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A business without a budget

I have been having a running conversation with a person who wants to open up a storefront.  Very good ideas, and he was ready to move fast.  So when I said, “Not to be forward, but what do your budgets show for sales and expenses?”  I was met with silence.  Then a quiet “I don’t have a budget yet”.  Sadly, that is a common response.  And while the business idea may be solid, I really prefer to make mistakes on paper.

Asking about a budget did not shake his confidence in the business.  It actually took a bit more than that.  I shared a customized budget template with him and filled in a few numbers based upon conversations with him.  When he started seeing how much sales he would need to cover cost of goods sold, rent, gas, electric, internet, and that pesky thing called owner draw (that’s your pay by the way!) he started thinking about the volume needed to carry a storefront.  It was only then that he slowed down and started to see the benefits of a solid business plan.

After using this template as a framework to look at his business idea, he backed off from signing a 12 month lease.  And that’s a good thing.  He has not lost sight of his dream, but is now focusing on building up his web sales before investing in the overhead of a storefront.  Now his focus is clearly defining his target market, building up his list of potential customers and finding out not only what they want and need, but how much they are willing to pay.  Those numbers are plugged those numbers into his budget, making an even better plan.

I have often heard that a business plan rarely survives first contact with customers, and I agree wholeheartedly!  But that does not mean that you ignore the basics of finance and sales.  Instead, focus on the needs and wants of your customers as you develop your budgets and business plan at the same time.  A business plan is much more robust when you approach the process by focusing on the customer first.  Take the time to work through the numbers first – whether it is a brand new business, or an expansion of an existing business, it pays to make the mistakes on paper first.

Need help developing a financial framework to look at your business?  Want to see the sample Excel budget that helped him change his path?  Send me an email and I will be happy to share it with you!

Focus on Profit

I was working with a client on tracking his sales and profitability when I helped him uncover over $15000. He had been making a simple math mistake – He was assuming that if he marked up his product by 35%, then his profit would be 35%. All of his research said you should shoot to have a profit margin of 35% to make money for covering overhead. Makes sense, right? Let’s go through the math for determining selling price:

Purchase price $1.00

Markup percent 35%

Selling Price $1.35

A quick math shortcut here is to add 1 plus the markup percent times the purchase price (1.35 in our example) to come up with 1.35 times purchase price = Selling price. We will use this number a little later.

With me so far? Good! Here’s where things got a little tricky: When he was working on his budget, he was pretty good at estimating sales, so to figure out his cost of goods sold, he simply took the estimated sales for May and said if I have $10,000 sales, my profit margin should be 35% of $10,000 or $3,500 (gross profit) to cover expenses. Problem is, he was losing money, and the check book balance backed it up…

Here’s where the math blew up. If you have $10,000 in sales, then you would need to divide by 1.35 to come up with a cost of goods sold of $7,407 and a gross profit of $2,592.59, not $3,500, a difference of $907 and change. In reality, it was a profit margin of 25%, not 35%. While it may not sound like a big difference, a math parlor trick of sorts, increasing the markup percentage so he could hit the goal of 35% profit margin ended up putting over $15,000 in the check book over the next year. All for changing the way he was pricing!

Too busy for training?

Sometimes training seems expensive, until you take into account the savings in time.  Bear with me on the math (I’m a numbers based person!), but if 4 employees are averaging $35,000 per year, and take an 8 hour class that saves them 30 minutes per day, it takes under 2 months to pay off the class and the time spent in the class.  I have seen equipment payoffs of over 3 years in some cases!  After that, the money goes right to your bottom line.

The lesson to learn is that it pays to assess your skill sets on a regular basis and find out where you can get big payoffs.  Spend time where it is important.

 

Annual Wages  $35,000.00
Working Weeks 50
Hours per Week 40
Labor Overhead – Taxes & Benefits 50%
Dollars per hour (wages/weeks/hrs per week)*labor overhead  $26.25
Course Time (hours) 8
Per Student Labor cost during training (dol per hour * course time)  $210.00
Number of people in class 4
Total Student Labor Cost (per student cost * num students)  $840.00
Instructor Cost in Dollars per hour $125
Instruction cost (Instr. $per hour * course time)  $1,000.00
Total Cost – Student and Instructor (instr. cost + student labor cost)  $1,965.00
Total Cost of training per student (*student & Instr. cost / # students)  $491.25
Hours Saved per week as result of training 2.5
Annual Savings (hrs saved per week * working weeks * labor $ per hour)  $13,125.00
Net Savings (savings – cost)  $11,160.00
Months to recoup investment (total cost / annual savings / 12 months) 1.797

 

Focus on the big picture

I met with a department manager the other day who had very little excel experience, he was able to do simple data entry and knew that formulas existed, but not how to create them.  In October we had a talk about training and how long it took to manually do state mandated reporting – about 40-50 hours of summary statistics, all done by hand sorting and calculations.  Call me in January and we can set up some training and set up a spreadsheet that will automate the process, should take under 2 hours for the spreadsheet development and we can cut your total time on state reporting down to under 5 hours, probably under 2.  Most of the data was already entered into MS Word, not in a spreadsheet to enable data manipulation.  No biggie, I thought, copy here, paste there, couple of totals, averages and percentage calculations,  and a year to date summary sheet, wave my magic wand, and ZAP!  Required yearly reporting done in record time.

January rolls around and I called on the manager to see how things are going.  “Not good” replied the manager, “my budget got cut by 25% and it was tight last year.  This year is going to be awful.”

