paying  direct costs for providing goods and services. This ratio will tell you how efficiently your company is at creating products and/or services. Knowing the history of this ratio will be helpful, but even more important is the comparison to you industry. If your company cannot provide equivalent products and services at a similar cost, you will have difficulty competing in the marketplace.

Operating Expense Ratio (sometimes called Selling, General and Administrative expenses, or SG&A) represents the percentage of sales that go to the general operations of the company. The Operating Expense Ratio is calculated as follows:

SG&A
Sales

In effect, there are two areas of a company that drive profitability, the cost of the product or service that the company sells and the cost of general operations to run the company. If either one is larger than it should be company profitability will suffer. Some companies have problems with one or the other, and at times some companies have trouble with both.

Next week, we will introduce activity ratios, and the week after, have a complete example of a financial analyisis, including an spreadsheet that you will be able to use as a model for you own company.