By John Aberle, Ph.D., Emeritus Professor of Marketing San Jose State University
In this continuation of my article from last month’s issue of Performance Racing Industry, we take a look at 10 of the most helpful rules in operating a small business. We only had room for the first four ‘commandments’ in the previous issue, so here are the final six..
The Fifth Commandment
Thou shall strive for capital gains by reinvesting in thine own firm.
The argument for the ‘rightness’ of this commandment is two-fold in nature: (1) your return on equity (the net worth of your firm) is far more likely to be greater than money taken from your firm and invested elsewhere; and (2) capital gains (the difference between the value of your firm when you started it and its value if you sell if after years of operation) will be taxed at a far lower rate than current income you may derive from it each year. This is even more important if your venture is organized as a corporation.
The statutory rate on long-term capital gains (the application of an investment that occurs in a period greater than a single year) will be 20% after 2012. In actuality, the rate is considerably lower because of the time cost of money. That is, a dollar to be received 20 years from now is not worth as much as a dollar received today.
A dollar received today can be invested at interest (in our situation, reinvested in your operation) and will be worth much more than a dollar after 20 years. Thus a dollar of tax paid every year for 20 years is much more tax than $20 to be paid 20 years from now. If the interest rate is 6%, a dollar a year for 20 years is 1.8 times as much as $20 twenty years from now.
Because of the value of time, the tax on capital gains is really much lower than the statutory rate of 20%. That is due to the deferral of the tax on the gain from the time the gain accrues to the time the gain is realized (in the situation, when you sell your firm)..
The Sixth Commandment
Thou shall learn to live with uncertainty.
Convince yourself that it is perfectly OK to be uncertain, because this state of mind goes hand-in-hand with being an entrepreneur. Market forces and the unknown future keep entrepreneurs guessing, and that’s never going to change. The trick is to navigate successfully through uncertainty.
Right off the bat, learn to be skeptical of those who are absolutely sure they are right, regardless of their credentials. In 99 cases out of 100 the truth will be somewhere in between absolutely correct and absolutely wrong. Rather, learn to think in terms of various alternative possibilities, none of which is absolutely correct or absolutely incorrect. Consider varying degrees of plausibilities for each alternative. It is this kind of thinking that will enable you to navigate successfully through uncertainty.
The Seventh Commandment
Thou Shall Not Be An Information Pack Rat.
The problem a lot of entrepreneurs seem to be having with computers appears to be in the mass of information they pile into the computer’s memory. The information is squirreled away without any thought given to use.
What entrepreneurs need to know is whether the assets they work with are earning their keep. Information is needed on product line profitability. Once profitability percentages are in hand, it is possible to decide what to discard and what to keep.
In keeping with product line profitability, total gross margin achieved by any given line during the year is another needed bit of information. It will supplement information forthcoming from product line profitability figures and greatly aid in merchandise selection.
Finally, information on cash flow is essential. Cash flow is the lifeblood of the enterprise. Once projections are made, incoming cash can be compared to the estimates on a regular basis.
Retailing is basically a trading business. In your store you trade merchandise for money. You use money to pay your expenses. Any interruption of this cycle means that the firm’s assets are not working hard enough.
The Eighth Commandment
Thou Shall Avoid The Folklore Of Management.
To obey this commandment, dismiss the following myths from your mind: 1) the notion that effective management of your firm requires thoughtful, precise planning; 2) the notion that you need access to complete information; 3) the notion that there is some business model that, if followed, will increase your firm’s profitability; 4) the notion that the manager’s role is to maintain a balanced performance by working through others; and 5) that management is a science—a systematic, analytically determined procedure.
Belief in such notion will lead any owner/manager of a smaller firm, who reviews his/her management procedures, to a monumental inferiority complex. The entrepreneur’s advantage is the ability to act quickly, so be wary of processes or directions that tend to erect roadblocks rather than eliminate them.
Research indicates that top executive in large-scaled firms follow essentially the same management patterns as you do. Like you, those people have specific intentions, not well-thought-out plans. Their information comes from a variety of sources and never is complete. Also, like you, they depend largely on a data bank in their heads rather than upon some business model.
By the same token, the idea of a balanced performance doesn’t ‘hold water.’ The research shows that large firm managers perform a wide variety of jobs, much of it ‘hands on.’ And, finally, these same managers have to rely on intuition and judgment, both ‘far cries’ from the scientific method.
The Ninth Commandment
Thou Shall Always Remember That Turnover Is Not Causative.
The ninth commandment is designed to emphasize that turnover is the result of good buying; it can’t cause anything. In effect, a firm may have a high turnover and yet go broke. This is sometimes hard to understand because the most profitable stores have good turnover. By the same token, they have margins that are large enough to pay the bills and leave a profit.
