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“Management is about coping with complexity”

-John Kotter[1]

Content created by Darin Gerdes. Copyright Great Business Networking.

How to Keep from Going Under
            Reality TV shows first hit the air in the 1990s. Survivor, may be the most prominent in the genre. It was followed by hundreds of other shows.
I am a big fan of reality shows about Alaska. In fact, at this time, there are dozens of shows about Alaska including Alaskan Bush People, Alaska the Last Frontier, and The Last Alaskans. I don’t know why, but I find these shows intriguing. I don’t want to move there. I like living where it is warm. I don’t want to live without electricity. I appreciate modern conveniences. I am just fascinated by the homesteader’s mentality.
For homesteaders, life is difficult. They have to do everything from scratch. They must prioritize what must be done—finding food, water, shelter, and wood for the winter—if they want to survive. Often, they have no startup capital to speak of beyond sweat equity and the resources on the land that they must convert and put to good use. Their experience is remarkably parallel to that of the entrepreneurs who must every function of business if they don’t want to go under.
In the last few lessons, I have tried to simplify the basics of business finance for readers without formal business training. When I began writing this section, I asked a few of my colleagues for their input, asking them what they thought that new business people needed to know about the subject. Between them, these professors have started nearly a dozen businesses, so their advice is wrought from hard experience.
Much of what they had to say fell neatly into previous lessons, but a number of concepts just did not lend themselves to those discussions. Here I will share the remaining concepts.
 
More about Cash Flow
Imagine you are an Alaskan homesteader. You have to cross a river. You know the river well, and you know that there’s no better place to cross. It’s getting dark, and to get home, your only option is to get into a leaky boat. There is a large hole at the bottom of the boat. Though you’ve plugged it as well as you can, it still leaks just because of your body weight. Each time you paddle, you rock the boat and water leaks in. With each stroke, you’re closer to your objective of solid ground, but in the process, you also sink a little deeper. Periodically, you have to stop rowing in order to bail water so that you don’t go under. It is a “two steps forward, one step back” scenario.
That’s a pretty good metaphor for how business works for the new entrepreneur. We talked about cash flow already, but it bears repeating because it is so critical. From the moment you start your business, your expenses are working against you, threatening to drown you. You must simultaneously move toward your goals and eliminate expenses if you hope to keep the business afloat.
You decide that you could be more efficient if you purchase new equipment. That is true. You are more efficient, but because you’ve taken on new expenses, you must grow to pay off the debt. More often than not, growth comes in the form of additional sales, but as we learned in a previous lesson, sales are not the same as cash.
Some businesses have to spend a lot of cash up front on equipment and inventory and they will not be paid for a long time. Even if every other aspect of the business is sound, this may be a recipe for bankruptcy.
It is instructive that Warren Buffett, on the other hand, tends to do the opposite. He invests in companies that have large float and free cash flow to equity such as insurance companies.[2]  Essentially, Buffett reverses that process.
Some businesses are cyclical. Many retailers are dependent on Christmas for a disproportionate percentage of their sales. At the same time, landscapers are out of their primary weekly lawn service, and they might have to adjust to odd jobs or snow removal. You must anticipate timing issues and prepare for the lean times.
During the lean times, you can’t rest. You must increase your marketing efforts, create new inventory, or engage in other activities that position you to capitalize on the next wave. If you’ve grown to the place for you have employees, spend the lean times building capacity in your people. Be proactive rather than reactive. The good news about cash flow is that, outside of an unexpected disaster, most of these events are predictable. If cash is king, timing is queen.
 
