Really…There Is No Secret To Starting A Business

Many start-up companies fail within the first few years. Learn how to establish a game plan and make a profit.

Imagine five basketball players that never practice, have no game plan or a backup in place to allow for change should something go wrong during a game. Should they expect to meet a professional team on the court and win? You are probably laughing because it would never happen. However, imagine you have an idea or think you have a better way to accomplish a goal than someone else. What do you do? You gather some money and away you go. Right? Wrong. There is a reason why 90% of start-up companies fail within the first few years of inception, if they make it that long.

The secret to success is establishing a game plan and learning how to make a profit. It sounds simple, but in fact the vast majority of business owners are never taught or understand how to make a profit. There are several factors that contribute to financial success or failure, but they fall into three main categories: revenue, operations and accounting In business, there is continuous interplay between these three factors. For instance, establishing a profitable selling price requires an understanding of ALL the costs associated with the production of the goods or services as well as the ability to allocate overhead and utilize breakeven. Profitable operations also require employees to take an active role in the management of the operation. As an owner, it is impossible to be everything to everyone. Everyday employees make seemingly small decisions, with little or no guidance, but those decisions have a substantial impact on the financial health of the company. The primary questions that must be asked are, “What do I need to know?” and “When do I need to know it?” The accounting function is fashioned around this question. The information produced must be timely, accurate and relevant.

When examining the revenue component, it is important to remember that 80% of your revenue comes from 20% of your customers. Inversely, it may also be said that 80% of your profit comes from only 20% of your customers. As a true paradox, the 20% of customers reflected in each statement are often not the same customers. The customer that demands difficult, or impossible, production schedules and unreasonable pricing structures consumes production capacity and limits the ability to service others who are willing to pay a fair price.

A properly incentivised sales team will produce profitable sales, not just sales for the sake of revenue. Develop a compensation program that rewards and pays a higher commission for sales with the healthiest gross margin. It should pay very little, or have no reward, for sales that do not meet the company’s minimum standards (i.e. nonprofitable sales).

Sales will generally increase without this compensation structure, but the company will literally “grow” itself out of business. The acceptance of marginal or unprofitable sales strains capacity and working capital may force the company into a cash flow shortage. Eventually, it will compel the company to extend vendor payments or attempt to increase a line of credit and/or secure short term expensive bridge loans thereby increasing interest expense. With production capacity tied up from unprofitable sales, there is no available opportunity to take on profitable sales. This ever-increasing downward spiral increases the chance for the business to default on obligations and eventually leads to business failure.

“Under promise and over deliver” sounds simple but in reality, it is not because business owners rely on employees to produce a desired result and success is not a forgone conclusion. For many companies, holding employees accountable is an elusive and trying endeavor. Accountability begins when all employees have a clear understanding of exactly what is expected of them.

For example, the performance requirement for a sales person may be that in addition to the maintenance of their active customers, they make a minimum of 15 cold calls per week to ensure at least one additional new customer. This minimum activity level assures the company that there will be enough new activity to meet the sales projections required to sustain profitability. In turn for this performance requirement, employees will ask, “What’s in it for me?” With unemployment now at near record lows in most parts of the country, the “work or get fired” mantra does not have the same motivating effect as it would during times of high unemployment. Employee profit based incentives are the best way to ensure that company activities are effectively carried out.

In applying profit based incentives, there are several factors that must be taken into account. Simplicity is the key. First, all employees MUST clearly understand how and why their actions have a direct positive, or negative, effect on their pay. This includes the actions of those around them. Shared responsibility, “win as a team or lose as a team,” is the motto every good company requires to consistently push forward. The objective is to have the employees take responsibility for their actions, and those of others, by tying the incentives to the team as a whole and ensuring all employees carry their own weight.

Second, the positive or negative shared reward should be dispersed throughout the team based upon each employee’s position within the company. Such as, the production manager with 10 years tenure will take a larger share than the kid who sweeps the floor and only has been with the company for six months. Regardless, each team member deserves a portion.

Finally, both positive and negative incentives should be paid frequently enough to maintain morale and give the employees something to look forward to. On the other hand, they shouldn’t be given so frequent that it causes an undue strain on the administration. In order for incentives to be effective, they should not extend out beyond a two week period or the excitement and momentum will wear off. Properly utilizing positive and negative reinforcement with incentives and making certain each employee understands their expected results will measurably increase the chances that the business “under promises and over delivers.”

As earlier stated, first, in order for a business owner to accomplish the goal of running a successful company they must know and understand the costs associated with the production of the goods or services. This is the foundation for management based accounting. The process starts with a highly developed chart of accounts that serves as the road map of the company operations. It starts with revenue and breaks it down into specific product or service types that allow business owners to track sales efforts and ensure that these efforts are made in the most profitable areas. Second, the cost of goods sold (COGS) is the variable cost that can include labor by function (i.e. service versus installation, production materials, equipment rental, freight, sales commissions, royalties, waste and warranty). Third is indirect overhead – the costs associated with the production of goods and services. Indirect overhead may include supervisor wages, estimating wages, quality control expense, shop expense, small tools, repair and maintenance of tools and equipment, fuel and oil, education and consumable supplies. They must be allocated across all of the revenue activities. Fourth is general and administrative (G&A). The items in the chart of accounts are the overhead items that generally occur whether there is any production activity or not. It may include bank fees, interest, lease expense, contributions, depreciation expense, office expense, officer wages, rent and utilities. A properly set up chart of accounts allows the business owner to quickly identify any areas that are not performing up to standard. Properly defined overhead expenses allow for correct allocation in the pricing process.

The secret of success in small business is to understand the difference between profitable sales and revenue, instill a clear definition of employee performance requirements, provide proper incentives to initiate ownership of business activity and maintain a well-oiled accounting system. Create a game plan and put controls in place that allow you to change the course of action as needed, without interrupting your forward momentum and opportunity to win the game.