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Why do we have managers who can’t manage finance?

The failure rate of startups has always dismayed me. In my consulting, I see two main reasons for business failure. First, people don’t have a firm grasp of their financials. They just don’t know their numbers. Second, people underestimate the toll on their physical and mental health. Depression, divorce, heart attacks and strokes from stress are all too common and dismantle many companies that have everything else going for them.

Let’s look at the first reason for failure – Managers who can’t manage finances. The bulk of our entrepreneur class consists of people who start a business out of passion – I love to bake, to farm, to fix computers – but they don’t have any business background. How do they get their start? They are disgruntled employees who are so fed up with the way their boss does things that they quit and start their own business, with the barest of plans.

If you think about it, the entire restaurant industry has managers who do nothing but sooth irate customers and make sure people show up for work. Manufacturing is no different. From line managers to shift managers, financials are hidden from people. The focus is make your production numbers, or we will find someone who can. Anyone who has had a sales job knows it is all about hitting the sales quota. Just sell more, more, more. Rarely does anyone get to see the whole financial picture.

Is it any wonder todays entrepreneurs are missing critical skill sets? Budgeting. Reading financials. Financial controls. Cash flow. Profit and loss. Balance Sheet. Net Worth. Top that off with the misconception that having a CPA do their taxes once a year is more than enough and you have a small business at a disadvantage.

Here is a news flash. If you can’t put your hands on rock solid financial numbers to back up a decision and plan for the future, you are not managing. You are working hard and hoping for the best. Maybe it’s time to start working smarter, not harder. Focus on your financials.

Focus, but on the right thing.

Last week I met with a sales professional who was pretty darn good. At sales. She told me “last year I made 88 thousand. But in November, things got slow, and now in February, I have nothing left. I have been eating off of credit cards, and I don’t know where all that money went. I have over $12,000 in credit card debt.”

It’s not an uncommon scenario among people who make a living off of sales commissions. Real estate agents, car sales people, insurance agents – all of them are able to “sell” their way out of a financial hole. So how did she get in this financial hole? For starters, she was focused on one goal. Sell as much as possible. Generate lots of income. Period. Strong sales compensates for weak financial management skills, and when the sales dry up for whatever reason, the crash is hard and fast.

The solution?

First step: Change your focus. From sales, to net worth. Choosing the right metric makes all the difference in the world. Set realistic financial, sales, and personal goals.

Second step: Find out where you spent all the money. Download your check book register to QuickBooks, Excel, or any other program that lets you sift through the data easily and find out where you spent your money.

Third step: Create a budget. Replenish your cash reserves, plan not only your income and expense, but also your assets and liabilities. Make the budget robust enough to handle the variability in your income stream while adding to your net worth.

Fourth step: Develop processes that support your goals. Formalize your sales process to fill your sales funnel from prospects to sales. By keeping your sales funnel filled at the top and following your process, sales droughts are leveled out and financial stresses are reduced. Follow the sales processes religiously! Develop financial processes that alert you well before any financial issue becomes a business threatening disaster. Build in automation to make sales and finance functions efficient.

Fifth step: Breath. Control your thoughts and don’t panic. Decisions made in the heat of the moment are rarely good decisions. Gather data, develop a solid plan, and implement.

That’s the path out.

 

The Hidden Cost of Debt

Debt is a topic that gets people fired up.  It can make you money.  It should be avoided like the plague.  Classic good vs. evil arguments.  To me, it is just another tool that you can use.  From a business standpoint, it is very important to understand the impacts of debt and why it is called leverage.

Look at the table below.  It represents two scenarios – one where a company is making money, and another where the company is losing money.  I want to focus on ROA – Return on Assets, and ROE – Return on Equity.  If there is no debt, they are both the same.  But with debt, someone else owns a part of your company, and the amount of equity you have invested is less.  When you borrow money and have a good year, your ROE grows substantially more than the ROA.  In the example below, the difference is 20% ROA and 100% ROE.    Borrowing money allows you to make a substantially higher return on your portion of the money invested in the business.

Now for the other side of the coin.  What happens if you have a bad year?  In the second column, you see a company with 1 million in sales lost $50,000.  That’s a shortfall of 5% of total sales, and I have seen folks argue that is not much in the grand scheme of things.  But look at the ROA.  That $50,000 loss translates to a 10% loss in total assets.  And when you look at equity, that amounts to 50% of your equity in the business.

Leverage works both ways.  With debt, if you are making money, your equity grows much faster than without debt.  If you are losing money, your equity disappears much faster too.

The bottom line is, debt is an accelerator.  Make sure you know the direction you are traveling before stepping on the gas.

 

  Making Money Losing Money
Sales  $      1,000,000  $  1,000,000
COGS  $         400,000  $     600,000
Gross Sales  $         600,000  $     400,000
     
Total Expenses  $         500,000  $     450,000
Net Income  $         100,000  $      (50,000)
     
Assets  $         500,000  $     500,000
Liabilities  $         400,000  $     400,000
Equity  $         100,000  $     100,000
     
ROA 20% -10%
ROE 100% -50%
     
Equity AFTER Net Income or loss  $         200,000  $       50,000

Marketing Math

Everybody loves math! I know, people always tell me so! Hmm, now that I think about it, perhaps they were being sarcastic. What do you think?

