small business

Fear of Numbers – Planning beyond Bookkeeping

by tomgray | on Jan 06, 2012 | 1 Comments

Most small business owners do not understand bookkeeping, Quickbooks, contribution margin, or cash planning, so they shy away from learning how to use their results to improve the business. Yet when small businesses fail, it’s because they run out of cash. Why does this happen, and why do owners allow cash shortages to develop in the first place? Too often, it’s because they don’t try to understand their numbers.

They assign someone else to “keep track” of the numbers.  Unfortunately, bookkeepers are not planners. Bookkeepers look backward, not forward. Owners are the only ones whose job includes using past performance to improve future results, but they usually do not know how.

The owner is the expert on what the business does, spending up to 80 hours per week to make sure the business has effective operations, and maybe even spending some time on getting new customers. Small business owners typically do not make it a priority to understand their numbers well enough to predict their future. Short term demands make future planning seem like a low priority. Then they run out of cash!

Fortunately, it is not difficult for small business owners to understand their numbers well enough to plan even without learning software (e.g., Quickbooks) or bookkeeping. Three techniques are all they need. First, require the bookkeeper to export the monthly Quickbooks Profit and Loss Report to an Excel spreadsheet with one column for each month of the year. Second, have the bookkeeper reformat the data in Excel into an Income Statement with a reasonable number of revenue and expense categories (see below), and for each category heading show the “% of Revenue” in that line. Third, study where the money goes and create ideas to change those percentages.

Let’s look a little deeper at each of these techniques. First, the Internet has dozens of entries telling the bookkeeper how to export data from Quickbooks to Excel.

In the second task, you are making the Quickbooks data more useful by reducing the number of entries to a manageable number. For revenue, you should have a line for each product type. Even in a job shop, you can categorize your jobs into types. The next main category is variable costs, or COGS. Your lines for variable costs will be labor (and associated payroll tax and possibly benefit costs), materials, subcontractors, shipping, and sales commissions. The labor line will include labor costs devoted to production, with nonproductive labor hours shown elsewhere as overhead costs.

The last major category is fixed or overhead expenses, those that stay the same regardless of production volume. Here is where you will invent headings to group costs by type, so the number of lines is manageable. Ten categories should be sufficient. For example, nonproductive labor/tax/benefits, salary/tax/benefits, facility costs (rent, maintenance, utilities), computer costs (hardware, software, maintenance), vehicle costs, office expenses (include phone and bank charges), professional services (accountant, legal, consultants), marketing costs (include travel and entertainment, professional licenses and conferences and subscriptions), and perhaps the old favorite miscellaneous – but try to keep this minimal.

The key line is “contribution” (to cover overhead and provide profit) or operating margin. This is revenue minus variable costs. As a % of revenue, this line must exceed the % of revenue for total fixed/overhead costs, and that difference will be your profit as a percent of revenue. See the next article for examples.

The third technique is analyzing the results. This is the owner’s job, and no one else’s. Up to this point you have simply been telling the bookkeeper to present the data in a more useful way. In the next article, we will discuss how you can use this data to improve your business.

Numbers are the way we keep score. Without them, you cannot tell if you are winning the game or losing, until it is too late! Small business owners can avoid a cash shortage without expertise in bookkeeping if their results are presented in a way that enables planning, using percentage of revenue and contribution margin.

Does this seem do-able so far? Does it seem worth doing?

Tom Gray is a management consultant focused on small business, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

 

 

Profit Planning not Bookkeeping: Percentage of Revenue

by tomgray | on Jan 05, 2012 | 1 Comments

Small business owners can avoid a cash shortage and manage profitability without expertise in bookkeeping, if their results are presented in a way that enables planning, using percentage of revenue, variable vs. fixed costs, and contribution margin. For a good way to present the information, see Fear of Numbers – Planning beyond Bookkeeping.

With your data in Excel, you can experiment by changing the data to see how changes in your business would affect the bottom line– profit.

Assume you want a minimum profit of 10% of revenue, which will be something like 7.5% after income tax. If your fixed costs are 30% of revenue, then your contribution or operating margin MUST be 40% of revenue to cover that 30% overhead and leave a 10% profit.