Other Practical Advice
John Kotter, a Harvard management professor tells us that, “management is about coping with complexity.” That’s right. As a manager, the decisions you make can have a significant effect on the organization. One of my favorite professors in graduate school, a serial entrepreneur, often told us, “every mistake you make in business costs you real money.” Nowhere is this more true then when you’re making financial decisions. Should you bundle your product with other products? Will you offer bulk discounts to customers? Should you purchase more materials in order to get a volume discount from your suppliers? If you get that discount and spend the money up front, will you have the cash to hold you over while the materials are tied up in inventory?
Sometimes saving money is the expensive thing to do. Well-intended managers cut what they believe to be fat not realizing that they are really cutting muscle and the organization will not recover from those cuts for years.
These managers fall into the trap of avoiding all costs in the mistaken belief that all costs are bad. But costs that bring in greater revenues can be good. Sometimes you have to spend a dollar to make two dollars.  In the same vein, you must distinguish between good debt and bad debt. Good debt creates greater value; bad debt loses value. You must know the difference.
Watch variance.  In The real-life MBA, Jack and Suzy Welch wrote that when dealing with finance, you need “a mindset, if you will—that says, ‘When it comes to finance, I have one main interest, and it’s variance analysis.’”[3]  They continued, “Oh, how we love variance analysis—comparing key numbers month over month, or year-over-year, or comparing them to plan, see what’s working in your organization what isn’t. We love it . . . Because variance analysis is the aha part of finance.”[4]
The homesteader in the boat is engaged in continual variance analysis. His timeframe is condensed, but the principles are the same. He is constantly gauging how quickly the water has risen. You must do the same.
 
 
The Numbers Tell a Story
We discussed financial terms and concepts at some length. Here, I want to reinforce that message and urge you to learn which metrics are relevant to your business. Once you identify them, keep track of them. Jack and Suzy Welch mentioned that they are often asked which financial indicator is most important.  The answer is not simple because business is complex. There is no one measure that works for everyone, but they advised:
If you’re running a business, whether it’s a corner store or a multi-product multinational, we would say there are three key indicators that are very helpful: employee engagement and customer satisfaction—both of which are not technically financial—and cash flow, which is.
Employee engagement first. It goes without saying that no company, small or large, can win over the long run without energized employees who believe in the mission and understand how to achieve it. That’s why a company needs to take measure of employee engagement at least once a year through anonymous surveys in which people feel completely safe to speak their minds….
Growth is the key to any company’s long-term viability, which is why customer satisfaction is the second vital sign. This metric, we believe, is optimally assessed via site visits, and not just with your ‘good’ customers. Managers need to go and see the customers whose orders are inconsistent or dropping—the ones the salespeople don’t like to see themselves. And make these visits about learning. Find a dozen ways to ask ‘What can we do better?’
Along with visits, we also recommend utilizing Net Promoter Score, the customer satisfaction measurement system invented by consultant Fred Reichheld. NPS centers on the question, ‘How likely is it that you would recommend our company, product, or service to a friend or colleague?’ Customer favorites Amazon and Apple are reported to have NPS scores of around 70 out of a possible 100, while the near-monopolistic cable TV industry as a whole is said to be closer to 30….
Finally, when you talk about companies pulse, there’s cash flow, which, as we’ve said, also happens to be one of the must-know terms if you’re ever going to get comfortable with finance.
Here’s some good news. Cash is not complicated….
The main thing to know about cash flow is that it just does not lie. It tells you in raw, hard numbers how much money went out, how much came in and how much you have. That’s why so many managers and investors like it more than net income as a measure of profitability….Cash flow helps you understand and control your destiny.[5]
I found this passage insightful for a number of reasons. First, my colleagues also emphasized a number of these themes. I cut out a few pages of their advice because Jack and Suzy summarized it so well here.
Second, this way of thinking elevates the emphasis on customers and employee-customers. It seeks to quantify their experience in order to track, measure, and enhance it. Finally, you will notice that the metrics are not just about finances. Each metric tells a story about the health of a particular section of the organization.
 
