Street Smarts

What you need to be truly in command of your business is a pencil and paper

Here's the best advice I can give to anyone starting a business:

From day one, keep track of your monthly sales and gross margins by hand. Don't use a computer. Write down the numbers, broken out by product category or type of service and by customer, and do the math yourself, using nothing more sophisticated than a calculator. I promise that you'll save yourself all kinds of grief and improve your chances of success a hundred times over.

I'm not exaggerating. Consider the case of Anisa, who came to me looking for help after reading one of my columns. In four years, she wrote, she had taken her cosmetics-accessories business from zero to $1.5 million in sales, "and I have nothing to show for that growth at this time." She thought what she needed were better promotional materials. I suspected her problems lay elsewhere. In any case, I agreed to meet with her.

It quickly became apparent that Anisa was lost. She realized that something had to be wrong because she was having trouble paying her bills every month, but she couldn't understand why. She knew her costs, and she knew how much she typically marked up the price of her products. How could she be chronically short of cash? The problem, she figured, was that she didn't have enough sales.

In fact, her real problem was that she wasn't gathering simple, easy-to-get information that would have told her what was happening in her business.

You see, there were only two possible explanations for her situation. One was that she was not making enough gross profit on her sales to cover her other expenses and still get a decent return. The other was that the cash she generated was going someplace other than her bank account.

The second explanation seemed unlikely, given the nature of her business. She was a packager and marketer of cosmetics brushes, sponges, bags, and gift items, which she sold to department stores and cosmetics companies throughout the United States. Anisa would get the orders and forward them to manufacturers in the Far East, who then shipped them directly to the customers. The manufacturers got paid after she got paid.

So I knew that her cash couldn't be going into inventory: she didn't have any. And I doubted that she had much of an accounts-receivable problem, given the pressure she was under to pay her own suppliers.

My guess was that she was making too many low-margin sales. But which sales were they, and why? Was she charging too little for certain products? Was she giving too many breaks to certain customers? I couldn't find out, because she hadn't kept track.

I had her go back and write down her sales for the previous three months, showing me the total on every customer invoice and the cost of goods sold for each of those orders. One look at the list and I knew she had customer problems. She'd lost money on some of the orders. On others, she hadn't made nearly enough to survive.

Next I sent her a form on which I asked her to start tracking her sales and gross margins by product category. At the end of each month, she was to write down the sales, cost of goods, gross profit, and gross margin (that is, gross profit as a percentage of sales) on every type of product she carried, both for that month and for the year to date. Then she was to calculate the totals for the company as a whole. The entire exercise took less than 30 minutes a month and allowed her to see at a glance how much cash she was generating internally and where it was coming from. Meanwhile, she continued to track her monthly sales and gross margins by customer on a separate sheet of paper.

The reports were a revelation. Anisa later told me that it was like reality hitting her in the face. For the first time, she saw what it took to make money in business. Before, she said, she'd been winging it. Afterward she began to understand how she could be in control.

Not that she was suffering from low gross margins across the board. She was doing fine with some products and customers, but the others were dragging the average down. I told her there are basically four ways to deal with this type of situation: You can raise your prices. You can reduce your manufacturing costs. You can say no to low-margin business. Or you can find other products that you can sell at higher margins. Anisa decided to do all four.

Understand, my point is not that Anisa was wrong to have accepted low-margin sales in the first place. When you're just starting out in business, you have to be flexible. You have to put together the pieces of the business much as you would assemble a puzzle. In the beginning those low-margin sales may have helped Anisa build relationships with her manufacturers. How? By providing enough volume to make it worthwhile for them to do business with her on credit. As she soon discovered, their credit was the key to her survival.

But once she'd figured out how to earn a living from the business, she should have immediately turned her attention to increasing its profitability. She didn't because she had no idea what was going on. She wasn't even aware of the decisions that had to be made. She was operating on instinct and guesswork rather than information, and it takes information to survive.

As a business owner, you need to start gathering that information from the beginning. In particular, you need to track your gross margins. Why? Because high gross margins translate into high gross profit, and gross profit is the main source of the cash you'll need to support yourself and build the business.

And don't make the mistake of automating the tracking process. You have to write the numbers out by hand and calculate the percentages yourself. The fact is, you lose something when you let a computer do the work. The numbers become abstract. They start to blend together. You don't focus on them. You don't absorb them. You don't get to know them as well as you must if you're really going to be in control of your business.

Listen, I'm a very computer-literate guy. I have all the state-of-the-art toys, not to mention a degree in accounting, and I've started several businesses. But I still sit down every month to track the key numbers in my archive-retrieval company by hand--and it's a seven-year-old business doing millions of dollars in sales.

It's all part of the education process, and you can't skip over it. I don't care if you're a Harvard M.B.A. who's spent the past 10 years at McKinsey. You still need to track your numbers by hand.

I guarantee you'll learn something. Anisa sure did. Among other things she figured out that she could sell imported furniture as well as cosmetics accessories--and earn gross margins of 38% instead of 15%. So now she's added a whole new business to the one she already had.

Norm Brodsky is a veteran entrepreneur whose six businesses include a former Inc. 100 company and a three-time Inc. 500 company. This column was coauthored by Bo Burlingham.