by Bill McBean
There are other reasons that support the importance of understanding accounting and finance, but for an owner who is serious about being successful, these two factors say it all. Although most owners don’t start out with a strong background in the “numbers,” there are lots of ways to improve your knowledge. One way is to take your banker to lunch, ask what the bank looks for when making loans, and get him or her to explain how they analyze your statements. You can also ask your accountant for an hour of his or her time to teach you the basics. Neither of these will make you a “numbers” pro, but they are good starts, as are the numerous online courses and free information available on the Web. It’s important to remember that ownership is a career and should be treated as such.
You
To my mind, too little is discussed about the successful owner. Because our businesses are private, little is known about us, except for what we choose to let our staff and customers see. While a lot is written about what owners have to do, little is said about how we view business, what drives us, what our concerns are, and so on. For example, some of us never lose the fear of failing. Many people believe that once an owner achieves success, that fear evaporates, but the truth is that sometimes it’s the fear of failing and losing what we have that drives us to keep going. One thing is certain: what joins us—being owners and entrepreneurs—is also what separates us. What we share is having money and pride on the line, but beyond that most owners have different business styles, talents, goals, concerns, and dreams, all of which show up in how we operate our businesses.
Owning a business is more of an art than a science, because at times the owner has to feel his or her way through a mine field. Look, for example, at the difference between entrepreneurship and sports. Sports have easily recognizable rules, statistics that show how well everyone is doing their job, specific goals, and obvious accountability. Rules offer parameters within which to operate, the goals are clearly visible, and a scoring system offers immediate feedback so everyone knows how well they’re doing, both individually and as a team. Entrepreneurs, however, have only the rule of law to work within, and have to create their own rules, goals, and means of measuring performance, whether it’s on a daily, weekly, monthly, or even yearly basis. In business, too, every day is game day, with little time for practice—except on the job. In other words, while owners have the “freedom” to choose how they want their businesses to operate, with that freedom comes an enormous challenge, a challenge that, unless you have a good understanding of business, can be very difficult to meet.
Level 1: Ownership and Opportunity
Level 1 is always a mental concept, or preparation, level, where ownership and opportunity are analyzed and evaluated before determining what action should be taken. And in that respect, this fact is no different than any of the others. What is different about this fact is that instead of focusing on a particular aspect of business, it covers a wide range of important ownership issues. As a result, when combined with the other six facts, it allows you to make more informed Level 1 decisions by providing you with a broader perspective that enables you to use previously unknown business criteria to gather additional information and, accordingly, improve your chances of making the right decision.
As I have pointed out throughout this book, it is essential that you always let facts guide your decisions. But what makes ownership and opportunity decisions so difficult to make is that even when all the facts are lined up, not everyone will see it the same way. A perfect example of this is a story a friend of mine once told me. Many years ago, the president of a shoe manufacturer sent two men to study the market in the Amazon Basin of South America. One morning he received a cable from one of them saying, “No one here wears shoes. Selling shoes would be disaster.” Later on that afternoon, though, the president received a cable from the other man: “No one here wears shoes. Huge opportunity. Must move fast.” In other words, while the facts are clearly important in making any decision, what’s also extremely important is the person making the decision. And the truth is that the more you know about business and its many disciplines, the clearer the facts will speak to you. That’s why you don’t just have to know the business you’re in, you have to know business.
Most people understand this concept in general, but it can get confusing. Let’s say, for example, that your cousin Vinnie asks you to invest in his new computer repair business, but he doesn’t have any experience repairing computers or, for that matter, in any other business. Family responsibilities aside, you’d probably tell him he was nuts or fake a heart attack and tell him your health won’t take the stress. However, if Vinnie had 10 years of experience as a computer technician and was generally regarded as one of the best in his field, you’d listen to him when he told you about the great opportunity for competent computer repair people. He could make a persuasive argument based on his knowledge of the industry and the work he knows.
This, however, is where the confusion comes in. Vinnie may be able to discuss the opportunity based on what he knows, but he can’t explain in dollars and cents how much cash will be needed because he hasn’t been exposed to that part of the business. He also can’t tell you how good the opportunity is from a profit standpoint or how the business will grow. And, finally, he can’t conceptualize what needs to be done from an organizational standpoint to make the business operate properly. Going into business without this kind of information is a mistake new owners often make, and it’s something that must be considered when ownership and opportunity are being analyzed. The fact is that, although Vinnie may not realize it, fixing computers is only one piece of the pie where ownership and opportunity are concerned, and unless he takes the other pieces into consideration, the chances he will fail are high.
