January 25, 2013
One of my favorite financial concepts is “rationalizing” a business. By definition, from our friends at Merriam-Webster, rationalize means: to apply the principles of scientific management to (as an industry or its operations) for a desired result (as increased efficiency). Rationalization of a business’s operations is a simple concept. However, in my opinion, it’s not easy to implement because of ego.
Entrepreneurs work very diligently to grow their businesses by adding talented staff along with non-staff overhead (nicer office, computers, the list goes on, etc.). If a rapid growth strategy is not executed with a laser-like focus on financial metrics, here is the all-too-familiar scenario that unfolds: the anticipated revenues do not materialize and the business is unable to support the increase in staff and overhead.
This challenge leads to the conundrum that every risk-taking entrepreneur faces as profits disappear and losses rear their ugly head: should I dismantle my team and downsize immediately or should I wait a few months longer for sales to hopefully come in and just use my credit line to fund the losses?
This decision is the most critical determinant between living to fight another day and Chapter 11. Ego starts to get in the way: I built this damn business from nothing and I pledged my house to the Bank. It’s got to work! Not necessarily.
Even the best plans go awry; through no fault of the entrepreneur. A sale didn’t close when it was expected to. A prospect changed his/her mind at the last minute. A natural disaster ruined your brand new customer’s offices and they will delay signing your new deal for 6 months while they get back on their feet. There are a myriad of reasons (out of your control) that your plan could fail.
If you have adequate capital to weather the unexpected, you can see your way through. If you “bet the ranch” and lack adequate capital to weather a blip, your business could be faced with a potentially fatal liquidity crisis. Your credit line is now maxed out and you are out of money. Don’t look to your Bank to bail you out of your crisis because chances are they won’t consider it; especially in today’s economic situation (another thing you couldn’t control).
Keep a decent capital cushion in your company. Unless you have a pocket full of money, don’t try to double the size of your business every year. If you were profitable and then start taking losses, find out right away what is causing the losses and eliminate them. The decisions will be tough and painful, but you will live to fight another day.
Keep in mind that any business that can consistently and profitably grow 20% year-in and year-out would be revered on Wall Street. Banks will trip over each other trying to help you finance your continued growth.
As Warren Buffet pointed out in his 2008 letter to shareholders: “We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.”
As an entrepreneur, your livelihood depends on your ability to make painful decisions. Don’t let your ego get in the way of good business.
Remember, running a business successfully does not need to be complicated. Keep it simple!
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