Small Business Economics
28 May 2018
About 10 years ago, before my business became profitable, paying my bills was a constant struggle. The unevenness of income and the many demands of running a business and a household meant that any dollar that came in had a multitude of vying needs. I remember coming home from a trip to Walgreens and truly envying the sales clerk at the register because at least she got a paycheck every two weeks. So if you are like myself, and starting out with very little capital and less business knowledge then you are essentially creating something out of nothing. But watching a business grow organically to become self sustaining, and from there to supporting its employees and rewarding the risks taken by you, its founder is a very beautiful thing. My father told me early on that if you can persevere and succeed in building your own business, than there is nothing else quite like it.
If you hope to have genuine success in your business than you need to become financially savvy. You must learn how to manage your money prudently and with the foresight to look down the road and anticipate unexpected needs. Many people, especially, dare I say it, women, are dismissive of this essential building block. In my observations, they adopt a cavalier approach relying on a spouse, or outsourcing this function entirely from the outset to a bookkeeper. It is not possible to master everything, but a business owner must to a degree be a jack of all trades and adopt a hands on approach to every aspect that will enable the business to survive and grow. Once you have a firm grasp on the basics than yes, you can outsource tedious and time consuming financial paperwork to a bookkeeper. It is fully within the reach of even the most creative person to become conversant in basic accounting and budgeting.
So what are the basics of bookkeeping and cash flow management?
Firstly, you must secure a regular cash flow and be reasonably knowledgeable about when and how the money will come in. This means getting customers to prepay as much as possible. As a fledgling business you cannot afford to give credit to many customers. This luxury will come down the road when you are more established. But if your business relies on supplying only large accounts that pay after 45- 90 days, and frequently penalize you with chargebacks, you will need a hefty line of credit right off the bat to bridge temporary cash flow shortfalls. You must try get any and every sale you can regardless of the headache involved, later, you can become picky and fire your least profitable customers. You also need to bend over backwards to please those customers because you need them to like you and your product, and reorder. You are building a customer base and every customer is money in the bank. Every sale generates cash flow without which your business cannot run. If you are truly invested in your business, your net worth is tied up in it and you have put your heart and soul into making it work, than you will learn this lesson early and painfully.
Once you have secured a reliable cash flow because your product is so wonderful and your phone is ringing off the hook with orders, you must learn to be responsible with it. This involves realizing that the steady stream of income coming in could dry up at any time, or could diminish for significant periods. You must develop the discipline to build up as large a cash position as possible. This is what will make your business healthy and insures it against the hard times. Most businesses are somewhat cyclical in nature, or have bumpy earnings. You must acknowledge and plan for this. This may sound simple, but it is surprisingly hard to do. Just like Wall Street in the long term rewards stocks that maintain strong cash positions and low debt, risky but promising tech stocks may have high valuations at first, but their debt fueled cash burn and lack of profitability is unsustainable and many crash and burn. If you don’t do this, then you will start racking up debt and it will be very difficult to pay off. You do not want to go in to debt funding your basic business operations. Debt is an essential tool to business growth, but it should be used strategically to expand the business by building up inventory, machinery, hiring talented staff.. you get the idea. You want something to show for your debt. It should enable you to increase your sales, and your increased sales should more than fund the servicing of the debt.
It is essential to establish procedures for operations, inventory management and ordering. You will only be able to establish effective procedures by working in operations and becoming intimately familiar with every detail of your production. Coming up with efficient procedures is a constant work in progress. If you enjoy this challenge, and encourage the concept of “continuous improvement” in your staff, than your business will remain dynamic. You must also have in place accurate cost models for each of your products. How much does it really cost you to make each item? Are you charging enough? How accurate is your gross margin? Don’t underestimate the labor it costs to make things. Cost models will only use direct labor, but your indirect labor and overhead must be calculated as well and then applied across the board. A working bill of materials for each item will tell you how much your raw materials add up to for every product, and help you manage your raw material cost. As your product line grows, so too will your component parts. As Himalayan added collections, raw materials grew from dozens to hundreds. How will you keep track and how will you keep up with ordering? You don’t want to run out of anything, nor do you want to over order and tie up your cash. Establish a working inventory system early on. It does not have to be fancy or even software driven. Again, fancy ERP packages are down the road when growth makes such investment viable. One of the best systems my production supervisor put in place was a binder with pages for each product. Beginning inventory was marked and each time the product was pulled from the warehouse it was noted in the binder . Inventory numbers were easy for me to access, and relatively accurate. Doing frequent physical inventory counts is perfectly fine, as long as it is done regularly as part of the production process schedule. This won’t work if your are tracking hundreds of items, but for a few dozen items it is a low tech solution.
Becoming familiar with bookkeeping, accounting basics and the tax code as it applies to you will help you immeasurably gain confidence as a business owner. This means learning how to maintain your ledger, reconcile your bank accounts at the end of the month, accurately categorize all your expenses and setting up the appropriate accounting structures for your particular business. Keep your personal and business expenses separated from the beginning, and learn the difference between expensable and depreciable purchases. Get a smart CPA to do your taxes..for my business it meant the difference between getting that manufacturing tax credit that we were entitled to and saving tens of thousands of dollars. Have a budget in place, and a rolling operating forecast.. no you probably can’t set this up yourself because you don’t know how to design sophisticated formula driven Excel reports, but get some help from a business analyst. Having good financial reports in place and learning how to maintain them will keep your books clean and professional and keep your business on its financial track.
Once you have grasped a working knowledge of your financial operations, accounting, money management and how much your business costs to run, you can delegate these functions. You are after all the creator and founder and your time can now be more effectively utilized creating the value that will propel your business to the next level. You are financially literate enough to understand how your business generates cash and whether it is truly profitable. It will influence your creative process and set you up for long term growth and sustainability.
- Posted by jleaphart