It’s all about the drivers

Financial statements report end results really well but they don't give insight into daily activity. For that you need to understand the drivers behind the numbers. This is easy to do once you understand how to keep peeling back the layers of the onion. Here's an example.

One of our clients has a professional practice. He wants to get his practice to the point where he can take three days per week off without experiencing a downturn in his take home pay. His number of customers is pretty much capped, meaning additional marketing efforts to bring in new customers would just be throwing money away since he's already at capacity. In order to take three days per week off he will need to hire another practitioner to cover for him on those days. We calculated that he has about 3,600 appointments per year and the cost to have someone cover three days per week would be approximately $45,000 for the year.

So now the question becomes "What is the key revenue driver in this business?" If we can identify that we can focus our efforts on improving it to generate more revenue. We already said the number of customers is capped so that's not the answer. Pricing could be a driver but his practice is already the second highest priced in the area and wouldn't tolerate any across the board price increases. The driver that was left revolved around the average transaction price. This business has the opportunity to sell add on services and products during each client appointment. So here was our answer. If we could increase the average revenue per appointment by just $12.50 we would have the $45,000 needed to pay for his three days off (45000/3600=12.5).

So how to do that? What we've settled on over the next thirty days is implementing a series of business processes that structure the sales script. This has two advantages. First, it brings structure to the practitioners follow up conversations with the client. There were many instances when the business owner would fail to take the opportunity to cross sell a related product or service just because he was busy or forgot. Practitioners who cover on his days off hardly ever took advantage of the opportunity to cross sell or up sell because they had never been trained or incented to do so. The second advantage is that with a formal script the paraprofessionals in the office can be trained to sell and cross sell in cases where the practitioner isn't needed. This frees up more of his time and results in much higher profit margins.

Whether this strategy works or not only time will tell. But the search for underlying drivers uncovered a strategy that to date had not been pursued.

What does a CPA know about marketing?

Surprisingly, I spend a lot of time talking with business owners about marketing. Most of them don't have a concrete idea of what they hope to accomplish with their marketing efforts and many can distinguish a genuine marketing effort from a wishful advertising spending spree. I'm not a marketing genius but I know how to spot a business that understand the role good marketing plans play in their success. I also know how to measure a lot of stuff. In this podcast we'll talk about the components of a good marketing plan. Chief among these is the ability to measure results.



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The owner’s challenge: Stop working so much.

I met with a new client yesterday and we talked about one very prevalent challenge that business owners face. Most business owners start out working for someone else. They are good at what they do, are willing to take some risk and eventually go out on their own. The challenge is that running a business is much different from doing the work of the business. In this case the owner, a therapist, was very good at working with clients and as a result had received referrals and encouragement to the point that she eventually decided to start her own business. Now she has employees and subcontractors working for her and a number of issues are starting to surface.

1. Administrative responsibilities such as bookkeeping, payroll, taxes, ordering supplies, etc, all take up time that used to be spent meeting with clients. Business owners can and should hire someone to do these tasks for them when feasible but managing the relationship and maintaining proper oversight still takes time.



2. Marketing and finding new accounts can be very time consuming. Business owners are often conflicted, and rightfully so, over the tug-of-war between servicing existing clients and prospecting for new ones.



3. Business owners are often perfectionists when it comes to client service while their employees are somewhat less conscientious. This isn't always the case, many employees take pride in their work, but in almost all cases employees won't perform to the same exacting standards that the business owner demands of herself.
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The first two issues are solely a question of time management. Most business owners are not strict enough about segregating their time and deciding how many hours of each week they will dedicate to each activity. Evaluate how much time you need to commit to servicing existing clients, prospecting for new clients, and administrative work. Block that time out on your calendar and be ruthless when it comes to making exceptions. No enduring, successful business owner got that way by allowing others to dictate her time commitments.

The third issue concerns standards, delegation and accountability. As a business owner you must take the time to write out the standards you expect and the procedures that must need to be followed. This is a common theme I discuss with clients all the time. It may take you an extra hour to write out the procedure but unless you do it you'll be stuck doing and redoing your employee's work forever.

Effective delegation is the exercise of making good business decisions. It comes down to who can do this job most profitably and how much risk can I take to expand the knowledge and skill sets of my employees. The fact is that you as the business owner can probably do the job better and faster than your employees. But if you do that all the time your customer base won't grow and your employees won't learn anything new. You must be willing to live with less than 100% perfection in order to delegate effectively. You must be willing to let go a little.

