7 steps to business success.

Hi, I’m Bron Lawson from Westpac’s Davidson Institute here to talk to you today about 7 Steps to Business Success. Many business owners look to marketing and increasing sales as indicators of their business’s success but, while these are really important, there are many other aspects of a business that can be even more helpful – perhaps things you hadn’t thought about previously. Today I am going to explore seven of these other aspects with you to help you make your business more successful.

What are the 7 steps to a successful business? The first one is to have a business plan, not just a vision. Once you have a business plan, you need to understand your financial statements and use them to monitor your financial position. Our next step is to understand the relationship between your Price, Volume and Costs, because that’s all about profitability.

Making a profit is one thing, but you also need to manage your cash flow on a day to day basis. One of the major users of cash in your business, is growth. If you are growing your business, do you know how much cash you need to support that growth? Once you know how much cash you need, getting your borrowing structures right is really important too. And finally, don’t forget to plan for the end game, transitioning out of your business.

Let’s now explore each of these aspects in a little more detail to see how they can help make your business more successful. Let’s get started with ‘Have a plan, not just a vision’. There’s an old adage which says ‘Fail to plan, plan to fail’. I don’t think it’s actually quite that bad, but I do believe there are many benefits that come from having a business plan.

Now when I am talking about planning, there are lots of different types of plans. There’s great big 200-page documents; there’s your plans for your next three months. In fact, just your plans for today. Your business plan doesn’t need to be huge, but it does need to work for your business and in your business rather than taking up space in the bottom draw.

I know many business owners that have great visions for their business, but I also know that the ones that tend to be more successful are those that have a written plan. I can’t emphasise enough how important it is to write your plans down. There are two main reasons to write your plans down. Firstly, it starts to work on your subconscious. If you write your plans down, you are subconsciously committing to achieving your goals and objectives.

Secondly, if you’ve got them written down, you can pull them out every now and again have a look at them and ask yourself “Am I still heading here or have I let myself be distracted or pulled off course by other things?”

But even though writing them down is important I think it is the actual process of planning that you gain most benefit from. Being able to look at the different scenarios and outcomes, and deciding which is best for your business, then committing to that course of action gives you the opportunity to really focus on what you want to achieve out of the business.

If you want to find out more about business planning, check out our videos on Business Planning and Optimising Business Planning. Once you’ve got your plan in place, and have started to implement it, you discover not everything goes according to plan. That’s why it is important to monitor how you are going.

Now I know that for many of my clients monitoring their financial position meant checking the bank balance at the beginning of the day to ensure they had enough to pay the days wages, or that annual visit to the accountant to get their tax done! But believe me there is a whole lot more to it than that.

There is a wealth of information for you in your financial statements … if only you knew how to read them and could really drill down into the story they tell about your business. A good starting point for understanding what your financial reports are telling you, is a financial model called the Financial Operating Cycle. So, let’s have a look at the Financial Operating Cycle because it describes how every business operates financially.

When you first go into business, what do you do? You break open the piggy bank and get all the money you can together to put into the business to get it up and running. This is Net Worth or Equity. This is your money; the owners' money invested in your business.

The owners’ money is not always enough to get the business up and running. So, you might buy some stock on credit; or you might borrow money from a bank. In accounting terms, the borrowed money is called Liabilities. I like to call it ‘other peoples’ money.

So, you have your money in, Net Worth, the other people’s money, Liabilities, now what are you going to do with it? You’ll spend it on things like cash, debtors, stock, plant and equipment, computers, motor vehicles, and so on. All the things you need to operate your business, things the accountants call Assets.

Then what do you do with the assets? You use them to make sales. Of course, once you are making sales, you are going to have a whole series of expenses. If you manage this well and your sales are greater than your expenses, you make a profit. If you make a profit the taxman wants his share, but at the end of the day, you are left with Net Profit After Tax or NPAT.

There are then three things you can do with your profits. Firstly, you can reinvest them in assets to continue to grow the business. You can use them to reduce debt and reduce the risk to the business. Or you can take them home. You take profit out of the business to continue to grow your personal wealth.

