Businesses should Become Profitable Before they Become Big

Great article concerning the pit falls of creative accounting. Groupon reported earnings of $80M when they actually lost $114M.

Groupon Doomed by Too Much of a Good Thing

“Clayton Christensen would agree with the intuition that Groupon displays but ignores: businesses should become profitable before they become big. The best way to manage a fledgling business is for managers to be impatient for profit but patient for growth. Such a strategy limits an early venture's funding in order to force the business to develop a profitable business model and then invests heavily in growth once such a model is identified — Christensen terms such investments "good money" for incubating growth businesses and extols the strategy for three reasons.

• First, when a business is impatient for profit, managers are forced to validate their assumptions and demonstrate that customers are fundamentally willing to pay an acceptable price for the company's offering.
• Secondly, expecting a business to be profitable quickly forces it to keep its fixed costs low. Because a business's cost structure determines which customers it finds profitable, keeping these fixed costs low preserves strategic options for the company when it is choosing which customers to target.
• Finally, reaching profitability quickly ensures that when outside financing dries up, the venture can succeed on its own.”

We are so all consumed by winning that we lose sight of what score keeping is about. It’s about showing position and progress. It is not about the score, but what the score tells us. If things are not going as well as we would like or if we know according to the Sigmoid Curve that they will get worse before they get better, wouldn’t we want to know exactly what our position is? Wouldn’t we want to know as factually as possible the levers that we can push and pull to make things better?

I talk with many small businesses that I know will never achieve the level of success they should because of the way they keep score. In some cases it not just the way they keep score, they haven’t developed the skill to know what the score is telling them. They are too busy trying to look successful by redefining success.

Don’t fit the score keeping to your desired results…. Drive the desired result with better score keeping…

Service verse Sustainability, The Government Way

I’ve toyed with this idea for some time. It seemed we needed to wake up to what we as voters and taxpayer have allowed to happen. Our country is now run by two major corporations whose only true interest is sustainability. It’s no longer about the people or the nation, it’s about sustaining the life of the party. 546 people have become the royalty of the “republic for which they stand”. For the most part they hold themselves above the law and only answer to their parties. The voters for the most part only get to chose between the candidates the two parties have put forward.

Starbucks CEO Howard Schultz stated, "All it seems people are interested in is re-election,". "And that re-election -- the lifeblood of it is fundraising."

There are a number of similarities between corporate America and political parties. Both know to continue they need a revenue source that is sustainable over time. Otherwise the corporation dies out. For political parties that is fund raising. Build up a large enough war chest and new parties cannot afford to enter the marketplace. Both major political parties, combine, raised $1.9B during the 2008 election cycle. Corporations sell products and services to generate funds, what do political parties do?

Political parties use taxpayer money to fund projects targeted toward potential donors. Potential donors might be individuals, corporations or lobby groups. It really doesn’t matter to them, money is money. It would appear that the goal of legislation is primarily to garner good will among potential donors. One of reasons so much “pork” is added to every bill is to influence potential donors to contribute. Why else would congress add something like a library or bridge to a bill on healthcare or immigration? Why would a bill exclude certain groups from participating? Why would congress exempt certain groups from taxes or levies? It’s all about fund raising.

Both corporations and political parties engage in branding, advertising and public relations. One of the major differences is that corporations must reinvest their own money in product development to keep the revenues flowing. Political parties on the other hand have the ability to tax the general public to create “products” they can give to the market in exchange for donations. The money comes from the public but goes to the party. It’s a nice scheme. There is no direct connection between taking money from the tax payers… providing a “service” to the public… and collecting donations for the party. But those most willing to donate to the party are the ones who reap the most benefit from the “services” and generally don’t pay as much tax toward its delivery.

Almost 50% of those who filed taxes at the federal level paid no taxes. This does not include all of those who survive but have no taxable income, mainly due to entitlements. (not saying all entitlements are bad, just pointing out a fact) So the majority of the constituents (voters) are not currently paying for any of the services that they receive. From a business standpoint this is not sustainable. Why would congress pursue an unsustainable strategy? Because sustainability is about fundraising, not government spending. When worse comes to worse, they can just print more money or add more taxes.

The system has been broken for some time. It is now coming to a tipping point. Unfortunately the political parties will not chip in to bail us out. They will simply tax the voters and use the money to influence donors. It’s what they do…..

Personal Value in Economic Terms

One of the things that I constantly come back to when I hear dissension concerning compensations is “What was fair to you when you made the decision to take the job?” There is so much discussion concerning wealth redistribution and income parity. There have been numerous editorials and op-ed articles on CEO compensation. The NFL players union is in negotiations with the NFL owners concerning the distribution of revenue. There seems to be a lot of focus on the other guy. There seems to be a prevailing opinion that income is fixed and therefore compensation must be rationed between parties.

