Small Business Finances and Common Sense

Sometimes I find it hard to believe, but I heard it from a credible source. Not many small business owners pay attention to their financial data or understand what they get from their accountants. If some of them have gone through a business valuation (through a partnership change, divorce, death or sale), they rarely understand the information that shows how to increase the value. My source works with hundreds of businesses and he simply lays out the financial numbers in a manner that makes it fairly obvious what areas to put some attention to.

As I was listening to him the other day, I had some thoughts:

• Budgets: these are good for the disciplined but are best used as a map, rather than a recipe. A budget doesn't need to be followed like a recipe, because the one thing you don't have control over (revenues) is an important ingredient to the budget. If you use the budget to control expenses, but it's not in relation to revenues, you will find you are overspending or under-investing in your business at inappropriate times. Instead, it should be a map that allows you to figure out a route, but also shows some alternatives in case you run into construction (unexpected expenses) or find out that a new highway has just opened and isn't on the map yet (unexpected revenue stream) or the traffic is a little heavier and the back roads might be a better choice (unexpected competition).
• Investments in the business: maybe I've been in business so long, I've forgotten that perhaps at one time I had to learn how to decide on investments like new equipment, new software or a new hire. In order to justify any new thing or person, I knew it had to generate enough revenue to increase profits by 20% of its value. Will that new person allow me to focus on getting new profitable sales? Will that new piece of equipment help me get more profitable product out the door (remembering what I know about Theory of Constraints)? Will the software make us more productive so that I don't have to hire a new person as sales increase?
• Major on the majors: small business owners can cut their budget for paper clips, but it isn't going to return them to profitability. They have to look at the major expenses and figure out how to get more sales out of the same people and other assets. Or make some drastic cuts where it's going to hurt.
• Theory of Constraints: similarly, the right investment is one that increases throughput (output). Owners can invest in the latest software that will make order entry faster, but if the rate of getting a product or service to the customers is determined by how fast dispatch operates, the investment is a waste. On paper, it might look like you're saving money, but it's not letting you reduce a person or transfer them to the warehouse. There are no savings. More importantly, it's not letting you get more sales, and more profits. It's only letting you get the measly amount of orders to dispatch faster so they can sit in the electronic/paperwork queue a lot longer till the new orders surface at the top of the "pile".

I was surprised the other day to learn from this person that common sense is not so common. However, the good thing about common sense is that when you hear it, it seems obvious and right.