The Fiscal Physical

I say this because, sadly, many business owners do not know the cost structure of their own business. Consider this simple example: Say that your (1) variable cost percentage is 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.

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 from Jay Goltz that is disturbingly real: “I learned the hard way: You can afford decreased profits if you have cash flow; however, the opposite is not true.”

 
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, but it’s also a document that banks will be scrutinizing in 2012. The secret to successful cash flow management is understanding the impact of revenue patterns on the key cash flow drivers.

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 that were required to support robust sales growth, but this growth often used cash faster than profits could supply it. In addition, the easy credit of the five years prior to the current economic environment allowed those sales to be achieved with increasing levels capital inefficiency.

Probably the most valuable and effective financial planning resource of the last 25+ 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 which consume cash when managed inefficiently.

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 2012: (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 that business owners all too often get wrong: (1) How much do you need? and (2) How long do you need it for? It is remarkably common for business owners to underestimate “how much” and “for how long.” In addition, it is critical to understand that short-term debt is repaid from cash flow, and long-term debt is repaid from net profits. Make sure you’re on “the same sheet of music” as your banker. 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 is safe to say that there has not been a time in the last decade when “knowing your numbers” has been more critical.

Furthermore, using only the Balance Sheet and the Profit and Loss statement, the Fiscal Physical 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, but they are also invaluable in helping you re-write the parts of the story you don’t like and providing the financial intelligence and strategic analysis to actually accomplish it.

PLAN FOR TRANSITION
The owner eventually comes to the end of his/her business career – their 30-40 productive years. What to do with the business? Transition is not fun to think about, but it is very real. Too many people take 30 years to build a nice business, but only 30 minutes to plan what will happen when they’re gone. Nothing good comes of this. Take the time to do it right.

SUMMARY
When do we learn the most about running a business, in good times or bad times? Most would say bad times. Why? Because in bad times we are forced to focus on the drivers of performance and reassess everything we’re doing. Like the forest fire that clears out 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 on a consistent basis, you’ll gain increased control of your business – and performance will improve.