Whenever I talk to business owners about their business success they’re forever talking to me about how they are increasing their sales and how well they are marketing their products or services. But while sales are really important for your business success there are many other aspects of a business to get right to truly be successful. In this article, I will be going to explore 7 of these commonly overlooked signs of business success.
1 – Business Plan
The obvious first one is to have a business plan. Once you have a business plan you need to understand your financial statement and use them to monitor your financial position. Do you know your breakeven point or are you oblivious to the relationship between your price, your volume, and your costs? Making a profit is one thing but you need to manage your cash flow to stay in business. One of the major uses of cash in your business is growth. If you are growing your business do you know how much cash do you need to grow? Once you know how much cash you need, getting your borrowing structures right can really help you concentrate on the main thing. Don’t forget to plan on the end game transitioning out of your business.
Have a plan not just a vision there an old saying we’ve all heard, which says “Fail to plan; plan to fail”: I actually don’t think it’s quite as bad as that but my gosh it comes close. Let me give you a little example. It’s okay if you don’t have to plan in your business, but if you are not planning it would take you a lot longer to reach your goals and objectives. You will end up fighting a lot more fires and having a lot more stress along the way and you won’t end up in as good financial position as if you take that bitter time out to do some planning. Now when I’m talking about planning there are lots of different types of plans. I mean there’s this great big 200 glossy planning documents that you see. But there’s also just the plans that you might have for the next 3 months (90-day sprints) of it might even just be planning out your day. The big thing about plans and the one thing that I really want to get across to you in this article is you have to write them down. If you don’t write them down it won’t take long until all the day to day things you have to do in your business will take over and your plans are neglected and start to become a bit fuzzy.
A business plan even one written on the back of a scrap of paper helps to clarify your objectives and keeps you focused on your goals and objectives. Now if you want to find out more about planning you can check out our other articles and tools on our website. Once you’ve got your plan in place and have started to implement it you’re going to discover that not everything goes according to plan and this is why it is important to monitor how you are going.
2 –Financial Reports
Now there’s a world of information for you to monitor your progress, one way is to understand your financial statements, you know those pages you get from your accountant if you only you knew how to read them. The starting point for understanding what your financial reports are telling you is the concept called the financial operating cycle. The financial operating cycle describes how every business operates financially. I’m going to start this description from the beginning.
Now when you first go into business what do you do. You get all the cash, all that money together you can to put into your business to get it and running. We call this net worth or equity. This is your money, the owner’s money invested in your business. Now the owner’s money is not always enough to get the business up and running. So what do you do? You get some money from other people. You borrow some money in accounting terms the borrowed money is called liabilities. I like to call it other people’s money. So what did you spend it on?
We’ll you’re going to spend it on things like debtors, stock, plant and equipment, computers, motor vehicles, land and buildings. You know thing us accountants like to call assets this equation I’ve just shown you is one of your financial statements. It is the balance sheet this is what a balance sheet tells you. Where did you get the money from? You know the owners and other people and where did you spend that money? On what assets? Why did you buy the assets? Well of course to make sales. Sales are the main activity of your business. Of course, once you have sales. You’re going to have some cost of sales and expenses hopefully your sales are greater than your expenses and you make a profit. This, of course, is your other financial statement the profit and loss or income statement. I’m hoping you are starting to see a relationship between your balance sheet and your income statement.
You get everything together on your balance sheet so you can do all this activity, your day to day stuff on your income statement. The relationship doesn’t end there if you’ve made all these net profits after tax. What do you do with it? Well, there are 3 things you can do with your profits. Firstly you can re-invest them into the assets of the business by more assets and you have the capacity to grow your sales.Secondly, you can use them to pay back some of those other people your liabilities and get your debt levels down to a level of risk that you are comfortable with. Thirdly you can take the profits out of business. You could take profits via dividends or wages or super and spend that cash on your desired lifestyle.
This financial operation cycle is how every business in the world operates. It does not matter how big you are or how small you are, it does not matter what industry you are in. They all operate the same way financially. Once you understand this financial operating cycle I guarantee your financial statements will begin to make more sense to you. You will then be able to monitor the areas of your business that will help you to be more successful. One of these areas, of course, is your income statement. When looking at your profit and loss or income statement it is important to remember you are really looking at the efficiency of converting sales into profits or in other words the relationship between the price you charge for your goods or services, how much do you sell the volume and at what cost?
3– Breakeven Analysis
This leads us to breakeven relationship, it’s a fabulous tool and it’s a very simple tool to use. In fact, there are only 4 steps involved in how to calculate it. Now, most people use Breakeven to tell them the point where their business makes no profit but it also makes no loss. You’re probably thinking why I would want a tool that tells me at what point I want to make no profits. The reason, this is the point you have to get the pass to start making profits this is your first milestone you’ll want to reach.