In other words, while Vinnie may be an extraordinary computer technician, unless he familiarizes himself with other aspects of business, he’s going to have a problem. He would probably be fine as long as he’s the only one doing repairs, but if that’s the case, the company will never be able to grow and all he will have done is buy himself a job. Once he starts hiring other people to repair computers, answer the phone, handle Internet inquiries, do the books, and even clean the office, he is no longer a computer technician but a businessperson, which is something he knows little about and may not even want to do. There is no escaping the fact that if you don’t know business and its various concepts, you are setting yourself and your business up for failure, not because you were wrong about the opportunity, but because without a general understanding of business, you’re not ready to be an owner. That’s why it’s so important to take this into consideration at Level 1.
The Benefits of Knowing Business at Level 1
Knowing business enables you to evaluate ownership and opportunity decisions from a broader perspective.
Knowing business helps you understand the importance of making a correct decision as well as the costs of getting it wrong.
Knowing business enables you to discover your weaknesses and find ways to overcome them, before you go into business or expand an existing business.
Knowing business helps you realize you don’t have to know it all, but you do have to be willing to admit it and find a way to upgrade your business knowledge.
Knowing business provides you with a better chance of recognizing an opportunity because having a broader perspective could enable you to see an opportunity that you might not have otherwise seen.
Knowing business makes it more likely that you will be able to create an opportunity because you have more tools to work with in your toolbox.
Knowing business helps you understand that ownership and opportunity have to work in conjunction with each other, and that in most cases having one without the other means failure.
Product at Level 1
Since product is what your business offers the customer, it speaks directly to the question of opportunity. Opportunity, in fact, is a measurement of the demand for the product. For that reason the two ar
e essentially joined at the hip, so without one the other has little meaning. Since Level 1 is a preparation level, one at which your business is still only a mental concept, the goal is straightforward. You have to determine the continuous demand for the product and find out if the demand is strong enough to produce adequate profits. And the more you know about business in general, and how successful businesses operate, the better your decision is likely to be.
For example, if you are an owner who has only industry-specific knowledge, the chances of your knowing and understanding product innovation will be remote. While it’s true that product innovation can mean different things to different people, in this context it means how you differentiate your business and products from your competitors and their products. And product innovation is one of the key concepts you should review at this level because it speaks to expanding the opportunity beyond the present, that is, it addresses not just what your company will be offering its customers when you first open the doors, but also what it will be offering them in the future.
Here’s a good way to look at product innovation. It might seem that a shot of Jack Daniels is the same at any bar, a Toyota Camry is the same from one dealer to the next, and watching a movie is the same regardless of which movie theater you go to. The fact is, though, they’re not. That’s because product isn’t just about what a customer buys, it’s about how his or her needs are served. A shot of “Jack” tastes a lot better if it’s served in a clean glass and delivered by a friendly bartender, as opposed to one who hasn’t shaved or combed his hair in days and looks like he’s been up all night sampling “Jack.” The point is that customers have expectations, and when these expectations are met, it separates the winners from the losers. That’s why some businesses selling the same product excel, some do just all right, and others fail. The key to product innovation lies in your creativity, your willingness to compete, and your not letting the thought of constant innovation and changes intimidate you. But unless you understand the importance of knowing business, you may never appreciate the importance of product innovation and the role it plays in opportunity.
People at Level 1
Since at Level 1 the business doesn’t exist yet, it might not seem like people or employees are an important factor. The fact is, though, that considering your potential staff and the type of talent you will need is something you need to do because it speaks to your ability to manage them, which in turn speaks to your ownership ability. This is an important point because if you’re starting a new business or expanding one, you will have to recruit some experienced people, and both your knowledge and ability will be evaluated by those you recruit. Similarly, if you’re buying a business, the current employees will be judging your every move and every statement. The question you have to ask yourself, then, is whether or not you’re ready for this challenge and/or scrutiny. If, as an owner, you can’t lead, market the business, and “motivate, educate, and entertain” your employees, the strength of the opportunity will be of little importance because you’ll never get there.
One of your responsibilities as an owner is to tell your employees how you want them to execute their jobs. But you also have to be able to back it up through determination, persistence, and a willingness to discipline those employees who don’t do what you want. In regard to the question of ownership, then, you have to honestly evaluate whether you will be able to do this consistently. Consistency is a key word because owners and managers often have a different view of how things should be done than their employees do. That means conflicts are going to occur, and they will need to be settled. And it’s the willingness to address those conflicts that separates the good owners from the poor ones. In other words, the tail can’t wag the dog, and if you’re not willing to mix it up with employees on occasion, you shouldn’t become an owner. So your ability—or inability—to deal with people is something you need to take into consideration in making the ownership decision at Level 1.
