Managing Your Business with 7 Key Numbers

Stroud

Introduction

If the number one symptom of Arithmophobia is lack of cash, what’s the cure? Get an accounting degree? Absolutely not! Here’s a deep dark secret your accountant won’t tell you: all you need to understand your numbers and to run your business better is two things. First, just simple third-grade math. Nothing fancy, just basic addition, subtraction, multiplication, and division. Even better? Computers can do most of it for you! Second, you need to have the ability to point your thumbs. Point your thumbs up if things are on track or better than expected. Thumbs down if things aren’t what you expected or worse than you expected. Are sales what you expected? Are costs within reason? Thumbs up or thumbs down?

This book will explain how you can interpret your accounting data to grow your business—even if you suffer from Arithmophobia. Numbers can be both a lagging indicator (like your financial statements, which tell you what you should already know) and your leading indicators, which tell you where you’re going. We also hope to illustrate how you can improve your ability to use these numbers to make it easier for others (management, investors, and creditors) to judge your operations, your probable future, and operating results so they can assist you. We are not attempting to cover the whole range of financial analysis or projections, but we limited our discussions to basic financial planning and creditor relations.

This book is not just about numbers. It is about cash flow engineering: developing systems and processes to ensure consistent and predictable cash flow.

A problem is a problem until you reduce it to a procedure, is a saying I constantly use. By spending time at the front end, you will save hours and hours of time at the back end. Why? Because you won’t fall into the trap that ensnares most entrepreneurs and business owners—reinventing the wheel every time you do a job!

In this book, we will share with you many of our wheels—proven procedures that we’ve developed and refined over the years that will enable you to create the results you want.

Problems in Growth

The building industry is characterized by many small- to medium-size operators with a high degree of changing management and a changing legal and regulatory environment. This translates into high risk and an uncertain future.

Cash is our number one concern, and we need this cash in order to grow. This is true with all companies, but is especially important in uncertain environments just to survive, let alone grow.

Of course, growth has its own challenges. Just on the financial side, rapid growth creates a need for more capital to support that growth. You often need more front-end money to allow for larger volume. Yet, turnover ratios tend to decline. So, the question is: Where do we begin?

Three Basic Functions in a Business

There are three basic functions in a business: sales and marketing, operations and financial management.

It’s hard enough for a business owner to be great at all three functions, and few businesses have the luxury of having specialists to perform each well. So, for an owner to succeed at all three as an individual, he may need a little help. That is the purpose of this book. In particular, we are going to elaborate on all three functions through three simple yet powerful concepts: The 7 Key Numbers help manage daily cash flow through your entire sales and marketing (and business) funnel and the 5 C’s of financial management are designed to continually sharpen and refine your business processes.

Some of this discussion parallels topics that were discussed in The Peddler’s Son: How my Dad’s Tiny Business Taught Me to Grow Multimillion-Dollar Companies by Jeffrey Kenneth Prager. The Peddler’s Son focuses on the six long-term success factors. The key word is long-term. In the short term, you need to focus on the 7 Key Numbers that drive business success. We will learn how to use those 7 Key Numbers and determine which ones we like and which ones we dislike. Based on that, we will develop strategies to improve those numbers. All 7 Key Numbers will have an influence on the profits you make, so we will look at each one individually.

As an aside, I am an economist by training. Why is that important? Because, as an economist, we focus on the short term, the intermediate term, and the long term. As a CPA, I was taught to look only one year into the future. That’s maybe what’s wrong with Wall Street as well.

Why Do You Need Numbers?

Over my life, I’ve thought about this a lot, and as I’ve worked for companies, or as I’ve run my own businesses, I’ve noticed that those who succeed never think in terms of pennies. In fact, they do something that most people running a business don’t: they manage their numbers. So, let’s look at why you need better numbers:

To manage the business. This includes planning, organizing, directing, and monitoring all aspects of the business.

To expand the business. A business can’t expand without proper preparation and planning. In order to expand, you need to understand the investment you are going to make, the cost of the expansion, and have a plan for getting the capital to achieve your goal.

To sell the business. If you eventually want to sell your business, a prospective purchaser will probably look at historical financial statements as a benchmark for future performance. If the financial statements are not representative of actual past performance, they could delay or even sabotage your deal. One thing we consistently hear from business brokers is that they can’t really maximize the value of a business because they don’t have good numbers.

To raise capital. Without the right numbers and the right plans in place, you can’t raise the necessary money to fund the business’s growth. Banks tell us that the biggest impediment to lending is the financial state of the business.

To lower taxes. How would you like to pay no taxes? My goal is to pay $1 million in taxes. Think about what I just said. What does it mean if I pay $1 million in taxes? It means I’m making a lot of money. So don’t let the tail wag the dog. Make your economic deal then structure that deal to minimize your tax liability.

Is Your Business Where You Want It?

Let’s start by taking a short quiz. This survey allows you to rate the vital components of your company. It also helps you prioritize and develop a game plan for improving your company and achieving your goals. For each question, rate yourself on a scale from 1 to 10.