Breakeven is not just for telling you what the level of sales you have to get over before you start making profits. It can also help you with day-to-day decision-making what if your cost were to go up like your rent or insurance premium. In fact, it could be any cost going up. What have you got to do in your business to continue to make the same amount of profit if your cost goes up? Now I know you’re sitting there thinking “if my cost goes up I’ve either got to get out there and put my prices up or I have to get out there and sell more. Now we all know that what our gut tells us but your gut doesn’t tell you is how much to put your prices up by? Or how much more do you have to sell. Breakeven can tell you exactly how much more you’ve got to sell or exactly how much you have to put your prices up. Let me give you an example one of my customers Bob. His landlord put his rent up by $24,000/year, just take a moment and think about your own business if your landlord put your rent up by $24,000 how much more sales would you need to do to cover that so that you continue to make the same amount of profit. Now I know a lot of you have come up with different ideas in your head about what it might be. For Bob, at his cost structure, yours is likely to be different. Bob needed to make another $150,000 in sales. I can pretty much guarantee you, none of you was thinking $150,000 and yes your business might not need as much as Bob.
The point here is you know you have to do more than $24,000 you just don’t know how much more. Breakeven can tell you that figure. If you do not know this figure you will not find out if you have done enough extra sales until after you get your financials at the end of the year.
If you have not done enough sales you would have made less profit. The magic of Breakeven is you know what your target is to maintain your profit at the moment the cost changes and you will know what the impact of your profit will be even before you see your financials keeping you ahead of the game. But Breakeven it’s not just about the increase in cost we can also use Breakeven to help with resourcing and growth decisions. You know what if you wanted to put on a new employee how much more sales would you need to get to justify that or maybe it’s to buy a new piece of equipment or open up a new office or branch or store somewhere. You can use Break Even to help you understand how much extra volume you have to do to make it a sensible investment. We’ve looked at your cost changing but you could also use Breakeven to look at the impact of pricing changes. Let’s say your competitors are putting their prices down and you want to follow them. What have you got to do to maintain your profit you are either to have sell more or get rid of cost. Let’s use Bob again as an example. What we did is we put Bob’s prices down by 2% and with Bob’s cost structure it meant here to do 14% more volume just to make the same amount of profit. Let me repeat that a 2% price decrease means Bob have to do 14% more work if he doesn’t get 14% more sales he will make less profit. I am hoping this will make you think twice before you discount in your business. We also did the opposite scenario for Bob and we’ve put this prices up by 2% now for Bob’s particular business with his cost structure this meant he could afford to lose 11% of his volume and he would still make the same amount of profit.
Now if Bob didn’t lose 11% of volume he would make more profit. My question for you is if you put your prices up to 2% on average how many customers would you lose. If your answer is none or not many why haven’t you put your prices up? You should be regularly reviewing your prices and putting them up now as often as you can get away with it. Now to find out how to calculate Breakeven get in touch with us or head over to tools and resources section of our website.
4 – Working Capital Cycle
Now when you have your profit and loss statement working efficiently and you’re making a nice profit you would think you would have a lot of cash, that’s not always the case as cash and profit are not the same things. The 4th thing of successful business is to manage cash flow somebody once said to me profit is a matter of opinion it is something your accountant puts together for you but cash is real, cash is key, cash is the lifeblood of your business and I have to agree with it.
If you ran out of cash, if you cannot pay your bills as in when they told you, you are out of business. Whenever I look at a business one of the first things I want to understand is how the cash flow from/through the business. A great starting point to understand how cash flows through your business is a concept called the working capital cycle. Every business has a working capital cycle but they’re not all the same. I’m going to start out with a generic working capital cycle and then I’ll talk about retailers and service businesses specifically.
You start off with the money or cash in your bank account now your money sitting in your bank account is not good to you. You want to use that cash to make profits. To do this you first need to buy or doing something to sell. In this case, you’re going to take the cash out of the bank account and go and buy some the stock. The stock comes in and you fill up your store or your warehouse or your garage at home, wherever you put your stock. By the way, if you’re in a business that has stock, one of the things I’d like you to do is, sometime in the next couple of days go to where most of your stock is, stand in the middle of it, close your eyes and imagine that stock as bags of cash. But they are bags of cash you cannot use the cash until you sell the stock!
For some of us when you sell your stock you get your cash straight away either as cash or as credit. For others, though you sell them credit, you issue invoices and end up with things go Debtors or Accounts Receivable this where you become the banker to your customers what you were doing is you are lending your customers the money to buy your goods or services.You hope they pay you back eventually and the dollar comes back into your bank account. The reason we are interested in this cycle it’s all about how long or fast it takes for your dollar to go all the way around the cycle. If you can turn your dollar faster around the cycle, it means one of 3 things for you.