And so the cycle continues. This Financial operating cycle is how every business in the world operates. It does not matter how big you are or how small you are. It does not matter what industry you are in. They all operate the same way financially, and the key to long-term sustainability is to keep this cycle turning over smoothly and efficiently.

Now those of you more familiar with those statements may have recognised that along the top here is a picture of our Balance Sheet. And down the left here is a picture of our Income Statement or Profit and Loss as you may know it. So, when viewed like this we can start to see that what happens in your balance sheet impacts what happens in your income statement and vice versa – what happens in your income statement will impact your balance sheet.

So now we can see that these two financial statements are intrinsically linked and that we now have a more holistic picture of the business instead of just concentrating on profits or sales. Understanding this cycle and how it works in your business is of course just the beginning of monitoring your financial position. If you want to find out more about monitoring your financial position, watch our videos on Understanding Financial Statements and Measuring Financial Performance.

Moving on. Our next step here is … understanding the relationship between your price, volume, and costs. I love looking at this relationship between price volume and costs because to me it’s all about profitability so I think it’s something every business owner should have a keen interest in. Think about it … price is how much you sell your goods/services for, volume is how much of them you can sell, and costs are how much it costs you to do that – leaving you with your profit.

So, if my costs are going up and I want to stay as profitable as I am now then that means I either need to sell more, or I need to put my prices up. But, by how much? If I put my price up I am likely to sell less. How much less can I afford to sell without going backwards?

Or, what if I put my prices down to match the competition? That means I’ll need to sell more because it’s unlikely that my costs will go down. But how much more do I need to sell? And what if that’s not possible? To help answer these questions and more you can use a tool called breakeven analysis. It’s a fabulous tool that’s simple to use and can answer many, many questions in the day to day running of your business.

Breakeven, of course, is the point where a business makes no profit, but it also makes no loss. But another way of thinking about it is that its the point you need to get past to start making profits. I had a client who owned a little coffee booth and he knew exactly how many coffees he had to sell each day to breakeven, and how much profit each coffee after that made him.

If he hadn’t reached his breakeven number of coffees by 11 o’clock he went into action to ensure he sold enough to make his profit target for the day. But it is not just for telling you what level of sales you have to get over before you start making profits, it can also help you with day-to-day decision making. What if your costs go up? Like your rent, insurance premiums, or energy costs? What do you need to do in your business to continue to make the same amount of profit?

Breakeven analysis can help you understand the relationship between your price, volume, and costs which can help you make more informed decisions about growing your business, putting on additional employees or purchasing new equipment, about matching the competitions price, or about putting your own prices up. As I said, it’s a great tool and can help you answer lots of questions that arise on a day-to-day basis.

If you want to find out more about breakeven analysis, please watch our video on Using Breakeven analysis available on the Davidson Institute website.

Now that you’ve got your profitability under control the 4th step of successful businesses is to manage cash flow … because, believe me, the two are not the same and your business needs both to be sustainable in the long run. Somebody once said to me “Profit is a matter of opinion. It is something your accountant calculates for you. But cash is real. Cash is the lifeblood of your business.” If you run out of cash, and you can’t pay your bills, you are potentially out of business.

Whenever I look at a business, one of the first things I want to understand is how cash flows through the business. A great starting point to understand how cash flows through your business is a model called the Working Capital Cycle. Every business has a Working Capital Cycle, but they are not all the same. I am going to start with a generic Working Capital Cycle and then I’ll talk about some variations.

You start with the money or cash sitting in your bank account. Now your money sitting in your bank account is not doing much for you. You want to use that cash to make profits. To do this, you first need to buy something that you can sell.

In this case, you are going to take the cash out of the bank account and go and buy some stock. The stock comes in and you fill up your store, or your warehouse, and then you look to sell that stock as quickly as possible as this is now cash tied up that you can’t use for other purposes.

