As you know I am not an expert in the fields in the title above. I do know a few things about them so here’s a quick overview.
1. Companies that are only starting up need to keep their planning in a soft, moldable, adjustable mode. Usually such planning revolves around the actual value that a company is about to provide to the market. One needs to ask questions such as: what does our product do, who does it do it for, how does it come to its customer, how is this different or better from the competition. A nice phrase describing this process is the search for product-market fit. Once a fit is found, things start to roll.
2. The problem before the point above is that people tend to miss the signals. They don’t see it, they can’t read the market, they are insecure, changing their mind too often. In such cases people are not ready to plan just yet, they need mentoring, coaching. They need assurance, feeling of self confidence. A mentor can guide them towards challenges that are appropriate, not to heavy, yet also hard enough to provide learning lessons.
3. Business model is the way you make money. A typical business activity might be very complex, however the way money is made in the end is very simple. Imagine apple. First one needs to have the soil with appropriate levels of sun and rain, bees in the environment and other magical ingredients usually unknowingly provided by the nature. Then one needs the plant. The plant grows at least for a year, and finally, the product appears, an apple. Yet, the work is not done, as the product needs to arrive to its final destination, the mouth of your customer. The same fruit can provide for different business models. One could rent out the land for the orchards, one could sell the plants, one could charge servising of the orchard, sell the apples, but also cook the apples and sell apple pie, or build a hotel and sell hotel rooms wherein one would serve apple juice. Myriads of options myriads.
4. The decision about the business model ties closely with the cost structure one will incur. A business is nothing if it is not a repetition of the same business model day in day out. The cycle of activities needed to support the business model is directly reflected in the cost structure. Everyone agrees, the faster the cycle moves or the more cycles there are, the stronger the business. The costs have to be analysed properly, which is much easier to do in existing companies, simply because data exists, at least in accounting, if not in many other departments too. New companies, and new products, often have to guess, yet this risk can also be reduced by careful examination of conditions that would be available in the near.
The biggest insight one can have about costs is in which of the costs are variable and which are fixed. The answer is far from easy, however one needs to find it. The variable costs are the costs directly related to running a single product cycle, as described in the point above. Fixed costs are all other costs not directly related to how many product cycles there are.
An apple, or more appropriately, a box of 20 kg of apples, in a shop could have the following variable cost items: yearly rental cost of 10 sq. meters of orchard divided by number of boxes produced on that surface, cost of work for keeping the tree in good shape throughout the year, cost of picking a box of apples, cost of sorting and cleaning the apples, cost of the box itself, cost of transport. The same box of apples needs to pay for the fixed costs too. Such costs are: administration, agronomy & lab staff, sales, logistics, insurance, machinery, buildings, energy, tractors, oil, etc. Clearly, costs can be either variable of fixed, however they should not be both. It is up to each company in how ot decides to cut the costs up.
5. Pricing. Pricing is one of principal task of any business. One cannot get the pricing right unless one does the cost analysis first. The sum of variable cost is the lowest one can sell if one does not want to sell under the price. Everything above the variable costs is contribution and pays for the existence and also growth of the company.
Obviously good data and understanding of it is needed for profesionally informed decision making. One needs to be very strict in this, which is often not the case. Entrepreneurs don’t understand their own data and plan their activities on shabby foundations. There might be short term success in such a company, but in the long run the disqualifications stemming from such faulty planning doesn’t bring peace and happiness.
6. Balance sheet, Income statement and Cashflow
This is the area I like to hand over to the actual finance guys or ladies, however, I still do need to understand the principles. Here are a few.
Balance sheet is a snapshot of what company has and who this what belongs to. The what are the assets, the who is how the assets are claimed, the obligations. The nice principle here is that assets and obligations always match, they are balanced. Here is where the name comes from, the “balance” sheet.
On the asset side of the balance sheet one finds cash, materials, buildings, machines, inventory, accounts receivable and others. These are all the ingredients a business needs in order to be able to operate. The obligations side you have owners equity (capital), debt to banks, debt to suppliers, accounts payable and similar. A nicely organised balance sheet usually also shows which of the assets are short-term and which are long-term. The same division appears under obligations. Bank credit under one year is deemed as short-term obligation, for example. By the same token, a two-year credit would be a long-term item.
As said, a balance sheet can be done in any moment, good companies do it several times a year, while all other wait and only do it once every 12 months, as required by the tax authorities.
The income statement is different, because it always states a history of business events, it always relates to a period. An income statement says how much a company sold, expensed, invested, divested and earned (or lost) in a chosen period of time. Good companies know that any sale ties-in with some profile of cost and they try to keep their bookkeeping organised in a way that resembles this. Bad companies think that money that comes into the bank is all that is needed, often forgetting about properly accruing for everything that needs to be taken of during the non-paying periods.
Cashflow statement tells us how much cash we are actually generating in a business. It is crucially important as it combines all elements of the business puzzle. Everyone knows that one might have sold for millions, but unless that money is collected it would have been better of the initial sales success was not even there. The cashflow statement helps companies understand how timing influences the actual activities. Cashflow statement is in a way a measure of how well a business is synchroised. For example, a crudely organised newly successful company might think that booming sales is heaven, yet the cashflow statement might show it that it will go bust in a very short time, precisely because the sales have boomes so hard that the company now needs so much more working capital with repayment cycles being too long so that it simply cannot catch its balance anymore.
Sounds complicated? Well, that’s why I do consult companies. To make at least a part of this easier. And we haven’t yet touched marketing really, have we?