The first thing is if you turn your dollar around faster you end up with more cash back into your bank account that’s more cash you can do other things with. The second thing is if you are using an overdraft to fund your working capital cycle you may be able to reduce your overdraft by turning your cycle faster and operating your business more efficiently. The third thing if you are growing your business when you grow a business you need more stock or more debtors. But if you turn this cycle faster you don’t need as much more stock and you can grow faster without chewing up as much cash. It’s all about how fast can you turn your dollar around this cycle.
I said at the start of this not all businesses are the same the retailers out there are reading this saying “I get everything in cash and credit cards I don’t have debtors”. You would be right, your cycle just goes from cash to the bank to stock and back into cash. That’s a bit simpler, however, the biggest killer of details no matter where you go in the world is poor management of stock. A bill comes in I can’t pay it because all my cash is tied up in the stock on the floor you’ve got to turn your stock and make sure your cash is working for you. I know some of you are sitting there saying “well hold on a second I’m a service business I don’t have stock” and again I would agree with you. However, you have something that acts a little bit like stock it’s called Work in Progress (WIP). Basically, you take on a job from a customer you do all the work for them then you send out an invoice. Now when you are doing all that work before you send out your invoice what do you have to pay out? Do you have to pay wages? Do you have to pay rents? Do you have to pay out general your overheads? If you do then it’s chewing up your cash. The cash is further chewed up when you send out an invoice and you have to wait for your dollar come back into the bank account. Whatever business you’re in you have a working capital cycle it is important to understand how the cash flows through your business so you can find where your cash is hiding. Now you usually measure the speed in days. How many days on average does that stock sit on the shelf for before you sell it? How many days on average does it take you collect your debtors? Turning your working capital cycle faster frees up your cash. To get a better understanding of your cash flow you should put together a cash flow budget head over to our website or speak to us about how to optimise cash flow.
5 – Managing growth
That brings us to our next step managing growth. My first question for you is why do you want to grow to make money is a common answer again the real answer is to make more profit. If you are going to make more profit how do you measure growth most businesses measure growth through sales. Thinking if your sales are going up then your profits are going up I have no problem with you measuring growth in sales as long as you manage your cost correctly more sales should equal more profit. But here’s the thing if you are going to get more sales then you are going to need more customers and if you have more customers that mean you probably need more product or stocks, sell them if they are buying credit you’re going to have more debtors you may need more staff, more equipment, computers, motor vehicles etc. You may need to move into a bigger premises to give you more space, more sales means you need more resources. Do you need these resources before or after you make the new sales?
Most businesses need these resources before they make the sales if you buy this resources before you make the sales where does the cash come from pay for them it will need to come from the owner’s net worth or other people’s liabilities. For most businesses it usually means going to the bank this is why more sales quite often means less cash for many businesses as your sales go up your cash goes down, eventually your sales come in to pay for some of this back, but while you are growing your cash keeps going down because you keep having to buy more resources. You end up with a gap between your sales coming in and how much sales is going out. If you are growing you need to know what other resources you would need are. A useful tool called financial gap analysis helps projects what’s your balance sheet may look like if you hit your growth target, if you are interested in this, get in touch with us.
6 – Forecasting
Financial gap projects how much assets you may need. Once you know how much assets you might need then you will need to know how you’re going fund those assets funding will come from either yourself in the form of net worth or equity or from other people your liabilities. If you have no more equity to put in then you will be asked in your liabilities that is you’ll be borrowing the money to fund your growth if you are asked in the bank to fund your short call for your growth are you structuring it the right way and this brings us nicely into borrowing properly to structure your borrowings properly there is cardinal rule you need to remember. Match the life of the loan to the life of the asset. To explain what I mean by this let me tell you about a customer of mine Terry. Now Terry runs a warehouse in operation a number of years ago I went to visit Terry and on this particular occasion Terry had a great big smile on his face and said to me “James, come over here have a look at this I just bought a brand new forklift I pay cash for it and got a great discount. I said to Terry “Terry I am so glad you had the money set aside to take advantage of the discount” There was a problem though the following Wednesday comes around it’s about 3 o’clock in the afternoon and I get a call it’s Terry. Terry says James “I’ve got a problem I’ve got to pay all my people tomorrow and I don’t have enough cash and I don’t know what to do.” What Terry had done he had broken the cardinal rule matching the life of the loan with the life the asset. He had taken the cash he needed for his day-to-day operations you know paying off his staff, paying his suppliers those types of things and used it to buy a forklift. How long can a forklift last for? Well, the average is apparently about 7 years. Now I know some of you can get out to 20 years out of yours, our forklift on the farm has been going for nearly 15 but the national average is about 7 years. The point is though how does a forklift return cash to the business or in fact any piece of equipment you buy for your business how does it and return cash to your business. Now it generally turns cash to the business through using it the asset will either allow you to make more sales or make you more efficient reducing the cost of each sale whichever way it is it’s going to be adding a little bit of extra profit to your bottom line and as this extra profit that will eventually come back in as cash that is going to pay for your equipment or in Terry’s case his forklift. How long will it take for this bit of profit to add up to a full forklift as you can see it may take a number of years hopefully before the end of the life of the forklift so that Terry gets a return on his investment when did Terry actually the cash? He needed it now. You can use your own cash to buy your assets as long as you understand once you put your money in you can’t use it again except as it slowly comes back from the profits over the life of the asset. Or what you need to do is look at some long-term finance such as a lease or commercial loan where you can match the repayments with how fast the cash comes back from the use of your piece of equipment. Get this right and it will take a lot of pressure off your cash flow a lot of stress off yourself and it will free you up to work on the things that are going to make a business more successful going forward. Always remember to match the life of the loan to the life of the asset.