If you can cut overhead from 30% of revenue to 25%, your profit goes up from 10% to 15%. Review your overhead or fixed expenses to see what changes make sense. You will see that small changes, such as not buying soda for the office refrigerator, have little or no impact. If you cut marketing (probably no more than 5% of revenue), what will happen to your flow of new customers? Is such a cut worth the risk?

Maybe you can reduce nonproductive labor hours by changing work schedules. This is always worth examining. If this number is 5% of revenue including payroll taxes, cutting it to 3% raises profit by2% of revenue, which is a 20% increase in profit from 10% to 12%.

Variable costs and revenue are usually the most fruitful areas to consider. The FIRST technique here is to understand the profitability of each product or product type. On a separate worksheet in Excel, consider each product type. Show the revenue for one unit, and the variable costs to produce it. Subtract costs from  revenue to see product profit, and then show it as a % of revenue. If this product profit is more than your 10% profit target, great! If it is less, you must do something. Your choices are: raise the price, reduce the variable cost, stop selling it, or accept a profit lower than your target.

If you stop selling it, and you can replace the revenue by selling more of other products, your profit will increase as a % of revenue.

If you can reduce the variable costs for the product, your profit will increase as well. One technique is to pay less sales commission on less profitable products – change your commission structure to be different per product. Another technique is to change your production process. This is the BEST approach, and there are many techniques. They all start with mapping out the process as it is today, and then imagining what might be changed. A third technique is to move some subcontracted work in-house to use nonproductive hours, or move some work to other suppliers if you can offload the associated payroll hours.

Raising the price is the FASTEST way to improve profitability. A small price change may not be a problem for your customers, yet it will have a major effect on profit. For example, a 5% price increase would raise profits from 10% to 15%, a 50% gain! Even if you lost a few customers, the gain may be worth it. You can use Excel to change the revenue per product and reduce the number of units sold to see how many sales you could afford to lose and still be better off.

A word of caution: be careful of major investments that you hope will solve the problem. Examples include a major machine purchase, a major new marketing program, or moving to a larger newer location. They deserve their own careful analysis of costs vs. likely benefits. Your entrepreneurial optimism might be your own worst enemy with such major commitments!

As you can see, you don’t have to be a bookkeeper to make numbers-based decisions when the variable costs, fixed costs, and margins are presented in terms of % of revenue!

Have you tried this?  What did you learn?

Tom Gray is a management consultant focused on small business, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

Small Business — Employing Family

by tomgray | on Jan 01, 2012 | 6 Comments

Small business owners often resort to employing family members because they are available, known, and trusted. But workplace problems are more difficult to solve when they involve family members, requiring special attention to management tools and techniques.

The word “family” is positive. It conjures up images of wholesome, loyal, friendly, teamwork etc. Many employers talk about their workforce as family. But anyone who is actually in a family – that would be most of us! – has felt family discomfort too. Sibling rivalry, feeling unappreciated, expecting forgiveness for repeated trespasses – all the relationship issues crop up in workplace families as well as real families.

When the workplace family has some real family relationships as well, there are some rewards, but the risks resulting from dysfunction can be many times more serious. This risk is multiplied again where there are only a few employees – when the teapot is smaller, the tempest brews more quickly and explosively. And who does the most family hiring? You guessed it – the companies with the fewest employees: small business.

Why hire family? As Willie Nelson sang, “I’ve got a long list of real good reasons…” Some are trust; the devil you know; loyalty (he needed a job); tax benefits; and the expectation that family will be committed and willing to sacrifice from time to time when the business needs it.

Unfortunately, one does not often hear that the family member was the most competent candidate:”I needed a marketer, and my son Bill is the best marketing guy I’ve ever met.” Small businesses live on the edge. They are the businesses who can least afford mediocre employees. Small businesses need committed multi-talented people.