Seek Professional Help
Most small businessmen do not keep accurate records. This is unfortunate because such carelessness can do irreparable harm to the business. Keeping careful records is not high on the new entrepreneur’s priority list, but it is necessary.
In our first lesson, we talked about the excellent employee who struck out on his own to become an entrepreneur. He realized that he could make a lot more money as the owner than as an employee, but he also found that he had to do a lot more of the administrative tasks.
In the lesson on accounting, I advised that you learn enough to understand accounting and then find professional help. This advice is not only true for accounting, but for tax, payroll, and legal services.
You simply must keep accurate records even if you use professionals to do the heavy lifting. For example, one of my colleagues told me a horror story that I like to share with you is a cautionary tale. He went to lawyers to incorporate his business, but his lawyers apparently never filed the paperwork and this created a huge problem for him. Three years later, he received a huge tax bill from the IRS and he had to sue the law firm for not performing the tasks they were paid to perform. Ultimately, he won the suit, but he would have been better off had he checked to ensure it was done right to begin with.
You have to do your due diligence.
Even if you outsource the work to professionals, you must still understand what you are doing.  You must learn about tax law to factor that into your projections. You must understand the implications for payroll and learn the legal requirements for dealing with employees. Determine what you need and invest in continuing education or books that help you shorten your learning curve. In short, seek professional help, but learn about the business of business.
 
A Cautionary Tale
George McGovern first ran for congress in 1956. He served in congress until 1960 when he ran for Senate and lost to Karl Mundt. He joined the Kennedy administration, running the Food for Peace program. He ran for Senate again in 1962, a seat that he would hold until 1981, but in 1972, he ran for president of the United States. He lost to Richard Nixon in a landslide, winning only Massachusetts and the District of Columbia.[6]  For decades, the name McGovern was almost interchangeable with liberal. Josh Mound, writing in the New Republic, explained:
For the past 40 years, whenever a Democratic presidential hopeful has given off the slightest whiff of leftish anti-establishmentarianism, party leaders and mainstream pundits have invoked McGovern’s name. In 2004, Howard Dean was the new McGovern. In 2008, Barack Obama became the new McGovern. This year, it’s Bernie Sanders’s turn.[7]
While in office, McGovern advocated a number of anti-business positions in the name of fairness and equality. He sought to raise taxes on corporations and “the rich” in order to redistribute that money to the poor. His policies betrayed a deep ignorance of business.
When he retired from politics he went on the lecture circuit. In 1988, he invested most of his life savings in a small hotel, the Stratford Inn, which soon went bankrupt. He confided in a reporter,
In retrospect, I wish I had known more about the hazards and difficulties of such a business, especially during a recession of the kind that hit New England just as I was acquiring the inn’s 43-year leasehold. I also wish that during the years I was in public office, I had had this firsthand experience about the difficulties business
people face every day. That knowledge would have made me a better U.S. senator and a more understanding presidential contender.[8]
Business is difficult. If you want to keep yourself from going under, you need to learn everything you can about business. You can do it; you just need to be willing to learn and grow.
 
Actionable items:
 
What are your key metrics?
 
In what area of your business do you need to seek professional help?
 
In what area of your business can you learn more on your own through books?
 
 
End Notes
 
[1] Kotter, J. P. (1996). Leading change. Boston, Mass: Harvard Business School Press
[2] Harper, D. (n.d.) Warren Buffett’s investing style reviewed. Investopedia.  Retrieved from http://www.investopedia.com/articles/05/012705.asp
[3] Welch, J., & Welch, S. (2015). The real life MBA: Your no-BS guide to winning the game, building a team, and growing your career. New York: HarperCollins. (p. 77).
[4] Welch, J., & Welch, S. (2015). The real life MBA: Your no-BS guide to winning the game, building a team, and growing your career. New York: HarperCollins. (p. 77).
[5] Welch, J., & Welch, S. (2015). The real life MBA: Your no-BS guide to winning the game, building a team, and growing your career. New York: HarperCollins. (pp. 78-80).
[6] Nixon won the election by 520-17 in the electoral college vote.
[7] Mound, J. (2016, February 29). What Democrats still don’t get about George McGovern. New Republic. Retrieved from https://newrepublic.com/article/130737/democrats-still-dont-get-george-mcgovern
[8] McGovern, G. (2012, Oct. 21).  A politician’s dream is a businessman’s nightmare: A 1992 column on the realities of running a business. The Wall Street Journal. Retrieved from http://www.wsj.com/articles/SB10001424052970203406404578070543545022704