If you own a business and find yourself being pulled in many different directions, and if you are spending the majority of your time working in the day-to-day of your business, rather than working on your business, you are not alone. This is very common with business owners. People often enter into business because they are good at what they do, but face challenges as their business grows. Having worked with many businesses over the years as a CPA, I have identified a number of common factors, which can be viewed as key success factors for growing a healthy business, and I will be discussing 5 of them below.
So, if you are going to set aside time to work on your business each week, and are wondering where to focus that precious time, here are 5 areas that I would highly recommend, with an action item for each to get you started.
1. Clear Direction
Having a clear direction for your business is critical in getting there. Imagine you are on a canoe trip. If you do not have a clear direction in which you are rowing, you could end up anywhere, as you will be going in the direction you are rowing. The importance there is identifying where you want that to be, and rowing in that direction. Think of rowing as all the activity you do in your business. Is it taking you in the direction you want your business to go? There is much information out there about business goals, and creating a mission and vision for your business. What you want to be careful about here is not making it a complex process, as that will often create a barrier to even setting any goals for your business. As a starting point, think of where you want your business to be in the next year. Perhaps it’s a revenue target, perhaps you have goals for your team, or certain types of customers or clients. The important thing is this: once you know what that goal is, break it down into quarterly (3 month) targets that you can start working toward. Those will be more actionable targets to aim for. The key here is action. It is very common for businesses to go through goal planning exercises, only to have the goals sit somewhere in a binder or on their shared drive, and the goals do not impact where resources (time and money) in the business are allocated.
Action Item: Think of 3 specific things you would like to see for your business in the next year (e.g. a certain amount of revenue, team composition, etc.). Then, create quarterly goals for those targets over the next year to get you there. Start on them soon and secure a time in your calendar in 3 months to revisit your progress.
2. Revenue
It is very important for businesses to have sustainable and growing revenues for healthy growth. When it comes to planning for revenue growth, it is helpful to think about the 6 key drivers of your revenue. These are:
Number of leads or potential customers
Conversion rate
Retention rate
Referral rate
Average dollars per sale/transaction
Average number of transactions per customer
Understanding these drivers is critical, as it helps in setting very clear action items in growing your revenue. While it is great to set revenue targets each year (such as “10% year over year growth”), it is always important to break down what that looks like specifically; what will need to happen in order to see that growth? Is it a certain number of contracts you need to land? If so, how many proposals or estimates do you need to do (given your conversion rate) to secure that many contracts? Knowing that will give you more clarity on the business development work that needs to happen. You can dive into this topic further here.
Once you better understand the key drivers of your revenue, and what you can do to impact those drivers, you will want to put a mechanism in place to forecast your revenue. Doing this will help you better understand what your revenue will look like in the coming weeks and months, identifying potential dips that need to be addressed through additional business development activities. There are different platforms out there that have great tools for tracking your revenue pipeline, such as PipeDrive and HubSpot. Find one that works for you and start using it. You will find that even revisiting this on a monthly basis, taking the time to forecast out your revenue, will get you thinking more about ensuring that your revenue pipeline is full, and taking the steps to make that happen.
Action Item: Establish what your revenue target is for the year, and specifically how you will impact the revenue drivers to get you there. Then, start reviewing your revenue forecast on a monthly basis (whether it’s using an online platform or a simple spreadsheet), as this will help identify how you are tracking toward your overall revenue goal, and will help in recalibrating any actions that need to be taken with any of the revenue drivers.
3. Profit
Profitability is another key success factor for business growth. Despite its importance, it is very common for business owners to let time go on without revisiting their profitability, again, because they are often so busy doing the work in their business to look into this. Inevitably, as time goes on costs increase, and so it is important to review both your pricing and cost inputs in your business, as the difference between the two is your profit margin. A Cost Volume Profit (CVP) analysis will help you better understand how strong your pricing is relative to your costs, how that impacts your break-even point, and it then also helps you forecast out the required revenue needed to reach a target profit. If you would like to dive into this type of analysis for your business, you can click here for a free downloadable profit analysis tool, as well as access a video walk-through, guiding you on the use of the tool.
When it comes to pricing, there are a number of different strategies that you can consider. We dive into 5 common pricing strategies here. As it relates to your profitability specifically, you want to ensure your pricing is set to cover your costs and profit targets, and revisit this at least annually to ensure it is still sustainable for your costs and profit targets. Using our free downloadable CVP analysis tool can help you with this.