I was raised in the Midwest in a farm community. My thinking is somewhat molded by this experience. The concept of retirement is just not a real concept to a farmer. The farm never retires, there is always work to be done. It doesn’t provide medical benefits, 401K, or promotions. You can’t negotiate with Mother Nature to get a pay raise, try going on strike and see how that works. You make a commitment to a life style and you live up to that commitment or you change professions. Many children are leaving the farm because of that very issue. They expect medical benefits, they expect a retirement plan, they don’t want to work past 62, and they want their income to rise with the cost of living. These are all foreign concepts to farming.

I can’t tell you how many discussions I have had with employees who think their compensation is somehow relational to someone else’s. X-genres are the worst. “I’m doing all the work and fat old man in the corner office gets the big bucks.” And yet they agreed to do the work for the compensation offered. At the time they made the decision is seemed like a fair deal, or at least fair enough. Shouldn’t my concern be more along the lines of “I hope he makes a fortune because some day I’ll have his job…” Then figure out what it takes to get a job like his, build the prerequisite skills, knowledge and experience and apply. In economics, value is not derived by labor and materials. Value is created by demand in the marketplace. If I can find someone else who can perform your duties as well as you can for the same or less, then as a business stakeholder I have an obligation to consider them for employment. That job candidate should consider all possible avenues they can take to earn a living and take the most productive. What anybody else is doing only affects you as it relates to your decision to continue doing what you are doing.

I do think that many CEO, entertainers and sports figures are grossly overpaid, but that is because they don’t have a high level of value to me. I would never pay them at their current level. (Don’t misinterpret my statement as meaning they don’t have considerable value, just not as much in my view) The people who are paying them see their value or they wouldn’t pay them. If someone with higher value comes along then they will displace the current employee. That is how it works. The fact that I make less than them does not enter into the equation. My value and their value are independent.

An interesting read for those who want to understand economic value is “I, Pencil” by Leonard Read. He chronicles all of the independent people who help create the pencil. Everything from the tree growers, saw mills workers, and truckers, and graphite miners, and wax producers, and lacquer makers to Paper producers…. Everyone from all over the world…. Most of these people do not know they are involved. They all have a part. No one understands the entire process completely. This is how we fit in our perspective organizations. We all have a part. Each of us chooses to contribute or not. Each of us chooses if our compensation is enough or not. None of us, as individuals, depends on the value of others to create our own unique value. For a healthy economy we should all look for ways to increase our value independent of the value of others. If each of us increases our own value the economic ship will rise on the tide. If our goal is to drag others down to make ourselves feel better, no one will prosper.

It is not bad to want what others have. It is bad to want to take it from them as a form of compensation. Create value; create value in yourselves and others. Do not spend time trying to minimize the value of others. It will only bring everyone down.

Importance of Operational Accounting in the Small Businesses

I read an interesting article this week written by John Nessel. John Nessel is the President of Restaurant Resource Group, a Boston-based consultancy providing financial tools and support services to independent restaurants and the hospitality industry. John’s number one red flag to restaurants failure is “Absence of a well organized and implemented accounting system.” He goes on to say “Printed copies of basic financial statements (Profit & Loss and Balance Sheet) are not adequate for this task because they do not verify the accuracy of the numbers presented.”

Luis Luarca of Allectus, a business management advisory, says “As proper and accurate accounting is the life blood of business, accurate and relevant accounting procedures allow for the opportunity to affect all aspects of business efficiently and effectively.” They both agree on some simple yet extremely important indicators of a poorly run business.

1. An overall lack of understanding concerning financial statements and their importance in business decision making

Understanding the technical definitions of items portrayed in financial statements is a long way from understanding what it really means and how an understanding of the meaning can be used to help run the business for efficiently and more profitably. The structure of the financial statements can mask potential risk and hide growing concerns. Not knowing what do don’t know can hurt you.

2. Over reliance on online bank balances to manage cash flow

The statement or online bank balance doesn’t tell the real story. It doesn’t tell what deposits haven’t cleared, what checks have not been cashed or what credit card transactions are not reconciled. More importantly it does not provide a vision into future cash needs. It is a point-in-time view of the health of cash. It can be dramatically different within minutes as transactions clear.

3. Inaccurate posting of financial information

This can run from simple transposition errors, to the more complex allocation error. One of the most overlooked concerns for small businesses is that the chart of accounts does not reflect the way the owner operates their business. A badly thought out chart of accounts can actually hide business problems until they are too late. Because of this, the allocation of expenses may not accurately show their impact on the business.