The reasons to avoid hiring family are mostly about what can go wrong. The employee might feel exploited, and let that dissatisfaction show, poisoning the workplace atmosphere. Managing a family employee is only easy when it is not needed; correcting and coaching a family member is a touchy area that can spark issues outside the office on the home front. Family employees may have issues from home (arguments, rivalries, jealousies) that they cannot ignore when they work with the same people. Non-family employees feel out of the loop and less influential when they must compete with family members for the boss’s ear. They may also perceive unfair treatment compared to a family member, in terms of privileges or pay compared to competence and/or effort.

What should a small business do? Should it take advantage of the obvious benefits of depending on a trusted family member, especially when there are some tax benefits involved? Or should it avoid family employees to avoid the extra-difficult morale and relationship issues that result when all is not rosy? Are there some tools that a smart small business can use to employ family yet minimize the downside risk?

What do you think? Do some tools and techniques for managing family employees work especially well for you?

Tom Gray is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

Employing Family — More Techniques That Work

by tomgray | on Jan 01, 2012 | 2 Comments

Family employees can be problem as well as a blessing. See Small Business — Employing Family and Small Business: Employing Family – Techniques That Work. Establishing policies makes sense even for a small business. Address the problem once, write down the answer as a policy, and move on. Aside from job descriptions and a market-based compensation plan, other useful techniques include objectives, accountability, shared values, and even a major project approval process.

Imagine you employ your spouse, and he or she does the finances. You want him or her to produce the end-of-month reports by the fifth business day, not the fifteenth. When you ask for that, the response is a litany of how he or she spends their time.

What is missing here is a list of goals to be accomplished, agreed to by both parties at the beginning of the year. Your finance person needs to deliver the reports when you need them. They have to figure out how to do that, rather than telling you their problems and, by implication, asking you to manage their time. This is their problem to solve, not yours. You care about the deliverable, not how they manage their time. The tool is agreed goals. Without them, there is no basis for the subordinate’s accountability.

The same idea can take the form of behavior expectations, commonly called “values”. These are “the way we do things around here.” Examples: we value teamwork; our integrity is never compromised; we deliver what we promise, to each other as well as to customers and suppliers; our behavior makes our colleagues proud.

It may seem silly to write down behavioral expectations, but it may be most important when you employ family. Why? Because family members have a history of behavior outside the workplace, and they may expect to behave the same way at work – after all, you know them. They may also believe there are no consequences for inappropriate workplace behavior if one is family, setting up a double standard when non-family employees are considered. The best way to handle this is a set of standards communicated (hence, in writing) before any problems arise. Like goals, these provide a basis for accountability and consequences.

One other “policy” could serve small business well: a “major project approval policy.” A major project is usually a large investment, such as a marketing program or a new machine or moving the business. By thinking in advance about what would justify taking such a risk, you improve communications with any co-owner or family member who may be affected by the decision. Prior decision criteria can also help you as the decision-maker, bringing a degree of dispassionate logic to what may be an emotional issue, with hope warring against fear, or courage facing down prudence.

For a small business owner, the unfamiliar behavior here is thinking about potential business problems before they arise, and writing down a framework of expectations, or solution criteria. These owners normally don’t feel they have enough time to handle immediate problems, let alone anticipating issues that might come up in the future! Also, they are not comfortable committing to written policies, because they know the future brings change and they will need flexibility. They might see policies as an obstacle to managing their future, rather than a tool for organizing their chaotic lives.

Managing employees is not easy, and family employees redouble the stress involved. Establishing and enforcing policies is the key to success: qualifications, job descriptions, shared values, objectives, accountability, market-based compensation, and a major project approval process.

Tom Gray is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

 

13 Week Cash Flow Statement

by tomgray | on Jan 01, 2012 | 2 Comments

“Cash is King” in a small business.  A cash shortage is one of the hallmarks of a business slipping into trouble – a distressed business. The owner’s first priority is to pay the vendors whose services keep cash coming in. Bank loans don’t do this, so the owner asks the bank to wait for its payments. In response, the bank wants to know the company’s prospects for paying in the future. It asks the owner to forecast revenue and costs, and predict cash flow using a 13 Week Cash Flow Statement. See 13-Week Cash Flow Model Creates Clear Communication Channels.