Perfect time to save 40-45 hours of your time, right?  Not according to this salaried manager – his time was already in the budget and all he could see is more money going out of the checkbook, not the time savings that would not translate into cash.  Now don’t get me wrong, I have been there where every single penny counts and there is not enough to pay all the bills.    But to ignore saving 40 hours for under a $200 investment?  Wow…. I am still shaking my head over that logic.  Since it was a REALLY small project, I did not want to get into a long sales pitch showing the benefits of the automation, I just walked away and wondered how much longer that manager would be around. – if your labor is paid minimum wage and you don’t believe the time savings, this is a logical conclusion.  At minimum wage, you must save more than 28 hours to pay off investment.

Is it worth monitoring?

I used to be over zealous about monitoring and tracking EVERYTHING. Now I am just zealous. It took me a while, but I have learned that if you are not using the information, why are you spending time to track it? For a numbers junkie like me, that is a very difficult conclusion to reach. However, after years of tracking everything under the sun, I have found the power of a simple and focused management metric system to be an incredibly effective management tool. It allows you to focus your management time on what you have identified as the most important variables in your business and effectively communicate that information to your people.

Don’t get me wrong; it is vitally important to track information in your business, and critical that you collect the correct building blocks of an information management system. It is much easier to enter a few pieces of data once a day than to try and recreate 6 months worth of data, just because you didn’t think it would be useful. But there needs to be a balance. I have seen accounting setups for small businesses with 150 expense account codes and setups with 4 expense codes. It doesn’t matter if you are drowning in information or starving for information, either scenario is ineffective.

So where do you start with figuring out what data to collect? With the goals for your business.

Lesson Learned: Analyze what you have and what you need, then strike a balance a to make it happen.

Do you know what you are measuring?

I worked with a restaurant owner on his food cost management system.  He was meticulous about keeping his food cost under 30% of sales and had worked out the cost for every item on his menu in a spreadsheet and could rapidly look at the impacts of price changes to his bottom line.  A very nice management system to say the least!  However, he would regularly add all of his food vendor bills and divide by total sales for the week and he was coming up with a food cost of closer to 40% of sales.

I was called in to help him figure out the error in his spreadsheet and he was suspecting he had a theft problem.  It didn’t take long to confirm that his calculations were correct, and he was starting to look through security tapes with a grim look on his face.  While he started down that path, I looked at the other half of his double check, the total of the food vendor bills.  Turns out that he was getting all of his paper products like take out containers, napkins, cleaning supplies, from the same vendors.  The consumables accounted for the difference in the food cost percentages.

Sometimes it’s the small things hiding in plain sight that trip you up.

Focus on the Numbers: Per Unit Cost of Production

What is a per unit cost of production and why should I care?  A per unit cost of production allows you to examine your business over time as the size of the business changes, giving you a much more objective way of measuring performance.  Think of it this way, if you add 5 employees to your payroll and your net income goes up, you won, right?  Maybe, maybe not.

If you take your profit and loss statement and divide each line item by the number of employees for that same time period, you can come up with a per unit (in this case, per employee) cost.  Now when you want to look at two time periods and ask are we doing better or worse, you can reliably answer by each line item.  So if in 2016 first Quarter, you employed 10 people and made 10,000 widgets, you would expect 2016 Second Quarter with 15 people to be able to produce 15,000 widgets.  If you actually produced 12,000 widgets, you better start digging into the numbers more.  If you increased production to more than 15,000 widgets, you may deserve a pat on the back!

Now there are a ton of variables that can affect the per unit cost of production – economy, new equipment, training programs, input cost increases – all will affect the per unit costs.  But at least now you have a tool to help you objectively monitor your business by line item on your P&L.  The fun part is in asking the question why.

Per employee is not the only way to look at your production facility – I have seen managers look at per unit cost by total production, employee, per thousand dollars of investment, and many other ways, searching for the best way of describing their individual business.

Here is a  really cool trick for you to play with:  export a report from QuickBooks into Excel.  Now it is just a matter of adding a column to the spreadsheet, figuring out what per unit you want to look at, and creating a formula to do all the work for you.

Piece of cake… I know!  But that’s another day’s blog post…

The curse of being of too busy

Small business owners are notoriously busy.  I grew up on a commercial farm with 800 acres of crops and 300 cows to milk and I have managed multiple businesses at the same time.  I know busy.  I know long hours.  I know what it takes to make things run.

All of my clients are busy – from the online sales-based businesses to the farms and machine shops.  Not to mention the inevitable curve balls that crunch your schedule even more, tiny windows of opportunity that force 24 hour days, tax season for CPAs,  the death of a key employee.

The response of just about every business owner to a curve ball is put their head down, pull harder, and work longer.  These are managers who are already too busy to read, too busy to hire new person, too busy to keep up with the never-ending stream of deadlines.  But that’s the coveted work ethic that is hard wired into entrepreneurs.  We make things happen.  Somehow, we find a way to push through and get it done.

When I meet with a client I will often say “Perhaps you are spending too much time working in your business and not enough time working on making the business stand by itself.  What if there is an easier way that you don’t notice because you have your head down and are so focused on the work?”

Here are three changes I made to break the “too busy” cycle and transition to balance in my life.

#1 – I walked away from low margin customers.  After telling a brand new BIG customer three times that I could not meet with them when they wanted because a low margin customer already had something scheduled, I stopped and said you know what, I will make it work to fit your needs.  That move made me more in 2 weeks with the new customer than I did in 2 months with the low margin customer.

#2 – I set aside time to work on MY business and MYSELF.  Not my clients, but me.  Time thinking about what I want the business to give me in return for my time.  Time spent in deliberate learning and expansion of my knowledge base.  I set goals, develop new products, and plan how to reach those goals.

#3 – Focus.  I keep my values, mission, goals, and task list aligned and focused.  I know that 80% of the output of my business is controlled by 20% of the input.  I find that 20% and leverage that knowledge by sharing it with everyone in my business.  I say no to things that are outside of the mission.

You have heard about my journey.  What is yours?

 

 

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.