Business 101 – The Basics
The Prime Directive of Business
My first business adventure started with my little red wagon when I was about 11 years old. In the summer, my dad would buy fresh vegetables from farmers and I’d load up my wagon and pull it around the neighborhood — “Fresh Vegetable’s, Fresh from the fields”, I’d say. Hardly a Fortune 500 endeavor, but the essence of entrepreneurship, I’ve got something you want, and when you buy it I make money.
I think of those days often, and the lessons I learned as a teenager. And what was that all important lesson? As a mentor would later say to me, it was simple, “Nothing happens until you sell something!”. And that is a very important lesson. All too often, I see business owners hung up on “getting ready to sell something” or writing a business plan or spending countless hours working on marketing pieces. Now all of those things are important, I’m not discounting their value, but the reality is, Nothing happens ‘til you sell something; except spending time and money or as some might say, making an investment in your future.
So I start this article with an emphasis on sales. Not marketing, Not advertising, Not brochures or websites…… Sales. Can you get your prospect to take out his pen and checkbook and spend some money? If you struggle asking for a sale, or spend excessive energy and money to get your customer to pick up the phone and place an order, you need to focus on the “Prime Directive” – Make a Sale. As a Bank President once said to me when evaluating my business for a loan….. “if you’ve got sales, everything else falls into place and works—you’re approved”.
Assuming you’ve got sales under control, which most businesses don’t, I’ll move on to other basic business principles that control your future success. Just keep this in mind, not only do you have to make a sale, you have to repeat the sales process, you have to increase the frequency of sales, and of course you have to increase the sales volume. All of which is often easier said than done.
YOU’VE GOT SALES…. But are you making money?
So you bought that widget for a dollar and sold it for two; dang, 100% profit, not too bad. In its purest sense, that one dollar profit is something I call Contribution; others call it Gross Margin. Most of us are driven by our self-talk, you know, those private mental conversations we have while driving, or while in the shower. And that self-talk seriously impacts our decision making. So what’s the difference between gross margin and contribution when I’m doing all that talking? Gross Margin implies profit while Contribution suggests a bigger picture – and that bigger picture is the related costs of making that sale. And at least in my mind, I am constantly measuring how much contribution (how many sales) I need to become profitable. As opposed to the thought that my gross margin shows me making a profit, so I am profitable. I recognize that these concepts may be hard to distinguish from each other, and I may simply be playing word games in a sense, but it’s those mental words games we play in our mind that motivate us, drive us, and make us successful. So bear with me, and accept my concept of Contribution…… but contribution to what? The payment of OVERHEAD Expenses.
ACCOUNTING – GAPP vs Managerial Accounting
Hopefully, you’ve made arrangements with a CPA to do your books; solid accounting is essential to managing your business. And you’ve probably heard of people keeping two sets of books; you know, one for the IRS and one for themselves. Well that is dangerous and could be illegal. First rule, PAY YOUR TAXES.
Your CPA will prepare your financial statements in accordance with Generally Accepted Accounting Principles (GAAP); CPA’s are governed by strict rules on how to account for your financial affairs. You don’t need a second set of books, what you need are internal management reports that provide you insight into your business that you don’t get from GAAP. Let me explain by talking about Cost of Goods sold and Gross Margin; as reported by your CPA.
Marketing & Sales expenses are usually reported by your CPA as overhead expenses. From a managerial accounting perspective, I suggest that the costs associated with getting the customer to buy, like advertising, tradeshows booths, brochures, giveaways, website, and similar expenses are direct costs of the product you are selling; just like what you are paying for the product. Under GAAP, your CPA will not list marketing and sales expense in cost of goods sold; I normally do. And the difference? Your financial statements will report a larger gross margin than my managerial reports.
Now let’s think about that. If you sell widgets that cost a buck and you sell them for $2, you spend $100 on sales & marketing activity; sell one hundred widgets – how much contribution is being made to overhead? Your CPA’s will categorize sales and marketing as overhead expenses, not a cost of goods sold. So your CPA might show your company making a gross margin of $100 on those 100 widgets. My approach shows NO Contribution on your 100 widget sales; because it cost you $100 in marketing to make those sales.
Are we just moving line items around on the income statement, not hardly. What if that $100 expenditure only generated 50 widget sales? Your CPA might report a 50% gross margin and suggest you focus on reducing overhead. And I might say, you lost money on those sales, you need to focus on the effectiveness of your marketing and look at your pricing; maybe you need to charge $3 per widget. But increased pricing reduces sales. Yep, but increases contribution, that’s what is important. We’ll work on increase sales volume once our sales are contributing cash towards overhead. This exercise is often called Break Even Analysis, how many widgets do I have to sell to break even?
GETTING TO BREAK EVEN – then making Money.
There are two basic elements to profitability; Revenue and Cost. If you want to become more profitable, then you can focus on either of these two elements and or both. If you solely rely on your CPA financial statements, you may inadvertently overlook an opportunity to make more money; or at least the best path to achieving that goal. If you begin supplementing your CPA compilations with meaningful managerial reports, you’re much more likely to achieve that success. Don’t just look at the bottom line, make sure you’re providing yourself with the information you need to determine where the problem really lies if you’re not as profitable as you’d like; or as profitable as you think you should be.
My recommendation is to always look to revenue generation; sales. What am I spending? Is my sales force really working? What are the results? What can I do to improve sales performance to get to break even, and beyond.