The final element is what allows you to manage a great deal more work than you could possibly do yourself. Accountability is the act of holding people to their word and to the standards they have agreed to work under. More than anything accountability describes a partnership between employee and business owner where the two understand what is expected and they think enough of one another to communicate honestly. This doesn't usually happen by itself. Too many business owners either brandish a bull whip and threaten their employees or avoid confrontation entirely. The fact is that accountability is a two way street and most business owners aren't willing to be held accountable BY their employees so they fail to enforce standards of accountability FOR their employees.

Making the transition from an employee to a business owner is challenging but also incredibly rewarding. Sometimes just taking a step back to understand the challenges and get a few words of encouragement from someone who's been in your shoes makes a big difference.

Deciding to fire someone

I had a conversation with a business owner last week that is fairly typical. This business when compared to its peers was carrying way too much overhead. Delving further into the financial statements it didn't 't take long to identify the culprit. Wages and salaries were way too high. We ran some metrics such as revenue per employee, production per employee, production per non-production employee, etc. All of the KPI's we measured pointed to an under performing business. There were two ways out of the mess:

1. Increase revenue by roughly 50%


2. Decrease overhead by three administrative positions or one production position and one administrative position.

In our local economy and in this particular industry increasing revenue was not an option. In fact, all the indicators pointed to a trend of decreasing revenue until the real estate market recovers. That left what I thought was a clear option, but the more we talked the more resistance I experienced. This business owner simply was resisting the inevitable. I finally said "Look, you can do this now or you can flush another $120,000 down the drain and do it in six months. Either way, these people will eventually be gone.

I know what it's like. I've made bad decisions and I've been unwilling to do what was necessary to fix it. Most small businesses operate like families and some business owners can't stomach letting someone go. Eventually they are backed into a financial corner and there is no other choice. Until then they bury their head in the sand and the business suffers as a result. Here are three suggestions I offer business owners to try to keep them out of this mess in the first place.

1. Measure the amount of revenue generated by every employee against what it costs you to keep that person on the payroll. This sounds hard and sometimes it takes some real work, but if you can't point to a bottom line improvement in the financial statements you cannot justify keeping that person on the payroll.


2. Share the numbers with your employees. If they see that the business isn't doing so well they WILL get the message (if they don't they shouldn't be there anyway). I think it's far better to have a team striving toward a common goal than it is to have a bunch of people worried only about their individual quarterly performance evaluations. And for small business there's no better team goal than profitability.


3. Talk often. I recommend my clients sit down with their direct reports every 30 days. This gives you plenty of opportunities to talk about personal and professional development as well as any productivity or performance issues. Let the sessions be less formal than performance appraisals and listen twice as much as you talk. These sessions are invaluable for resolving the important but non-urgent problems your business faces every day.

Seasonal analysis, cash vs. accrual

I had an interesting exercise yesterday where we met with a new client to get a broad overview of their business model. As it turned out the only financial information we had access to for this first meeting was revenue. But we had revenues on both a cash and accrual basis. I charted the revenue by month for the last several years then analyzed the percentage of annual revenue realized each month. This is basic seasonal trending and when viewed on an accrual basis it produced the expected seasonal curve for this business. Something like this.



However, when we reviewed the same graph on a cash basis (booking revenues only when cash is received) the graph looked a lot different. As you can see below the erratic ups and downs still indicate a seasonal trend but it's harder to identify given the inconsistent nature of the graph.



If you think about it, the problem with this particular business is very obvious. What is this business owner's biggest problem? What keeps him awake at night? It's cash flow. There are huge swings in cash basis revenue every month. That's not exactly rocket science. Most businesses that are struggling have problems with cash flow. But in this case I was able to nail down the specific issue that was causing a cash crunch. Any guesses?

In this particular instance the business owner had a very poor process for managing receivables. In essence he would do the work like a mad man for a month, then spend the next month running around trying to collect. Then he was back at it...driving trucks, working jobs, doing whatever was necessary to get through the back log. Then a month later he's chasing collections again.

This proved to be a real eye opener for the owner. He FELT like he was on this constant roller coaster but he had never been able to quantify how inconsistent cash flow was affecting his operation. To see it in black and white was a real revelation. Cash vs. accrual analysis is very useful if done correctly.