As far as costs are concerned, these are also something that should be reviewed regularly. If you are not already doing so, set up the capability in your accounting system to view your income statement on a comparative monthly basis. This lets you see each of your accounts in your income statement on a month over month basis, which really helps in identifying cost trends and anomalies. Then, at least on a quarterly basis, dive into the transaction level to identify any costs that may be unnecessary. These are often referred to as the “set-and-forget” expenses. Here you can use an approach that we call Traffic Light Budgeting, where you highlight costs that you will continue in green, those that you may consider discontinuing in orange (to revisit in the next month or quarter), and those that you will cancel in red. If you are observing rising costs in an area, this exercise may help identify the need to negotiate pricing with some of your suppliers, or identify the need to perhaps find alternative suppliers and vendors.
If you have a contracting or construction business, you may also want to consider enhancing your finance operations to include project accounting, which helps you have a better understanding of your profitability at a project level.
Action Item: Download a free copy of our profitability analysis tool, and watch the video walk-through, to help you better understand the profitability of your products or services, and the level of sales required for your business to break even. Then, put in a monthly profit target and that should inform what your revenue target should be each month. Then, compare this to your revenue forecast (discussed above). A revenue forecast that is lower will mean decreased profitability, whereas a revenue forecast that is higher than your revenue target will mean higher profits.
4. Cash Flow
The saying goes “Revenue is vanity, profit is sanity, and cash is king”, and I have seen this play out many times with businesses. You can have great revenues, and excellent profit margins, but if your cash flow is not strong, you could quickly find your business in financial difficulty. Cash flow management goes hand in hand with managing your working capital. Generally speaking, you want to speed up the time it takes to receive cash and elongate the time it takes for cash to go out the door. Now, there are a number of strategies that you can consider in this (which we go through in a webinar here, or you can simply download the slide-deck, or you can download our free cash flow eBook here), and you need to also strike a healthy balance with the importance of maintaining strong business relationships as you consider optimizing your cash flow, as simply choosing to pay all your vendors later may have not be the best blanketed approach in terms of long-term business relationships.
What you should also be doing is regularly forecasting your cash flow. When I say regularly, I recommend weekly, biweekly, or monthly. Any rhythm beyond a monthly cadence results in a span of time within which too much can happen to really have a meaningful cash flow forecast. A cash flow forecast will help you better understand your cash inflows and outflows, and what is impacting those, and will also help you identify when you may be running into a cash constraint, or a significant cash surplus, well before those may happen. Identifying these constraints or surpluses well in advance can help you best prepare for them, whether it is finding sources of financing (in the case of cash constraints), or finding ways to put excess cash to work for you.
Action Item: If you are not already doing so, begin preparing a cash flow forecast at least monthly. This will help you identify any future cash constraints that you can plan for, and will also help you better understand the trends in your cash flow.
5. Building Value
As you work on your business, you are also making it more valuable. One thing we discuss with clients is the reality that they will eventually exit their business. This happens through a planned exit, such as a sale or gradual transition to employee or family ownership, for example, or an unplanned exit, such as the less popular options of death or illness. Whatever it may be, you will eventually leave your business. Once that reality is acknowledged, the common question that follows is, “how can you harvest as much value out of your business as possible when you exit?” There are numerous benefits in maximizing the amount of value you can harvest out of your business when you exit, such as funding potential retirement, buying another business, having capital available for other investments, contributing to charitable causes, or setting up options for your kids’ futures.
So, how can you focus on building value in your business?
Understanding a common way of calculating business value can help you intentionally build a more valuable business. While business valuations can be complex and involve procedures that are specific to the business, at a high-level business valuations come down to a profitability metric and a multiple. Here is a simple formula to calculate a business value estimate:
Profitability Metric x Multiple = Business Value
Let’s look at the profitability metric and multiple further, as improving each of these will result in a corresponding increase in business value:
Profitability Metric
The profitability metric often used when it comes to valuations is EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is a financial performance metric that shows the operating profit of a company and its ability to generate cash flow. This is calculated by taking a company’s net income, from the income statement, and adding back interest, taxes, depreciation, and amortization. For the purposes of business valuations, there are usually a number of adjustments done to your EBITDA figure to get to what we call normalized or adjusted EBITDA, but that is getting into more detail than we’re going in this post, as we’re more talking high level concepts here. So, when considering the impact of EBITDA on overall business value, this really comes down to profitability, and so improving profitability is the focus here. While improving profitability is a topic that would require a book to cover, and we discussed some ways above, some general areas you can look at here could include:
Reassessing your pricing strategies.