For some, when you sell your stock you get your cash straight away either as cash or credit cards. Others though sell on credit. You issue invoices and end up with things called debtors or accounts receivable. Then you want to collect from those debtors as quickly as possible to complete the cycle and your dollars come back to you … hopefully with a little bit of profit too.

The reason we are interested in this cycle is that the strength of your cash flow is all about how long it takes for your dollars to go all the way around the cycle. The faster you turn the cycle, the more cash you will have available to you; allowing you to grow more rapidly, reduce the risk and cost of using short-term debt, and potentially improving your profitability.

Of course, not all businesses are the same. The retailers out there are looking at this and saying, “I get everything in cash and credit cards I don’t have debtors.” You’re right, of course. Your cycle just goes from cash in the bank to stock and back into cash. It’s a bit simpler. However, the biggest killer of retailers, no matter where you go in the world, is poor stock management.

A bill comes in it can’t be paid because all the cash is tied up in the stock on the floor. You’ve got to turn your stock and make sure your cash is working for you. Others of you are saying, “Well hold on a second, I’m a service business. I don’t have stock”. And again, I agree with you, however, you have something that acts a little bit like stock it’s called ‘work in progress’ or WIP.

Basically, you take on a job from a customer, you do all the work for them, then you send out an invoice. While you are doing all that work, before you can send out the invoice, you have to pay out wages, rent, utilities and so on. And this is using up your cash. Then you send out an invoice and wait for your customer to pay you which is more time before your dollar comes back into the business.

Whatever business you’re in, you have a Working Capital Cycle. There are of course many other variations too, but it is important to understand how the cash flows through your business, so you can find where your cash is hiding, and speed up your Working Capital Cycle.

This cycle is measured in terms of the number of days it takes to turn. How many days on average does that stock sit on the shelf for before you sell it? How many days on average does it take you to collect your debtors? The turns are days, days are time, and time, of course, is money. Turning your Working Capital Cycle faster helps free up your cash flow.

To get a better understanding of your cash flow, please watch our videos on Managing Cash Flow and Optimising Cash Flow. One of the interesting things about cash flow is that as a business grows, it needs more cash. Which brings us to our next step to ‘Manage growth’.

The aim of growing a business is of course to make more profit. And the most common way of doing that is to increase sales. But when you’re increasing sales, what do you need more of? You are going to need more customers. And if you have more customers, that means you probably need more product or stock to sell them. If they are buying on credit you are going to have more debtors, you may need more staff, more equipment and you may need to move into larger premises to give you more space.

More sales means you need more resources. This is why more sales, quite often means less cash. As your sales go up your cash goes down. So, where does the cash come from to pay for these additional resources? Commonly there are 2 sources – either more investment from the owners in the form of Net Worth, or from outside the business in the form of Liabilities … which for many businesses means borrowing from the bank.

When you are growing it helps to understand what additional resources you are going to need and how or where you’ll source them from. If you’d like to know more, check our Managing Business Growth video. We take you through a process called Financial Gap Analysis, which projects the impact of growth on your business to help you make more informed decisions about growing.

When a business is growing rapidly, you often see the business becoming more reliant on its overdraft or line of credit – dipping in there as its quick and accessible cash. But, is this the right type of borrowing for the business? This brings us to step 6 which is ‘Borrowing properly’.

When it comes to structuring borrowings properly it’s important to remember the cardinal rule. Match the life of the loan to the life of the asset. To explain what I mean by this, let me tell you about a customer of mine, Terry, who ran a warehousing operation. A number of years ago I went to visit Terry and he had a great big smile on his face and he said to me, “Come over here and have a look at this. I just bought a brand-new forklift. I paid cash for it and got a great discount.”

I said to Terry, “That’s great! Lucky you had the cash put aside to take advantage of the discount.” There was a problem though. The following Wednesday comes around, it’s about 4.00pm in the afternoon and I get a call from Terry. “I’ve got a problem. I’ve got to pay my people tomorrow and I don’t have the cash. Can you increase my overdraft limit?”

