There seems to be a very strong correlation between small businesses that are struggling to make ends meet, and are also spending too much money on meal & entertainment expense. In my casual observance, when I examine accounting records, I begin to notice declining sales, margins, and profit when meal and entertainment expense is greater than 0.5 – 1%. Excessive spending in this area, such as 3-5% of sales is typical for companies in deep trouble.
It’s not that spending on coffee or lunch in and of itself is draining away needed cash flow. Rather, I think it’s more a problem of not having enough discipline to carefully monitor and curb outgoing cash flow. This unusually falls under the guise of “business luncheon”, “networking”, and “prospecting”. Good bookkeeping records with software such as QuickBooks or Peachtree will help measure this expense, but you’ve also got to be prepared to change habits if you want to improve. I find changing habits to be the most difficult task.
There is no correlation to the industry or kind of business. I see the problem with professional service firms as much as I do with contractors and retail businesses. How does your business compare? Is my theory right or wrong?
The difference between attracting a satisfied customer instead of a loyal customer is the difference between single-digit growth verses double-digit growth, a modest advertising budget and no spending on advertising (because they spread the word for you). It’s the difference between liking something and falling in love.
How many restaurants do you like, and which ones do you love? I’ll bet with the establishments you love, you’re also spending more money, telling more friends, and forgiving more readily if something went wrong.
How do you know if your customers like you or LOVE you? A customer satisfaction survey will ask things like, “Were the bathrooms clean?”, “Was your hold time within reason?”, etc. Your customers could answer yes to all the above and just be satisfied.
A loyalty survey on the other hand asks only one question: “How likely are you to recommend our business to a friend or college?” The response is measured on a scale of 1-10, with 9 or 10 being a loyal customer, 5-8 being satisfied. Anything less than a five and that customer is detracting from your business. Send me an email, if you’d like a copy of the survey.
A client once told me that the best part of owning her business was when she prepared and sent the monthly invoices. I’d take it one step further and say it’s when you actually receive the money. There’s a considerable difference between the two. Enough in fact to kill “profitable” businesses, because they couldn’t or didn’t’ collect money fast enough. Next to crushing debt, this is arguably the second biggest reason so many small businesses have shut down in the past 2-3 years.
Understand what your average days outstanding are, for your accounts receivable. This is expressed in number of days. For example, electrical contractors are typically at 55 days, child care centers collect in 4-5 days, and commercial printers in 44 days. Then set a goal to become better than your industry benchmark, better than you were last year, better than last month.
There are very specific methods to improve your collections. The most overlooked strategy is by simply assessing a finance charge on overdue balances. I can’t tell you how many clients have tried this, only to see money start flowing in.
One of the most consistently overlooked financial measures in small business is that of value. Almost every decision you make in business will either create or destroy value. Compare this idea to a house. When you consider purchasing a house, you examine the property condition, likeability of the neighborhood, price, quality of the construction, etc. Based on this information, you’ll make a subjective judgment of the value. After the purchase, you might refinance, replace the carpeting, put an addition on, all of which will continue to affect the value, either positively or negatively.
The same is true in business. Do you buy the truck or lease it? Should you pursue the new product/service line, or invest in your current business? Pay with equity or take on debt? Each little (and big) decision over the course of years in business will take you down a path which continues to affect the value. Who knows where you might end up? Could be in two distinctly different places depending on how good the decisions (and accounting records) behind them are.
Some day you’ll want to sell the business and hopefully, if you’ve made the right decisions, it’ll be worth something. The point is, you have a potentially valuable asset. Receiving a paycheck and having cash in the bank are great, but don’t ignore the value of your business.
There’s a simple financial principle regarding the management of debt, that many small businesses don’t follow. It’s called the matching principle. It basically means that you should use long term money for long term assets and short term money for short term assets. A good example is your line of credit. Because this gets renewed every year or two, it’s considered short term debt. Using it to cover payroll until an expected customer payment arrives is appropriate. The point is, it gets paid back within a couple of weeks or months. This is not something that should carry a balance year after year.
Once I owned a retail business, and within the second year of business I used the heavy cash inflow from spring sales to pay for a new asphalt parking lot. This was a bad idea. Remember long term assets (like a new parking lot) should be funded with long term dollars, like a 3-5 year loan.
I was just looking over my garden this morning, excited to see the lettuce and radishes popping up. It made me think about the different seasons a business goes through. There is definetly a good time to plant (spend) and a good time to harvest (save), unfortunately most business don’t know about that schedule, or they don’t have the discipline to follow it.
Several years ago when the economy was really flying and almost all businesses were doing great, you should have been harvesting. That is to say, you should have been piling up all the excess cash you were making into a savings account. It was the wrong time to spend money. It was time to harvest. Think about it, was anyone willing to sell you anything at a discount 5-10 years ago? Home builders weren’t because they were too busy.
Now, with the sluggish economy, you should think about planting, or rather taking your excess money and buying up assets, spending on marketing, etc. Today everything is for sale at bargain prices because whoever has cash right now, gets to make the rules.