Seven Steps to Fiscal Fitness: A

In the few minutes it takes you to read this article, 40 businesses across the nation will fail--and that statistic was before the economic downturn of the last 24 months. Tragic? Yes. Remarkable? Not at all. The road to business success is littered with the skeletons of companies whose owners--mostly brilliant and skilled individuals--failed to "take care of business" in the financial management of their enterprise.

Just a minute--am I saying that good ideas, technical skills, product knowledge, and sales ability don't guarantee success? You bet I am. Anyone in a position to provide capital will tell you: the ability to develop and control an organization financially is absolutely vital.

Consistent with the hundreds business classifications in the U.S., each owner manages to conclude that "my business is different." So true, but in the financial sense they're all different in the very same ways! It's these common business issues and success factors I want to address in this and future articles.

This entire process--which we call Profit Mastery--evolved out of my former work as a commercial banker and the hundreds of independent business owners my colleagues and I met in that capacity. In the midst of another economic downturn some 20-plus years ago, we sat around one day lamenting the economic factors that caused our bank to reduce staff, thus making it more difficult to connect with customers as often. And when we did, the same questions and issues kept coming up again and again. In fact, when we all listed our "Top 10" issues we wanted our customers to know about, we found seven common success factors, and we realized these would be critical in improving communication between banker and business owner. You might say, "Finance is the medium, but communication is the message."

We packaged these seven success factors into our Profit Mastery process--and for more than two decades we have worked diligently to bring these factors--and the financial tools and techniques that support them--to business owners and bankers to further the goals of enhanced communication and business performance. I'd like to share these seven steps with you now.

Seven steps to business success

Businesses with the highest odds of survival:

1. Plan properly before start-up
2. Monitor financial position
3. Understand the relationship between price, volume, and costs
4. Manage cash flow
5. Manage growth
6. Borrow properly
7. Plan for transition

Please note: I hope you'll use this outline as a "performance checklist." If you don't regularly (as in twice a year) evaluate one or more of them, it does not mean you won't succeed. Rather, it identifies an opportunity to measure results and improve performance.

To insure your own well-being, you have an annual physical every year from your doctor, don't you? Right. Well, your business is no different. It needs an annual checkup. All the businesses we work with go through a process we call the Fiscal Physical. It's a structured financial review that asks the questions: Where have we been? Where are we now? Where are we going? It's good, metaphorically speaking, to take your business and shake it--sort of get the cobwebs out.

About as exciting as watching grass grow, you say? Yes, I agree, but it's good for you. You don't have time? Let me remind you--you have all the time there is. Why is there never enough time to do a job right, when there is always time to do it over?

And, there's another--and perhaps more compelling--reason to use the Fiscal Physical to give your business a detailed performance review now. March through May is "loan renewal time" in the banking industry. For any of you planning to initiate, maintain, or expand credit access in 2010, you can expect far more rigorous standards than what you experienced in the past five years. In this recessionary economy, the banking industry is coming under far more stringent review guidelines, and you should expect that to be reflected in the way your own credit needs are evaluated. A Fiscal Physical of your business will not only uncover performance improvement opportunities, it will also provide valuable insights into the loan renewal/credit access process.

Let's talk about common problems and what we look at in a Fiscal Physical. We'll examine specific issues or tools and evolve action steps. What good is analysis if it doesn't lead to action?

1) Plan properly before start-up.

Mother Nature gives expectant mothers a nine-month gestation period to prepare for motherhood, but she isn't so kind to business owners. With regard to business organization and the IRS, the errors are usually of omission, not commission. Poor initial and ongoing planning is a common error. Far too many owners get into business without a sense of purpose and direction. It's the "jump and hope" philosophy. Most find that being in business is like being in school, except for one thing: in business, you take the test first! Although most business owners have a plan, far too often it resides in their head, and not on paper.

2) Monitor financial position.

Another common problem is the owner's failure to consistently and personally monitor their financial position. You leave the scorekeeping to your accountant because you don't use the information anyway. But who's at risk here? Does your accountant co-sign your bank notes? I know, financial statements reflect the past, and any enterprising owner only thinks of the future--it's tomorrow that matters. Unfortunately, tomorrow is the sum of a series of yesterdays. If you don't know where you've been, you can hardly know where you're going.

3) Know your costs/price properly.

Failure to price properly and know your costs is a real problem. Break-Even Analysis is the most strategic and powerful profit planning tool available. For the last 24 months, the most common message in the myriad of articles on business performance is: Cut your costs! To improve profitability, however, I would strongly suggest before you cut your costs you should know your costs. Then, you'll be able to "cut with a scalpel, not a hatchet."

