Growing Your Business
You’ll have many opportunities, we suspect, to put the lessons you’ve learned in this book to practical use. For an example, consider one of the biggest issues that usually concerns company owners: whether, and how fast, to try growing the business.
Many entrepreneurs misunderstand the process of growth. They assume that all they have to do is create a profitable company, and growth will take care of itself. In reality, putting your company into a growth mode should be a conscious choice. Not every business owner decides to take that route. Some prefer running tiny operations, with no more than a few people on the payroll. Others choose to limit their growth even though they have opportunities to expand into midsize or large companies. (For some fascinating stories about companies that “chose to be great instead of big,” see the book Small Giants, by Bo Burlingham.1)
But if you do decide to pursue growth, you will find yourself facing a series of decisions and choices. For example, when should you add employees? How fast should you add them? Which skill sets do you need most urgently? Where and how will you look for candidates? Which candidate will you choose for each position? It can be tempting to make these decisions by the seat of your pants—hiring someone just because you need help right now, say, or because a friend has recommended someone who would be great for your business.
But hiring people always has big financial consequences. You are committed to paying those people’s wages or salary unless and until you let them go. You will need enough cash on hand to make payroll every week or every month. You will have to abide by the laws and procedures governing personnel, such as gathering the required documentation from potential new employees and determining the requirements for workers’ compensation insurance. You will have to withhold taxes (which usually means engaging a payroll-services firm), and you will have to factor payroll taxes into your budget. If the people you want to hire expect benefits such as health insurance, you will have to set up and pay for an insurance plan. And don’t forget: everybody in a business needs workspace and equipment, whether it’s a computer, a phone, tools, a uniform, or whatever.
All these prospective expenses must be factored into the hiring decision. Most can be costed out with a high degree of accuracy. You can determine both the total expense that will hit the books during the next year and the exact timing of the outgoing cash flows. But then you must face the bigger challenge: figuring out where the money is going to come from. If you are in start-up mode—relying mainly on your initial equity investments or loans to fund your operations—you will have to calculate your burn rate, and then determine whether you will be generating sufficient cash from operations to cover your payroll before your capital is used up. If you are already operating, you will have to project an income statement showing anticipated sales and expenses for the year, and you will have to estimate the timing of the cash flows associated with those sales and expenses. By now you should have a pretty good idea on how to get started on all these tasks.
It is wise to be conservative in these projections. When you hire people, you are asking them to tie their livelihoods to your business. If you expect them to work hard and stick around, the expenses involved are not discretionary. To be sure, we don’t mean to be discouraging! Nobody builds a growing business alone, so every entrepreneur who seeks growth will inevitably wind up hiring people. And growing businesses always involve some risk. But we do urge you to apply your financial intelligence to the process so that you don’t find yourself overextended and unable to meet payroll.
Though every growth-oriented entrepreneur winds up hiring people, not everyone pursues the same path to growth. In fact, there are four generic strategies that can lead to growth, and each involves a somewhat different combination of financial skills.
Many companies grow simply by doing the same thing they always did, only more of it. They never expand beyond one location. They may add people and equipment as their sales expand, and they may move to a larger building—but it’s always the same basic business. Most single-location stores and restaurants fit this model; so do many other small companies, such as consulting firms and job-shop manufacturers.
Managing growth, in this model, first involves seeing the opportunity for more sales and then determining how to make them happen. Can your current mode of turning prospective customers into paying ones handle greater volume? Can your operations handle the increased sales? Do you need to hire more salespeople? If you do, you’ll need to develop a compensation plan that meets the needs of the sales reps, that your company can afford, and that will ultimately help the business grow profitably. You will need to project sales and then determine the impact that the increased sales, increased compensation, and increased operational activity are likely to have on your profitability and cash.
Then there’s the replication strategy: do the same thing in different locations. The most visible practitioners of this strategy are the big fast-food chains. Many of them operate on a franchise model, but some, such as Starbucks, own all their own stores. You don’t have to be a giant to grow by this model. Many entrepreneurial companies, for instance, operate a handful of stores, branch offices, or facilities in a given region.
Deciding to open an additional location is much like buying a piece of capital equipment, but on a larger scale. Just as with any capital expenditure, you need to project cash flow over a period of years, estimate all the expenses for the same time period, and do the calculations that will show you whether the new facility is likely to be a good investment. Companies that grow primarily by adding new facilities typically develop detailed formulas that allow them to project anticipated revenue, expenses, and cash flows with a high degree of accuracy. Nobody’s perfect, of course; even Starbucks makes the occasional bad bet and has to close an underperforming store. But the more you do it, the better you will get.
Many, many entrepreneurial companies begin by focusing on one product or service and gradually branch out into other businesses. Zingerman’s, for example, began as a delicatessen but now includes a family of related businesses, including a bake shop, mail-order food, a wholesale coffee roaster, and a consulting firm specializing in customer-service training. Our own company, the Business Literacy Institute, began by focusing purely on customized financial training programs for nonfinancial employees, managers, and leaders. Today it offers several different products and services, including one-on-one financial coaching, Money Maps, and webinars—and of course, the Financial Intelligence book series.