Seriously, it is important to make decisions based upon solid numbers. Today, I want to talk a bit about marketing math. Anyone who has listened to a sales pitch for advertising should consider a few calculations before spending any money. How much does it cost you to acquire one customer? How much does one customer spend over their lifetime with you? How much do you spend to purchase the product you are selling – which is called Cost of Goods Sold (COGS)?

Here are the math formulas for you to follow along with:

Cost to acquire 1 new customer = Marketing campaign $ divided by number of NEW customers.

Lifetime spending = Average sale times average times per year a customer buys times average years a customer buys.

COGS = how much you paid for your product. If you are making or assembling a product, add up the component costs plus the labor to assemble or produce. If you know what your sales margins are, you can use that percentage to come up with an average COGS.

Now for the number crunching. I have seen people say it costs me $100 to acquire a new customer, they buy about $500 worth of product over their lifetime with us. Good deal, right? Maybe… Depends on how much your COGS is. If you spend $100 for COGS, you have 300 to go to overhead and marketing. More than $400 COGS, and you have a real problem. You have not covered the COGS and additional marketing costs might be pushing you into a rising sales and falling profits scenario, a very dangerous place to be. There are other cost factors to consider, but this simplification is a good starting point.

This is why so many businesses go under during a sales growth period. Perplexing to the folks who don’t understand the numbers and it is hard to catch in time. But if you have rising sales and yet cash flow is getting tighter, that’s your sign to delve into the numbers. Ignore the euphoria when sales are growing fast and focus on the bottom line. That’s what is important.

If you find yourself in a low margin business – businesses like grocery stores, farm markets, and gas stations, what can you do? Lower the cost to acquire a new customer, develop loyalty programs to get your customers to buy more frequently and keep them longer, and add symbiotic products to raise the average a customer spends with you.

For many, this kind of math is as boring as watching paint dry, but if you want to play the entrepreneur game for a long time, you had better get used to it. Because if you wait until tax time to figure out you had a year of costs rising faster than sales, you won’t be around for long. Don’t like doing the math? That’s fine, we do.

Do you know what you don’t know?

I met with a plant manager a while ago about training his line managers to become proficient at Excel. You know, that fun number crunching spreadsheet program that people love to hate? So we sat down and I started asking questions. What skills do your line managers currently have? How many people? What do you want them to know how to do? So after about 10 minutes, I have a pretty decent idea of the skill level they were at, and where he wanted them to be.

I asked if he was going to be in the classes, and he quickly said, no, I know more about Excel than all of the line managers. I responded no problem, just checking.

Then I asked him to pull up a spreadsheet that he wanted the line mangers to be able to use so I could tailor the training to something they would use every day. He loved the ideas, and quickly pulled up a spreadsheet the mangers would need to use daily and a calculator, punched some numbers on the calculator and said “We take the daily production numbers, divide by hours of operations and plug the hourly rate in this cell right here”.

I stopped.

I stared.

I shut my mouth and tried very hard to be diplomatic. Because this self-proclaimed Excel expert that didn’t need training had missed an easy one. For those of you who don’t know anything about Excel, it is basically a giant glorified calculator with a monster memory. If you have Excel open, you don’t need a calculator, it is the calculator. On top of that, every time you reenter data, you double the chance for data entry error. I responded, “Is there a reason you don’t use Excel for the calculations?” He looked at me blankly and said “What do you mean?” So I showed him how to enter a formula in Excel to do the calculations automatically. He looked at me sheepishly, and said thank you. That was it. Never mentioned it again, never showed up for class.

Here is my question to you: Do you know what you don’t know? Because that’s what can hurt your business.

And if you don’t know what you don’t know, that’s ok. Call us. We can help fill in the gaps.

Production skills vs. Business skills

It doesn’t matter if you can build a house faster and better than your competition, if you can’t pay the bills on time, you will spiral down and out of business.  Most of us start a business born out of passion – for building or creating something that gives us joy.  When you started your business, no one told you that production is only one component of being a successful entrepreneur.

Here are six areas that exceptional entrepreneurs need to do well in:

  • Management and Leadership
  • Wellness
  • Finance
  • Sales and Marketing
  • Technology
  • Production

How do your skills stack up in these areas?  Want to learn more?  Download the Success Score Card and see for yourself.

What is the Success Score Card?  It is an assessment tool that forces you to look at the connections ACROSS your business.  It is a benchmarking tool that shows what is possible and your comparative strengths and weakness.  It provides a valuable outside viewpoint to help evaluate your business skills.

What you don’t know can kill your business.  Find out where you stand.

Mental Monday

I truly admire Jenny Lawson.  Her post this morning really struck a cord with me:  http://thebloggess.com/2018/01/31/escape/

We are all stronger than we think we are.  Jenny fights a thousand demons each day, and yet manages to write books, blog posts, and keep on moving.  Entrepreneurs must do the same thing.  Some days you win, some days you lose.  But each morning, you get up and get back in the game.  We are stronger than we think we are.

But be careful.  Strong as we are, the mental illness rates for entrepreneurs is significantly higher than the general population.  Alcoholism, drug abuse, divorce, depression, anxiety, anger issues, suicide, you name it, we have got it in spades.  There are some games you DON’T want to win.  We tend to push ourselves harder, take on more stressors, and not take care of ourselves.  Pay attention to your mental health, because without it, you risk losing much more than your business.