This is a spreadsheet starting with cash-on-hand. It then adds cash expected to be received from outstanding invoices, from work in progress, and from new business in the next 13 weeks, i.e. the next quarter of the year. It subtracts the cash used to pay for the variable costs for completing such work, and the expected overhead or fixed expenses to be paid during this period. The net is called “cash flow.”

The spreadsheet columns are the 13 weeks, and the cash flow at the bottom of each week becomes the cash on hand at the start of the next week. Thus the net at the bottom of each week is cumulative, showing all the expected cash-on-hand at the end of that week.

Each week’s column is like the page in a checkbook register, with cash at the top, money coming in, money going out, and the cash on hand at the end of the week.

Small business owners usually understand their expenses very well, and they know what is owed them from completed work and work in progress.

Their problem is forecasting new work and new revenue. Their bookkeeper is not a forecaster, and their accountant looks backward, not forward, so the cash forecast becomes the owner’s task. Unfortunately, the owner of a small business spends most of his or her time working in the business, not on the business. They normally rely on others to track the numbers.

When the owner has to do the forecast, they feel overwhelmed by the variety of possible work that might come in, and the uncertainty of what kind of work will come in during any given week. They know the bank is being reasonable to ask about their prospects, but feel frustration and resentment when asked to predict the unknown!

How does a small business owner predict revenue, costs, and cash flow on a weekly basis? Is there a secret formula? Probably not, but there are some techniques that can help you make a reasonable forecast for the coming weeks, whether or not your business is distressed and facing a cash shortage. We’ll describe them in future posts.

Tom Gray is a management consultant focused on small business, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

13 Week Cash Flow, Part 2 – Forecasting the Knowns

by tomgray | on Jan 01, 2011 | 2 Comments

Forecasting sales, revenue, and cash for the next 13 weeks is the most difficult part of the 13 Week Cash Flow Statement for a small business because it is the least certain. See 13 Week Cash Flow Statement. But this task has some easy parts too. The first step is to forecast known revenue and costs – those for outstanding invoices, work in progress, and new work from proposals already submitted.

First, identify the invoiced amounts you have not received yet. Note how much you expect to receive in each week.

Second, consider your work in progress. How much will you invoice for this work? When will you send the invoice, and how much later will the cash payment be received? Your revenue is booked when the invoice is sent, and this shows up on the “income statement” or “P&L Report”. But for a cash flow statement, the important date (or week) is when the cash comes in. You cannot pay a vendor with booked revenue! You need cash.

This timing difference between invoice and receipt of cash is the most important difference between the income statement and the cash flow statement.

If you expect to pay out additional cash to complete this work in progress, be sure to add that additional expense to your predicted cash outflow for the coming weeks. It is good idea to use separate lines (rows) in your spreadsheet to show the costs for work in progress separate from the costs of new work you have not started yet. In each case, the typical rows would be materials, labor, and subcontractor expenses, any unusual shipping or packaging expenses, and any sales commissions. These are called “variable costs” or “costs of goods sold (COGS).”

Third, consider the future work you know about. You may have already made a bid or proposal, or you intend to. This should be a third set of rows in your spreadsheet. It’s a good idea to use a separate sheet to estimate the revenue, costs, timing, and percent likelihood for each of these jobs; then you can use a summary on your master spreadsheet.

For this future work, you will need to make some realistic estimates. When will the customer decide? Should you assume he will take the price you bid, or will you need to come down a bit? When will you order supplies and when will you have to pay cash for them? When will you complete the job and invoice it, and when will you receive cash from the customer. If there are “progress payments” along the way, how much and when?

The last question may be the hardest: what are your chances for getting each of these jobs? You will multiply each of the revenue and cost figures by this “probability percentage” estimate, making your forecast a more realistic view of the prospects for the business.

The final step is to estimate business as yet unknown. We’ll cover that in the next post. At this point you know the format of the 13 week cash flow statement, you forecasted the revenue and costs for outstanding invoices, work in progress, and likely new work from bids already submitted.

Tom Gray is a management consultant focused on small business, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.