I say this because, sadly, many business owners do not know the cost structure of their own business. Simple example: 1) variable costs are 70 percent, 2) fixed costs are $144,000, and 3) target profit is $60,000. What sales are required to meet the profit goal?

Central to the issue of cost management is the recognition that there are only four ways to increase profits. Being able to identify these--and relate them to your business plan--is where the Break-Even Analysis tool becomes very strategic and uniquely effective.

4) Manage cash flow.

The current economic downturn has highlighted what we should have known all along: Cash is king! Many business owners--with their myopic focus on sales--often prioritize financial issues like this: 1) sales, 2) net profits, and 3) cash flow. However, I recently came across a quote that is disturbingly real:

"I learned the hard way: You can survive decreased profits if you have cash flow, but the converse is not true--if cash flow takes a dive, you're in trouble." (Jay Goltz)

A recession-driven priority list reveals what was true all along. The priorities should read: 1) cash flow, 2) net profits, and 3) sales. A rolling 12-month cash flow projection is not only a critical planning tool, it's also a document banks will be scrutinizing in 2010. The secret to successful cash flow management is understanding the impact of revenue patterns on the key cash flow drivers.

5) Manage growth--and capital efficiency.

For years many business owners attempted to resolve cash flow challenges with increased sales. Not only did increased sales often lead to increased borrowing to fund the assets required to support robust sales growth, this growth often used cash faster than profits could supply it. In addition, the easy credit of the five years preceding the current recession allowed those sales to be achieved with increasing levels of capital inefficiency.

Probably the most valuable and effective financial planning resource of the last 25-plus years is a tool called Financial Gap, which focuses specifically on the propensity of a growing (or inefficiently managed) balance sheet to absorb cash faster than it can be produced.

The solution to this apparent growth/cash flow dilemma (other than a national recession to curb sales growth) lies in managing the balance sheet to increase capital efficiency. This is most effectively accomplished by understanding and managing both the four sources of capital and the primary assets that consume cash when managed inefficiently.

6) Borrow properly.

A good friend of mine who runs the business credit group for a major bank has these words of advice for would-be borrowers in 2010: 1) Remember that borrowing is a privilege, not a right; and 2) Know your numbers, or stay home.

The tools outlined above allow you to accurately answer the two primary questions business owners get wrong all too often: 1) How much do you need?; and 2) How long do you need it for? It is remarkably common for business owners to underestimate both "how much" and "how long."

In addition, it's critical to understand that short-term debt is repaid from cash flow, while long-term debt is repaid from net profits. Make sure you're on "the same sheet of music" as your banker, and be prepared to demonstrate your company's ability to service the loans you're requesting.

Clearly, there is a lot of money available in the banking industry. However, in the current economic environment, banks are extremely risk-averse, and regulatory aggressiveness is only making it worse. Never before has the old Boy Scout motto been more relevant: Be Prepared.

It's safe to say there has not been a time in the past decade when "knowing your numbers" has been more critical. Furthermore, using only the Balance Sheet and the Profit and Loss statement, the Fiscal Physical process outlined here provides powerful strategic financial intelligence absolutely necessary to any business owner.

These tools not only help you tell the story of the business, they are also invaluable in helping you rewrite the parts of the story you don't like. This is what experts call management. And the Profit Mastery tools provide the financial intelligence and strategic analysis to actually accomplish it.

7) Plan for transition.

Finally, of course, you will come to the end of your business career. What to do with the business? "Transition" is not fun to think about, but it's very real. Too many people take 30 years to build a nice business, and 30 minutes to plan what will happen to it when they're gone. Nothing good comes of this. Take time to do it right.

Summary

When do we learn the most about running a business--in good times or bad? Most would say bad times. Why? Because in bad times we are forced to focus on the drivers of performance and to reassess everything we're doing. Like the forest fire that clears underbrush to make way for new growth, economic downturns force us to reexamine our strategies and tactics. We can condition ourselves, and our businesses, to perform at a higher level.

Never waste a good recession. The Fiscal Physical provides structure to a performance analysis that leads to survival, renewal, and success.

Here's what I can guarantee: If you apply the Fiscal Physical process on a consistent basis, you'll gain increased control of your business--and performance will improve.

Steve LeFever is chair of Business Resource Services (BRS), a consulting firm that provides financial training, performance benchmarking, and accountability/bankability modeling for franchisors and franchisees. He has worked with franchisors and franchisees for more than 10 years to provide financial training and benchmarking to improve financial performance. Please send suggestions for topics you'd like to see covered in future columns at 800-488-3520 x14 or lefever@brs-seattle.com.