Fundamentals of Growing a Business & Creating Value
In the every changing and competitive business environment we work in, understanding the fundamentals of growing a business and creating value is very important. Add to the risk uncertainty of the Canadian Federal government seemly lack of understanding of how small business operates, how to encourage small business investment and the flip flop on tax policy, the small business owner is operating in scary times even though the economy is going well. We should be feeling a little stress now. So lowering risk to your business will allow you to be more prepared for the events you have no control of in the future (other than a federal election).
As a business owner that mentors other business owners, there is sometimes a misunderstanding of accounting and finance priorities. I do have an advantage of being an accountant and finance specialist, but we all should understand vital parts of any business operation. We have to accept every business runs on cash and that cashflow is king. When a company is dealing with internal problems especially with cash flow and operational business development, I often start with this diagnostic question, “What is better for your company; increase revenue $10,000 or decrease expenses $10,000?”
In the majority of the responses, increasing revenue is the first response. But this answer is not correct. In most business’, when you make a dollar of revenue, you usually have to pay commissions, buy materials and there are other variable expenses that have to be paid when sales are made. So a good company’s margin is, say, 60% which means (for this question) $6,000 will be added to your pre-tax profit. However, if you reduce expenses by $10,000, $10,000 is added to your pre-tax profit. So although, increasing sales is very important to any business, running your business very efficiently with the lowest cost of operations is where you will make your most money. Remember, you don’t spend revenue, you spend after tax income.
- Increase Revenue
- Decrease Expenses
- No Difference
The reality, many businesses fail not because of lack of revenue, but increasing sales beyond what their company can support, letting customers down and losing them forever. So decreasing expenses to the most efficient level and investing profits in expanding capacity of your business before the sales come in will always be prudent this will lower the risk of your business by being able to handle additional sales. But as sales grow, the business owner can’t lose site of the expenses being kept conservative. There is a tendency to “spend freely” when times are good and only focus on expenses when sales decrease and they are desperate. No matter what business cycle, expenses have to be monitored.
When your profits have increased to the point of not being able to reduce costs efficiently, then profits have to be spent on de-risking your business so when troubles happen, you can be prepared for them. This does leave less cash for the owner, but ensures the longevity of the business, increases its value makes it more marketable to potential sellers. Which ultimately should be every business owners ultimate goal, to sell his business for the most cash he can get.
Sean Cavanagh – is the founder of First Servant, a valuation and financial advisory firm.
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