4. Daily and Weekly financial information is not routinely collected, reviewed and acted upon.

Many business owners are too preoccupied with data input to take the time to routinely apply a logic test to the financial information. Expand the effort to daily or weekly information gathering and little time is left to run the business. Owners should spend the majority to their time reviewing financial information for trends and taking action on those trends to improve the business performance. Instead many spend their time with the low level activity of capturing data.

5. The absence of a well organized and implemented accounting system that includes business specific Chart of Accounting, key performance tracking and repeatable procedures.

This seems to be the last thing any small business owners wants to take on. There are a lot of reasons for this. Tactical operational issues take precedence. There is a lack of understand as to the quantifiable benefits. There is a lack of interest or aptitude. All of these are the very reasons that a small business owner should look outside of their own expertise and time. This is a primary skill, much like tax accounting, that should be outsourced.

These trying economic times have brought to the surface ongoing operational issues that were previously covered by a better economy. Although poor profitability might have still been a problem, cash flow allowed these problems to go unaddressed. Many companies managed this through short term borrowing or lines-of-credit. Once credit was constrained and cash flow became an issue, operational inefficiencies came to light.

A lack of attention to good operational accounting may have masked many of these issues until they became a crisis. Crisis management is never a good answer. For some companies it became the only viable answer. The owner must take back control. To accomplish this there must be an in-depth review of how they currently account for financial activity and what that tells them or doesn’t tell them about the health of their business. This many times requires a third party that can objectively assess the environment exclusive of day-to-day operational bias and business ownership pride.

Social Entrepreneurship

Let me start out with a few definitions from Wikipedia.

Capitalism is an economic system in which the means of production are privately owned and operated for profit. Income in a Capitalist system takes at least two forms, profit on the one hand and wages on the other. There is no consensus on the precise definition of capitalism, nor how the term should be used as an analytical category. There is, however, little controversy that private ownership of the means of production, creation of goods or services for profit in a market, and prices and wages are elements of capitalism

Social capitalism (Socio-capitalism), as a theory or political or philosophical stance, challenges the idea that socialism and capitalism are inherently antagonistic. The essence of social capitalism is that markets work best and output is maximized through sound social management of the macroeconomy. Social capitalism posits that a strong social support network for the poor enhances capital output. By decreasing poverty, capital market participation is enlarged.

Social entrepreneurship is the work of social entrepreneurs. A social entrepreneur recognizes a social problem and uses entrepreneurial principles to organize, create and manage a venture to achieve social change (a social venture). While a business entrepreneur typically measures performance in profit and return, a social entrepreneur focuses on creating social capital. Thus, the main aim of social entrepreneurship is to further social and environmental goals. Social entrepreneurs are most commonly associated with the voluntary and not-for-profit sectors, but this need not preclude making a profit. The terms social entrepreneur and social entrepreneurship were used first in the literature on social change in the 1960s and 1970s

Many people, this people tend to be workers or politicians rather than owners or investors, see capitalism as a system of moving money from the poor to the rich. They believe that the entire ecosystem is disproportionately tilted toward the rich. The poor may benefit to some extent by having jobs but the preponderance of the benefit is given to the rich. I can’t argue this view. Capitalism rewards those with resources, who reinvest them, with greater gains then those without. I could argue that without those who are willing to risk what they have there would be no jobs for those who have little to risk. But only the truly greedy person would accept this as a valid response. After all, one person can only consume so much. The incremental value to their quality of life of spending more on themselves diminishes as assets accumulate. It’s the law of diminishing returns.

Social capitalism says that there is an inherent benefit to the economic enterprise to address social issues. That by building a business around serving the community, the business prospers. True social capitalist suggest that government should regulate the social interaction. I disagree with this mainly on the grounds that politicians are not free of bias. They tend to sponsor bills that promote their own longevity. Fundamentally political parties are just a special form of capitalism. The exchange rate is not calculated in dollars but power and influence. They produce a product, they raise funds, they distribute funds, and they pay wages. They do not fund social programs outside of their specific agendas.

Free of regulation companies and individuals could determine where social investments create the best return. Money would not be spent on programs that look and sound good but do not produce positive change.

There is the caveat to social capitalism and social entrepreneurship; enterprises must be economically driven to be sustainable. If they do not have a good profit structure, they too will become a social casualty. Without a true long term profit driven approach the enterprise will dry up for lack of capital and its social value will go away. The failure of most social entrepreneurs is not that their idea for social change was not valid; it was they lost the concept of perpetuating their enterprise by failing to more aggressively promote economic capitalism.