Getting under the hood - do you know how your business actually runs?
Okay, it may sound like a silly question. Of course you know your business! Who’s closer to your day to day operations than you? And that’s fair enough. But when small business owners are doing everything, there’s going to be elements of the business that get more attention than others. It’s only reasonable that providing your service to your customers is priority number one. Even well-established small businesses turning over reasonable revenue can lose sight of the detail around the financials.
In this article we’ll cover some of the questions business owners may want to ask about their own businesses to really get under the hood.
The challenge with being an owner/operator
Owner/operators represent a good portion of the 530,000 small businesses in New Zealand. It’s very common practice for those owners to be involved with or leading the service to customers and managing day-to-day operations. This is a big advantage in many ways as they can ensure the quality of service remains high and stay in control of the direction of the business. However, as the business grows, there’s simply not enough hours in the day for an owner/operator to do everything to the extent they’d otherwise want to. It’s why engaging help externally may be a good idea for small business owners who don’t have the budget for a full-time employee for that task, such as accounting.
Protecting some time in the week or month to review the business and make tweaks can pay off big time - even if the time allocated is relatively short among ‘billable’ activities.
Building a profitability model by client vs. overall
Reviewing the business’ profitability is a crucial exercise to do each month. And while it’s important to understand what your bottom line is doing, on the whole, many business owners don’t take the time to model this profitability on a client-by-client basis. If you’re in a service industry where each client is worth considerable amounts of revenue to you throughout the year, it’s wise to dedicate time to building a view of time and money in vs. money out.
Here’s the information you’ll want to have accessible via your accounting software and customer relationships management process/system (CRM):
- List of services carried out for the customer
- Value of each of the services
- Total sales for that customer
- Time spent on that customer
- Cost of resourcing that customer (e.g. salary/wages of staff)
- Effective hourly rate (total revenue for customer/hours spent)
- The total cost of materials or associated costs of delivery (travel, building materials)
You may have some of this information but not all - as a start simply put together a spreadsheet of sales per customer and hours spent. If you aren’t tracking hours (a good idea), use your best estimates by reviewing calendar bookings or other information available to you.
Are you investing too much time in the wrong customer?
What this exercise should show you are the customers where total sales are lower but the time spent is higher. This criteria is really valuable to highlight those clients that simply aren’t generating the business enough money to focus time on.
Your options include working on the business engagement to align revenue with effort or to phase out these customers. it's important to understand what makes these customers time-hungry and low value - are they difficult to deal with? Is the nature of the work simply not conducive to a good effective hourly rate? The issues will vary wildly. It’s common for a business to spend more time on low-value clients who demand more for less; all business owners go through a period where they need to learn how to reduce or avoid these customers, often by remaining firm on the details of their service provided.
Other signs a customer might be wrong for your business include:
- Changing times or dates on you with short/no notice.
- Not paying their bills.
- Paying their bills late.
- Questioning every line item of an invoice despite agreeing to the quote.
- Changing their mind on what they want during your provision of services.
- Continually complaining/never satisfied (although ensure there are not some quality improvement opportunities here if you’re receiving this feedback frequently from many clients).
- Unpleasant to deal with.
- Tell you how you should deliver your services.
- Expect you to go above and beyond every time.
- Are looking for any chance to pull you up on a gap or lack of perfection in what you deliver.
- Don’t respect your team.
If you’re a business over investing time and effort into low-value clients, you’ll want to make changes starting today. Your business’ growth and success rely on it.
Creating an ideal customer and planning accordingly
Early on in a business’ life, there is a motivation to bring in business to stay afloat. As more clients come on board, however, you have the ability to refine your acquisition to focus on the most valuable customers to engage with. Creating a profile (or a number of profiles) that reflect your ideal customer type allows you to do a few things:
- Get agreement on the traits that make a customer good or not.
- Create specific marketing and communication strategies for each customer type.
- Build specific target revenue/profitability goals for different tiers of clients (vs. one size fits all).
- Avoid chasing work that doesn’t fit within your ideal customer profile.
- Craft services around the specific challenges these customer types have.
- Conduct a review of your website with help from your customer ‘personas’ to ensure it resonates.
This exercise may become easier the longer you’re in business and have worked with a broad range of customer types. If you’re looking to build these customer types early on in the business, take care to do ample research and not inadvertently exclude a potentially high-value customer type.
Find out where all your money is going
Getting under the hood of the business and its performance requires a full understanding of the costs you’re incurring and what’s leftover in the end. There are a few key places to start looking at:
What are the regular costs associated with running the business? Operating costs will include things like power, travel, office supplies, bank fees, subscriptions, and travel.
Operating costs aren’t avoidable, but how many of these there are and how much they cost are certainly something you can control. This practice of ‘cost control’ is strongly recommended for any business that wants to ensure a healthy bottom line. There are a few things you can do to practice good cost control:
- Get multiple quotes for everything - internet, power, software, etc. Make sure each provider knows you are comparison shopping.
- Outsource certain operations to a specialist provider.
- Practice energy conservation practices.
- Plan out travel strategically to reduce petrol costs and vehicle upkeep.
- Stop any services or costs that aren’t necessary - over time you will outgrow the need for certain things.
- Look for more efficient ways to produce products, or choose equipment that will last longer and thus be cheaper long term.
Paying your employees’ salary or wages is another operating cost that at a certain size of business becomes a necessity. Keeping good employees will require an investment by you, with this increasing over time to keep them engaged. Paying more for good employees is potentially a cost-saving measure in the long run as they add additional value to the business.
As you bring on new staff, make sure you are paying market rates and take the time to recruit carefully and onboard thoroughly. Losing staff and rehiring can host a business significantly, as the deficit in productivity is addressed. It can take a new hire 3 months or more to be properly adding the intended value to your business.
The key to managing employee costs is to do the numbers before hiring and have a clear calculation on what the business can afford.
One of the biggest costs a business can incur is paying the monthly lease for premises. For some businesses, this is simply unavoidable (hairdressers, mechanics etc). But you do have control over where you are based in many cases. Like any operating expense, doing your homework and shopping around for the best location is well worth the effort.
Consider some of the following:
- Is the space adequate for your needs? Don’t overpay for a larger space than you need; it's a needless strain on the finances.
- Is the location well suited to your customers’ convenience? E.g. close to parking.
- Have you compared similar spaces’ lease payments and other costs that may be passed on? Sometimes the cost difference is significant.
Given leases are often locked in for a period of years and fit-out will be required, take the time to choose carefully, and only commit once all your criteria and budget needs are met.
Drawings from business owner
As a business owner, you may take drawings or pay yourself a salary via PAYE. You need to earn a living so the business’ budget needs to keep your personal costs covered such as your mortgage, rent, food, insurance, etc. Don’t automatically assume that running a small business early on means you shouldn’t earn a living wage. After all, one of your reasons for getting into business should be to earn a good living.
Ultimately how much you draw from your business on a regular basis is a highly subjective matter. But if you’re looking at the business’ financials as a whole and are unable to protect your bottom line and profit margins, you may want to check that you’re not putting undue pressure on the business through the amount that you draw out.
You may want to build a plan where a certain level of business income equates to an amount you can draw each month - you’re seeing the short-term benefit of a growing business without compromising its ability to pay all the bills and build a strong cash position.
Want to learn more about how to understand your own business?
Learn more about what RightWay’s expert Business Partners offer in terms of guidance around making your business more successful. It’s okay to not understand all components of business deeply; in fact, getting external support will allow you to spend less time on these questions and more on running your business. Our team provides valuable insights and teaches you along the way.
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