The total concept works in favor because of the time cost of money. If you know what your customers want and the amount of money they are willing to trade for it, the margins will be adequate and the inventory will move.
Profitability compounds from the movement at adequate margins (not necessarily the highest) because the dollars you currently receive can be reinvested more quickly than dollars you get gat later.
In summary, good buying works hand-in-hand with the time cost of money to increase profitability.
The Tenth Commandment
Thou Shall Shed Bad Habits That Thou Has Accumulated.
Certain habitual patterns that evolve from the conventional wisdom can inhibit profits and, at worst, lead to bankruptcy. Among them are: 1) the constant striving for sales growth; 2) too great attention paid to the income statement, while the balance sheet is neglected; and 3) the assumption that the terms ‘sales’ and ‘marketing’ are interchangeable.
The objective most smaller firm owners have is to increase return on investment (ROI). This is the ratio between the profit of the operation and the assets employed to achieve the profit. The conventional view, which sees sales as the route to this objective, looks at turnover of assets and neglects profitability. An improved habit pattern would also consider pruning assets while maintaining sales. The results would be an increased ROI and a far better financial position for the owner.
FOR PROFITS, LOOK TO BOTH SALES AND OVERHEAD
Racing entrepreneurs are just naturally built to look to sales as the fastest method of increasing their profits. However, many companies with significant sales levels flounder as the result of another key aspect of running a successful business—cost control.
“The firms I took over and rejuvenated were profitless because of wasteful expenditures that didn’t need to be made,” Gary Sutton said, in a lecture I attended. It was titled, “Tight Ships Don’t Sink—Plugging Profit Leaks In The Smaller Firm.” As president of Knight Protective Industries, Sutton was regarded as a turnaround specialist. The techniques he used to turn these firms around can be put into practice by any smaller firm owner. I’ll share the points that would tend to add most to your bottom line.
First of all, said Sutton, forget about the experts’ forecast of future interest rates, inflation or the Gross Domestic Product. “Such predictions are seldom accurate,” argues Sutton. Personal concern about them will interfere with decisions of the moment that you must make if your racing is to be profitable.
It makes more sense to set guidelines at the start of each year based upon your intuitive feelings with regard to interest rates, inflation and the state of the economy. If things change dramatically, adjust the guidelines.
Use your CPA as more than an accountant, said Sutton. “Auditors are your best advisors,” he argues. “They know your numbers and, more importantly, how your numbers stack up against the world’s. Better than you,” he notes, “they know how you’re doing.
“Before each annual audit, have your CPA firm’s partner agree to spend extra time looking for a couple of extra things, such a possible cost reduction; or have the firm compare your management and operations to similar clients—reporting your relative strengths.”
Woo the bankers. “Instead of cursing the bankers when times are tough, try romancing them when times are good,” said Sutton. “To keep the bankers on your side, it is important to know your lending office’s boss. There is so much turnover, as young lending officers move up in the bank, that you’ll find yourself starting all over every two years if you don’t.
“By the same token,” he goes on, “always be acquainted with several different banks, to protect yourself when your banker changes jobs and forgets you.
“Every quarter, give the bankers background information on your industry. Give it to them whether or not you need money. Give them quarterly financial statements and talk with them about the future. Soon,” he argues, “your bankers will anticipate your needs and ask if you need a loan.
“When things go bad,” he summarized, “give the banks more information than normal. This will force you to really tighten up your actions. The bankers will feel a strong bond when you pull through.
“When bankers see you beat a tough time, they see you as a worthwhile investment—and less of a risk.”
Fuzzy direction kills more businesses than competition. Sutton believes that the owner of a firm should build a reputation around a theme and not deviate from it. He said, “Survey your customers, employees and vendors. Figure out where your organization excels or could. Decide which most mentioned things have the greatest validity and future. Put all this into short phrases. See which stick with people. Never claim best quality, price and service together because they are incompatible. Pick one or two. Be specific. ‘At 60 miles per hour, the loudest noise is the clock’ said Rolls Royce. That tells more than a tired claim like quality.”
Sutton has little use for consultants. He frankly advises: Don’t hire consultants; you know more about your business than they do. Sutton argues that the owner of a smaller firm knows far more about his or her business; it costs less for the owner to analyze it; and he or she will be held responsible for the results. “The Captain,” as he said, “goes down with the ship. The consultant rows back to dry land to seek more business from others.”
Look for other areas to tighten up your ship. You and your staff have worked hard to get money into the business, it’s certainly worth the time and effort to plug up leaks. —John Aberle, Ph.D.