Understanding what drives your revenue, and having a solid revenue growth strategy in place.
Looking at your costs to deliver products or services, and understanding your break-even point.
Knowing your profitability metrics, and monitoring changes in profitability over time.
Working on understanding and streamlining your workflows, to avoid waste and rework.
Reviewing your overhead expenses regularly (we recommend monthly, using your monthly comparative income statement).
As you are working on improving the profitability of your business in order to drive your business value, you will also benefit from that increased profitability!
Multiple
The valuation multiple is a number that is generally specific to the industry that the business is in, is based on historical data from other recent business sales in the industry, and is typically a range, with a low and a high end. So, for example, perhaps you have a construction contracting business in Canada, and the valuation multiples at the time you are considering selling range from 2 to 5 (often times there’s a decimal figure, but we’re working with simple hypotheticals here). This would mean that your business may be valued at approximately 2 to 5 times your adjusted EBITDA. So, if your adjusted EBITDA is $500,000, that would mean that the value of your business may range from $1M to $2.5M. The big question then is, how do you know where your business value falls within that range? This comes down to how systematized and turnkey your business is. Think of it this way; if you were to sell your business today, would the person purchasing it be buying a job that they need to work in for it to function, or a business that can operate without them? This is a big driver of how far along the valuation scale your business may be. If your business is entirely dependent on you, lacks good internal systems, and does not have a strong team, it is quite possible it may be valued at less than that range (perhaps 1x or less).
So, what levers can you pull to move your business up the valuation multiple scale? Again, entire books have been written about this, but here are some general areas you can focus on:
Minimize the dependency of the business on you as the owner.
Enhance the structural systems in your business, which includes having well documented workflows and procedures, which allow for continuous improvement and optimization, as well as more streamlined and effective training and delegation for your team.
Develop your team, making sure you have the right people on the bus, and that they are all sitting in the right seats. Invest in your team so they can perform well, and be sure to compensate them competitively, and make sure they know they are appreciated, as your team is a large part of the value of your business.
Work to develop strong relationships with your customers. If you only have a few key customers, this will be a perceived risk from the perspective of a potential buyer, and so diversifying your customer base is important, being careful to also ensure that customer relationships are not dependent on the owner, but can easily transfer to someone else in the company who can effectively manage customer relationships well.
Build your overall business brand. This is going to be the experience that people have with your business, whether that be internal, such as people on your team, or external, such as customers, vendors or other stakeholders. This overall experience may be captured by your values (which should be more than a list of words on your wall), and may really help move the needle on the valuation multiple.
Action Item: Once a quarter, identify 2 to 3 key areas that you can focus on to move the needle on the value of your business. This can be an area of profitability, or an area that may impact your valuation multiple. These should be tied in some way to your 3 overall goals relating to clear direction that we discussed above. At the start of each quarter, create specific goals for those 2 to 3 key areas that you can focus on over the next 90 days.
Whether you are starting out in business, or have been at it for years, it can be easy to be pulled into the day-to-day demands of your business. Find ways to create space to work on your business, and when you have that bandwidth, focus on these 5 key areas that we have seen over the years that will help you build a great business.
People often enter into business because they are good at what they do, but face challenges as their business grows. At BasePoint CPA, we serve as your experienced financial guides, so you can have confidence with regular financial insights and the ability to make informed strategic decisions. If you need help in your business, to help optimize profitability, increase value, have regular ongoing financial oversight, please click here to book a complimentary introduction Zoom call.
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The information above is intended to be of a general nature, and is not intended to address the circumstances of any particular individual or entity, and is not able to capture changes that may be enacted that would impact the information above following the date of publication. As such, there is no guarantee that the information above is accurate as of any given date following publication, and so no one should act on or make specific decisions based on the information above without first receiving professional advice that can take into consideration specific circumstances for each person. Should you wish to discuss your specific situation, you can contact us here.
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