7 – Transition Plan
Everybody will get out for the business at some stage either voluntary or involuntarily the ones to do well at this stage are the ones who plan for it. There are basically three main ways to exit your business you can close it down, you can sell it, or you can pass it on to family or management. Now there are other combinations but these are the main ways out.
Now of these 3 which one do you think will take the least amount of planning? If you say close your business down I would agree with you. The amount of planning this takes is you wake up one morning and decide I don’t want to be in business anymore. You go into your office or your shop and you put a closed sign on the door you’re out of business. That took a lot of planning now it may take you some time to extricate yourself from your contracts but it does not require a lot of planning. I have another question for you which of these 3 will usually give you the least of value for your business. Now trust me it’s closed it down again if you close your business down you are saying all the time that effort and money you put into building up a great business of great customer base a successful profitable business was worth nothing you are saying all your business is worth is the stock and equipment left sitting on the floor. Now let me tell you if your business is truly profitable it is worth more than the stock and equipment left sitting on the floor it has what is called goodwill but to realise goodwill you have to plan for it so you could plan to sell it or pass your business on. So when do you need to start all this planning? The best time is when you first went into business so that you set up the right business structures to minimise capital gains tax and Stamp duty in the future. But if you haven’t done it yet the next best time to start planning for transition is now. Now when they start to plan the first thing you have to think about is when do you want to get out of your business is it in six months time or 30 years? That decision is yours. Next, how do you want to get out of your business do you want to close it, sell it, or pass it on depending what you choose will actually impact how you run your business on a day-by-day basis. Think of it this way if you’re going to close the business do you care what it looks like at the end of the day? No, you want to take as much profit out along the way to put the aside for nest take for whatever you want to do next in your life. You will probably run the business down so there is little left sitting on the floor at the end of the day.
Whereas if you’re going to sell your business you need to think about who is going to buy your business is it going to be a major Corporate or maybe it’s an investor or will it be someone who will want to run the business themselves or is it just one of your competitors or a customer. You’ve got to think about who is your target customer for your business. What do they want to see in the business? How do you make it attractive to them so that they are going to want to buy it? It should, of course, be profitable but it should also look good and be able to be run by the new owner one of the things that can help is having good documented systems and procedures in place if you are thinking of passing it on to family the first question you need to ask is do they want it and if they do how will you train them up so they can run the business. If you are thinking of passing it over to management. How are they going to finance their way into it? Whichever way you decide there is a lot of planning and it’s not just you, it involves your family, management, your accountant, lawyers, financial planners, insurance brokers, business brokers and even your banker so you need to start it now you’ll also need to review it every couple of years because things will change over time but start transition plan now.
Success to business is not limited only to these 7 things, however having them you are well on your way to business success. I’ve seen many businesses with plenty of sales go out of business what you should do is take care of your whole business have your plan, make sure your financial position, understand that relationship between your price bullying and cost, learn break even and how that works in your business. Now you also need to really put together a cash flow budget and understand how your cash but works. If you’re growing to understand how much cash you will need to do to grow if you are borrowing money make sure you are structuring it right and remember to match the life of the loan to the life of the acid and finally make sure that you are planning for your exit for your transition out of your business. You do all 7 of these you will probably be one of the most successful businesses in your industry. Now I’m not saying you are going to be the biggest or even the most profitable but as far as reaching your goals and objectives you will generally do it faster with a lot less stress and hassle along the way and end up in a better financial position than those businesses that are not doing these things.
Email us at firstname.lastname@example.org or call 07 3668 0646 if you need assistance and support with your small business from start, scale thru to sale.
James Huy Vuong is a CPA and the owner of Your Accounting Partners. Partnering with businesses from start to scale thru to sale.