Category: Finance

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.

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…

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.

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.