If your score is between 35 and 40, congratulations! You have a good handle on managing the key elements of your business. If your score is between 30 and 35, then some tune-up work will make you more effective. If your score is under 30, then you might want to stop and assess your internal processes. And if your score is under 25, then Houston, we have a problem!

In any case, this assessment may be either a formality to clear your thinking or truly transformational.

Definition of a Business

A business is a well-positioned, well-defined organization generating cash flow that encourages growth and leads to building wealth. The key to this definition is that the company is organized. The company management understands its internal and external strengths, weaknesses, opportunities, and threats (or what we call SWOT).

Well-positioned is an external definition (based on the customers’ point of view) that means the company clearly understands its mission, vision, products, and target market. It understands which trends in the competitive environment might be threats and which might be opportunities. It means understanding the price, targeting the right client with the right message. Leverage the business’s position to its advantage.

Well-defined is an internal definition that means the company has well-developed, well-implemented methods and systems for production, distribution, pricing, accounting, financial management, human resources, etc. A well-defined business grows in profitability. It has methods and systems in place to produce a consistent customer and employee experience. It consistently produces and sells quality products. The company is also well managed. When it makes a mistake, it not only corrects the mistake but improves the flaws in the system that led to that decision. It learns from the experience.

Compensation to an Owner

When you own a business, you must make money as an owner and as an investor. Most businesses are designed to create an environment to pay the owner a salary. In reality, most don’t even cover the salary an owner would make by having a job, let alone compensate him for his sweat equity—the feeling of waking up at three in the morning in a cold sweat, wondering how to make tomorrow’s payroll. As a business owner, you need to be compensated for your sweat equity.

As a business owner, you should plan on getting paid in three different ways:

First, you should budget your fixed costs to include a yearly salary that, at a minimum, would equal the amount you’d receive doing the same work for someone else.

Second, you should budget a profit goal to compensate you for the risk, the sweat, and the stress you endure as a business owner.

Finally, you should get paid for the value you created when you reach your long-term goals. At that point, you can either sell your business, go public, or double down to build an even bigger business.

Types of Business Owners

There are two types of business owners: shopkeepers and successful business owners. The shopkeeper is an individual who opens his store at eight in the morning, closes at five, and goes to his accountant around April 15th and asks him how much was left over. When the shopkeeper makes money, it’s a pleasant surprise. This owner is just surviving.

As we said before, there are problems in just surviving. If your objective is to just survive then you probably aren’t running your business for the long term. Ironically, this makes it much tougher to survive in the short term too. For example, you are probably always chasing the next deal, at least it feels that way. You likely also have disjointed marketing; it isn’t a system that keeps the pipeline full month after month, year after year. In the end, it’s almost a chicken-and-egg situation. If you want to just survive, it’s a safe bet that you don’t have the necessary confidence that will get the business to the next level generating the required cash flow and profits you need. Does the lack of confidence drive the objective to survive or does the short-sighted objective create the lack of confidence? In either case, you are right.

Conversely, the successful business owner performs an ongoing analysis of how the business is doing and what he or she might do to improve its performance. When this business owner makes money, it’s the predictable result of executing a well-considered plan.

So, which do you want to be? You do have a choice. You could earn money both as an employee or as an investor, but you must transition from a passive business owner who lets time control you, to a successful business owner where you control your own fate.

You are a business owner, and as a business owner, you just have three resources:

Time, which refers to your time only. It does not include your employees’ time, which you pay for as money.

Energy, which accounts for your effort, frustration, mental expenditure, and emotional engagement with your business.

Money can be separated into labor and non-labor costs, like materials and supplies.

Now, which one provides your competitive advantage? Do you have a competitive advantage when it comes to money? Probably not! There are always businesses with deeper pockets. And if it just comes to money, your business would always lose.

Is your competitive advantage that you do everything yourself, assuming that hard work and long hours are necessary for success? Here’s the reality: Working 10-hour days onsite, then spending your evenings doing paperwork and accounting until the wee hours are not a way to earn money. That’s a recipe for saving money but not making money. You need systems and a process that gives you more time, energy, and money … and that’s the purpose of this book! We want to give you a system for generating a lucrative business. Our goal in this book is to help you generate more cash flow now, institute change that maximizes cash flow, and finally turn your business into a cash cow, creating long-term value.

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The 7 Key Numbers that Drive Revenue and Cash Flow

The 5 C’s of Financial Management

Let’s take a step back and talk about management in general. The 5 C’s are the key to management of every aspect of your business (fig 1.1). They relate to your action plan and represent a proactive philosophy designed to continually sharpen and refine every one of your business processes.

Here are the 5 C’s:

Create your benchmarks. Also called key performance indicators, these benchmarks will be used to measure the progress of your business. Using the 7 Key Numbers and strategically aligning them with your goals create these benchmarks.

Collect meaningful information. This includes both financial and non-financial information. You need this to track your progress toward your