Often, in financially stressful times, the typical accountants/CPA’s will tell you to start cutting costs. The marketing and sales budget are easy targets for CPA’s, Why? Because CPA’s usually list those expenses as “Overhead”; so cut overhead. And I say, look at how you’re spending those monies. Do you need to change sales staff? Do you need to change your advertising program? Do you need to put the heat on your sales manager? Remember, when you stop selling, your contribution goes down, and with less cash, you’ll struggle even more.
So go back to the basics, how many widgets do you need to sell, at what price, in order to break even? Once you know that, direct initiatives to meet that sales volume and develop strategies to get beyond break even and into profitability.
SO WHAT ARE THE BASICS IN BUSINESS?? – Selling and Delivering at a Profit
Many business owners guess at how to price their products. I’ve actually had business owners tell me that they try to be fair in their mark-ups; not charging too much over what they pay for the product. Now I don’t believe in taking advantage of customers, I do believe in being profitable. Price your product at market, not based upon what you pay for your widget. And make a decision as to your intent: Are you a price leader or a price follower?
I remember years ago in one of my first businesses, we were constantly behind in installations; due to increasing sales volume. I couldn’t hire enough staff quick enough. When I mentioned the dilemma to a mentor, his advice was simple Raise your Price. And I responded, “but I’ll lose sales”…. To which he replied, yes, but you’ll make more money and have better satisfied customers, so become a price leader, charge more than your competitors and when they raise their price to yours, raise your prices again. I did it, it worked, but let me tell ya, that move scared the dog out of me. In retrospect, it was the right thing to do.
So the first step in profitability is pricing of your products. Know your competitors. Know your breakeven point. Know your capabilities. Set your price accordingly. Oh, and over the years who do you think complains the most about higher pricing? Yep, your trusted sales force. Once you raise prices, they are challenged to sell, not just take orders. And if you end up with a salesman that can’t sell, get someone who can and pay them well. I don’t want a “Greeter” at my front door, I want a sales force that has the skill sets, the motivation, and the discipline to grow my company; you should expect nothing less. So if you need to get to break even, look at your sales effort, not your overhead; increase revenue and try to avoid cutting expenses.
And next on the agenda of business basics is product delivery; and that usually means staffing. Invariably over time, companies end up hiring more people than they really need. Sometimes a position is added in anticipation of growth. Other times, existing staff convince management that the workload is too heavy and they can’t keep up. And sometimes, business owners hired extra staff just because they can afford it. Now if you want to be as profitable as possible, you must avoid adding overhead staff.
Like every other element of your business, your cost of product delivery must be identified and kept under control. In our widget example, do we have freight costs? Do we actually deliver? Do we have to service or warranty? We have to generate management reports that keep us informed. If our delivery costs are on the rise, we need to find out why. And we may have to increase pricing, or crack the whip on operations. But critical to delivery costs is knowing what those costs should be, what they are, what to do to maintain those expenses.
SO REVENUE IS MAXED OUT – Now What?
Ok so revenues just won’t rise enough. Time to examine overhead costs. Rent? No, signed a lease. Electricity? Nope, no choice there. Insurance? Hmmm, that would be nice, but not likely. Supplies? Well that’s not much money. So what the heck can I cut? You’re gonna hate this, but look at your staff. Now be careful here.
If you’re at that point where staff cuts must be considered, those decisions must be considered with the Prime Directive in mind; making money. Do you give across the board salary reductions? Do you fire the last hired? Is it time to get rid of that employee you never really liked anyway? Hmmmm, what are you trying to accomplish with your staff cuts?
Here’s what I recommend. Think as if you were just starting your business. Money is tight, future is uncertain. What positions, not people, do you need to operate? How much do you have to pay to get competent people into those positions? Formulate a budget, just like you hopefully did when you started the company. And when you formulate that budget, consolidate positions; think in terms of demanding more work from an employee; not business as usual.
Now you have a platform to work from. You know what will work within the available revenue, and you don’t have to run ads to recruit people. You’ve got your entire staff to choose from, you know their strengths and weaknesses, and you know who is best for the positions you need to fill.
And the tough part, fill the positions and terminate the others. In filling those positions, if you’ve consolidated two or more positions, consider paying the employee you kept more money; obviously not as much as the combined pay of the two jobs, but a pay incentive for the extra work. Once these decisions are implemented, it is important that the remaining staff be motivated to help you become profitable; you want them secure in their jobs, not looking for employment elsewhere.
Now there certainly are other area’s to look towards in reducing overhead costs. And each of them should be carefully examined. A good guide is your company’s prior history. Go back to your financial statements when your revenues where similar to today’s lower sales. Go over your expenditures, your staffing, and profitability to see how you remained profitable back then. You just might discover some things you really don’t need that are costing you money. And of course get rid of those things.
Just remember this: The purpose of forming a business is to make money. And as a business owner that is your job.
Revenue, costs, profit, they are all intertwined. It’s your job to sort through each component of your business and fine tune the machine to make as much money as possible. In good times, business owners relax and lose their edge. I don’t blame them, getting to a point where they can relax took a lot of work.
If you’re one of those fortunate owners who are now on easy street, don’t forget how you got there. Pay attention to your business, get your management reports in order, and constantly stay “tuned-in” to the day-to-day operations. There could come a day when you’ll have to work hard again to protect your empire. Keeping simple best business practices in place and staying engaged in your business is the best insurance you can buy. If a problem begins to develop, make sure you can detect it early and deal with it early.
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