Accounting and Finance at Level 1
Up until now, I have not singled out accounting and finance as a subject of its own, although I have made numerous references to it, because I wanted to make it clear that it doesn’t represent a separate discipline but one that is woven into the fabric of your business. Unfortunately, despite its importance, it’s one of the subjects owners and entrepreneurs understand the least. As a result, there are many owners who should have been successful but never were because they didn’t understand how important it is.
At Level 1, accounting and finance come into play in the opportunity analysis in two areas, cash and profits. We all know the saying “cash is king,” but the reality is that some owners don’t really understand why it is so important, particularly at this level. One of the reasons is that cash—or more correctly, the lack of it—can keep you from becoming an owner in the first place. Unless you have it, or have access to it, the likelihood of fulfilling your dream of starting or buying your own business is pretty remote. Moreover, the larger the business you want to buy, the more cash you will need to buy it.
In addition, even if you have enough cash to start or buy a business, you will need still more cash to operate it until the business is bringing in enough money to cover your expenses and provide a profit. In other words, “cash is king” means more than just having cash available. It also means having a solid understanding of how much overall cash will be needed to operate the business on a day-to-day basis, and of the positive and negative effects cash can have. Let’s say, for example, that you believe there is sufficient market demand for you to buy an expensive piece of equipment that will create more sales and gross profit. The question, then, is whether you should buy the equipment outright, finance it through your lender, or lease it. This is a “cash is king” decision. If you buy the equipment outright, the cash drain on your business could be severe, but if you combined cash with some financing, while it would increase the breakeven point, it would also enable you to keep more of your hard-earned cash. The point is that you have to take these considerations into account in making such decisions, because not understanding their impact can create serious financial difficulties.
Most business owners actually understand this concept, but making it work in the real world is a different story. In order to do so at Level 1, you need to familiarize yourself with the use of three essential financial tools: the cash flow analysis, the income (or profit-and-loss) statement, and the balance sheet. The cash flow analysis is a tool that tells you how much money has come into the business, how much has been spent, and how much remains. Without the cash flow analysis you would be operating in the dark in terms of what you should and shouldn’t do as far as using cash is concerned, and that’s a dangerous spot to be in even for a successful owner.
The second tool, the income (or profit-and-loss) statement, shows you sales revenue, cost of sales, gross profit, expenses, and net profit. This tool is essential because it enables you to see how much net profit you’ve made. In addition, when you are looking at an opportunity, it can show you how lucrative the opportunity may be based on certain facts, such as normal expenses, or educated assumptions, such as sales revenue and gross profit, and tell how much money drops to the bottom line. That is, by “playing with the numbers,” you can get a feel for various levels of sales revenue, gross profits generated from those sales, and expense levels, to determine where your breakeven point is. Without this knowledge every scenario becomes a surprise, and that’s not the way successful businesses operate.
The balance sheet, the third tool, shows current and long-term assets on the left side of the statement and the business’s liabilities and net worth on the right side. The reason it’s called a balance sheet is that the asset side of the page has to balance with the liability and net worth side. This tool essentially provides a picture in time that shows you, at the time it’s prepared, where your cash is located in terms of current and fixed assets, your working capital, net worth, and retained earnings. Having this information
is important because it provides you with basic facts about the business’s operation, such as the amount of cash on hand, receivables, business liability (including payables owed), and others. In addition, it’s a good tool to understand because most lenders rely heavily on the balance sheet for their lending criteria. In fact, it’s a more important document than most owners realize, because it can be the determining factor in a lender’s decision to give you money to buy or expand a business.
The bottom line, figuratively and literally, is this: if you don’t use these financial tools at Level 1 to analyze an opportunity in terms of how much cash is needed and how much profit is available, you haven’t done an adequate job in analyzing your opportunity decision. And in that case, you will be operating more on the “I hope this happens” theory than on the one that suggests “opportunity is there, I just have to make it happen.”
You at Level 1
By now, you may have made up your mind about ownership and opportunity, or at least have a pretty good idea of what your decision will be. I do, though, have a further word of advice: this is not the time to be impatient and hurry your decision. If you don’t take all the various considerations into account, and rush toward either starting a business or giving up on the idea, you will more than likely have neglected to take into account one of the most important elements in the ownership and opportunity decision process—you. This is because of all the many questions you have asked yourself in trying to make the ownership decision, it really comes down to one overriding question: “have I really been honest with myself?”