You can project results from adding a new product or line of business and analyze the results in the same way you analyze a proposed capital expenditure. But keep in mind that you are dealing with more variables. It can be tough to estimate revenues or cash flows from a new business or product line, just because you don’t know that part of the market as well as you know your own. Some companies that add to their lines of business do extensive customer research and invest in the new line only if they are reasonably comfortable that sufficient demand will materialize. Others dip their toes into the waters first. They invest only a modest amount, find a few customers, watch the returns carefully, and invest more only if the new line meets their expectations.
Another time-tested strategy for growth is to buy up similar businesses and either run them independently or incorporate them into your own company. Many well-known companies—Cisco Systems is an example—have grown rapidly through this approach. Entrepreneurs often pursue a variation of the acquisition model known as a roll-up, which involves buying many small companies in the same business (dry-cleaning stores, say) in hopes of building market clout and realizing economies of scale.
Any strategy of acquisition involves a wide variety of financial skills. You must be able to assess the financial situation of a potential acquiree during the process known as due diligence. Is the target company profitable? Has it been relying on any accounting tricks to boost its reported profits or to pretty up its balance sheet? Is its operating cash flow healthy, and has management maintained its asset base? How much is the goodwill worth? These, of course, are just a few of the financial questions you and your team will have to ask.
Then there’s the matter of valuation. Given what you find in the due diligence process, what is a fair price to pay for the acquired business? We discussed different methods of valuation in chapter 2, but those are really just starting points. You also need to assess how closely the acquired company will fit with your own business and what level of savings you might realize by eliminating duplication. You need to gauge the prospects for the new, larger company that you are creating. Unlike organic growth, acquisition is a quantum leap: suddenly, you will be managing a significantly larger business than you were before. You need to be sure your financial intelligence—or that of your advisers—is up to the task!
Keep in mind that these are generic strategies. In reality, growing companies often rely on a mix of different approaches. (For example, they may buy a competitor and turn it into a branch office that replicates the original business of the acquiring company.) But any growing company needs someone at the helm who understands the financial side of both where the company is today and where it hopes to be a year or five years down the road. Financial intelligence is an indispensable ingredient of any growth strategy.
This book wouldn’t be complete without a few words about going public, which means taking the steps necessary to sell stock to public investors.
To be sure, very few companies in the business population ever go public or even dream of going public. The vast majority of entrepreneurial businesses will begin and end their lives as the property of one owner or a small number of investors. Still, the minority of companies that do go public typically get a lot of press because large sums of money are often at stake. The founders of companies that go public can reap enormous rewards. So can anyone—venture capital firms, for instance—who invested in them when they were still private. The newly public company itself is likely to have a relatively large amount of capital at its disposal with which to expand.
Companies that are candidates for an initial public offering (IPO) generally fall into one of two groups. One is very young companies—often not far beyond the start-up stage—that are thought to hold the potential for explosive growth. They have a new technology or a new business concept that captures the fancy of investors, and they typically need large amounts of outside capital to grow. Many biotech firms, for instance, fall into this category. In the second group are companies that are better established and have already shown that they are capable of rapid and steady, if not explosive, growth. Some restaurant and retail chains are in this category.
If you are planning (or even dreaming) of taking your company public someday, you will want to manage it much like a public company from the very beginning. You will want to find accountants and financial advisers—and ultimately, a financial staff—who are experienced in working with companies heading toward an IPO. You will need audited financial statements every year. You will want to make sure that your own finances and the company’s finances are always kept wholly separate. (This is good business practice anyway, but it is particularly important in the case of companies that hope to go public.) You will want to be aware of the restrictions and regulations imposed by Sarbanes-Oxley and other relevant laws (see the toolbox at the end of this part). Going public is often alluring, but the cost of running your business so that you can go public is likely to be significant.
Whatever path you choose, we hope that we have helped you with one big part of running your company. We hope you now understand exactly what profit is, and why you need both profit and cash in your business. We hope you understand ratios, so that you can see the trends and opportunities for your business. We hope you know something about managing the balance sheet, so that you can make your company as efficient as possible. We hope you have an understanding of capital expenditure analysis, so that you can make good decisions about where to invest the company’s money. We hope you have learned something about all the other elements that make up financial intelligence.
If you want practice using these concepts, we urge you to do the exercises in appendix B or to sit down with your own company’s financials and analyze what they tell you. We also suggest passing this book along to the people you work with, so that you can all speak the same language—the language of numbers—and so that they, too, can increase their financial intelligence.
As we said in the preface, we know what it is to start and run a company. It involves a lot of hard work. It can keep you up nights. But it’s also one of the most interesting and satisfying endeavors a person can undertake. Increasing your financial intelligence makes the job a little bit easier and a lot more rewarding, because you can better understand what is happening and take the steps you need to take to improve your company’s performance. We wish you good luck.