What Terry had done was he had broken the cardinal rule. He had taken the short-term cash he needed for his day to day operations and used it to buy a forklift – a long-term asset. Long-term assets add little bits of profit improvement over a long period of time. They’re generally not used to generate short-term cash flow.

Now I’m not saying don’t use your own cash to buy equipment, but make sure you don’t need that cash for anything else in the meantime. Instead of using your own cash, consider whether borrowing might be a better option- where you can match the repayments with how fast the cash comes back from the use of the long-term asset. Getting your borrowing structure right can take a lot of pressure off your cash flow and a lot of stress off you.

For more information on the impact of purchasing assets and how they’re financed, please watch our video on Purchasing Business Assets. The first six steps are preparing you for the end game … getting out of your business. This is known as ‘Planning for transition’ or succession planning. And this is all about extracting the value you have created in your business.

The best way to extract the maximum amount of value is to plan for it and that planning should actually start the day you start the business … but sadly many people leave it too late and are disappointed with the end result. If you haven’t started thinking about when and how you are going to leave your business I’d encourage you to start now.

There are three main ways to exit your business. You can close it down, you can sell it, or you can pass it on to family or management. There are other combinations, but these are the three main ways out. Of these three, which one do you think will take the least amount of planning? If you said close your business down, I would agree with you. You go into your office or shop and put a closed sign on the door … and hey presto, you are out of business.

Now, it may still take you some time to extricate yourself from your contracts and so on, but it does not require a lot of planning.

My next question is, of these three which one will give you the least value for your business? Trust me, it is close it down again. If you simply close your business down, it’s as if you are saying that all the time, effort and money you put into building up a customer base, building up a successful profitable business was worth nothing. However, if your business is truly profitable, it has what is called goodwill. But to realise the goodwill you have to plan to sell or pass your business on.

So, close it, sell it or pass it on, whichever you choose, will have an impact how you run your business on a day-to-day basis and what planning you need to put into place. Now, if you do decide to close your business, of course, it’s not quite as simple as closing the front door. You have obligations to staff, customers, and suppliers that need to be managed to extract as much value as you can. But as we said this exit requires the least planning but may also result in the least value.

Now, on the other hand, if you are going to sell your business this takes considerably more planning. The better your plan, the more value you are likely to be able to extract. The first step here is to think about “Who is going to buy your business?”. Is it likely to be a bigger corporate? Is it going to be an investor? Will it be a competitor? Are they likely to want to run the business themselves? And so on.

Once you’ve settled on who the most likely buyer will be, then you set about making the business as attractive as possible for that buyer. Of course, a key thing here is demonstrating profitability and ongoing viability. Do you have future contracts that are going to provide ongoing sales? Is there a market for your product in the future? Do you have documented systems and procedures that someone else can pick up and run the business with?

There is a considerable amount of planning that needs to go into selling your business.

If you’re thinking about passing the business on to family or management then this often takes the most planning and may be the most difficult. Again, the first step is to think about “Who? … Who wants the business? My children? My management team?”

If you’re passing on to family, you need to consider things such as ‘Will ownership and management be handed over at the same time? How do you ensure that your heir has the skills to run the business, and the finances to buy you out when the time comes?’ Similarly, if you decide to pass it on to management, presumably they have the skills but how are they going to find the money to buy it from you?

There’s plenty of planning involved but its definitely worth the effort to ensure you extract the value you’ve worked so hard to build. As I said, if you haven’t already, start now. Of course, things will change over time which is a good reason to review it every couple of years and make any necessary adjustments. So that all is in readiness when it does come time to make that break.

These are our seven steps to business success. A successful business isn’t just about ‘more sales’. Have your plan, monitor your financial position, understand that relationship between your price, volume and costs, manage your cash flow and growth, borrow well, and plan for how you are going to exit your business.

By taking these 7 steps with your business you’ll go a long way to making it more successful. Thank you for watching our video on ‘7 steps to business success’. I trust you found the information useful and relevant and I encourage you to check out the other financial education resources on the Davidson Institute website to help build your financial confidence.

Bye for now.