It's the best way to spot problems before they become life-threatening.
It's the best way to spot problems before they become life-threatening.
As longtime readers of this column know, I strongly believe that when you launch a new business, it's important to track monthly sales and gross margins by hand for the first year or two. I tell people, "Don't use a computer. Write down the numbers. Break them out by product category or service type and by customer. And do the math yourself, using nothing more sophisticated than a calculator."
To be successful in any business, you need to develop a feel for the numbers. You need to get a sense of the relationships between them, see the connections, figure out which ones are critical and have to be monitored. Why? Because numbers run businesses. They tell you how you can make the most money in the least time and with the least effort--which is, or should be, the goal of every company. You can give it all away if you want. But first you have to earn it, and the numbers can tell you how to do that as efficiently as possible, provided you understand their language.
Tracking the numbers by hand is the best way I know to learn that language, at least as it applies to your particular business. You can switch to computer tracking once you've mastered it, but if you let a computer do the work in the beginning, you won't develop the same intimate connection with the numbers. As a result, you may miss important signposts later on, when the numbers start to change. Those changes can be significant, especially if they come as a surprise. They may herald new competition arriving or indicate a shift in your customers' preferences or reflect unseen problems with your products or services. There could be any number of reasons for the unexpected changes. But you'll see them--and be able to respond quickly--only if you get into the habit early on of looking for them and trying to understand what they mean.
My friends Bobby and Helene Stone are a case in point. They have a company, Data-Link Associates, that sells computer supplies as well as an improbable sideline: cabinets and cases for firearms. The Stones added gun products at the urging of a major supplier, a manufacturer of office furnishings that makes the gun cabinets as well. More than 15 years ago, I had helped Bobby and Helene get their business up and running. (See Bo Burlingham's article "How to Succeed in Business in Four Easy Steps," July 1995.) Back then, I insisted that they track their monthly sales and gross margins by hand until the process became second nature. As they've increased their sales from $160,000 in 1992 to $3.2 million today, they have continued to monitor their numbers closely. When they notice a disturbing trend, they call me.
Not long ago, they called in a bit of a panic. They told me that for the previous five months their monthly sales had been 20 percent to 25 percent lower than normal. Among other things, they'd lost almost all of their "special sales." Those are nonrepeating, high-volume, low-margin sales--exactly the kind of sales that I wouldn't let them accept when the company was small but that had become a nice source of profit for them in recent years.
I should probably say a few words about why those sales were dangerous in the early days but perfectly fine once the business became established. It has to do with risk. Whenever you extend credit to a customer, you run the risk of not getting paid and being stuck with having to cover the cost of whatever you've sold, plus delivery charges. The bigger the sale, the greater the risk. It's generally a bad idea to take that risk on a large, low-margin sale before your business becomes viable--that is, able to sustain itself on its own, internally generated cash flow. On a $2,500 sale with a 30 percent gross margin ($750 in gross profit), you'd lose about $1,750 if the customer went out of business or just refused to pay for whatever reason. On a $25,000 sale with a 10 percent gross margin ($2,500 in gross profit), you could lose $22,500. Granted, it's tempting to go for the larger profit, particularly when the sale seems like an easy one, but until your company has reached viability, you have to guard your start-up capital like the crown jewels. You can't afford the risk of losing a big chunk of it all at once. That $22,500 could be the difference between success and failure.
The picture changes, however, once your company becomes viable. Not that you should ever be blasé about the possibility of losing money. It's still important to do thorough credit checks on customers, especially high-volume ones. But if you know you'll survive even if you get stiffed, you can accept some high-volume, low-margin sales. You just have to make sure they don't become such a big percentage of your total sales that not getting paid for them could jeopardize your business.
As Data-Link's core business of high-margin sales had grown, Bobby and Helene had been able to do more high-volume, low-margin sales, and it had paid off handsomely. In their monthly income statements, they'd created a separate line for these special sales and kept a close eye on it. Whenever such an opportunity came along, they would decide whether to accept it based partly on how their regular low-volume, high-margin sales were doing and partly on how confident they were of getting paid.
Thanks largely to the special sales, they'd grown accustomed to doing from $250,000 to $300,000 a month in overall sales, and so they were concerned when they noticed a significant drop one month. One month's drop can be an aberration, but if it happens two months in a row, you start to wonder what's going on. After three months, it's "Houston, we have a problem." Bobby and Helene were well beyond that point by the time they came to see me.
"Look at these numbers," Helene said, pointing to a spreadsheet. Special sales were zero.
"Why is this happening?" I asked.
"We don't know," Bobby said.
"The answer is important," I said. "Maybe you're doing something wrong that you can change."
"How do we find that out?" he asked.
"You can start by calling up customers who've done special sales in the past. Ask them why they haven't come back lately. Meanwhile, let's think about what you can do if the special sales never come back."
"That would be horrible!" Helene said.
"No, it wouldn't," I said. "You have a wonderful business. You're making good money even without the special sales. But if you lose them, you'll probably want to find another source of revenue." I didn't have to explain. They knew that they'd reached a saturation point in their main line of business. Their regular sales had been more or less stable for four or five years. "While you're investigating the drop in special sales," I said, "think about ways to expand something else you're doing. Then we'll get back together."
When we reconvened a couple of weeks later, Bobby and Helene reported that the special sales decline appeared to be happening for several reasons. For one, there were more competitors offering these products. For another, the Internet allowed customers to shop more and pay less. In addition, one big customer had stopped buying, claiming that some products it had bought had been defective. That turned out to be untrue, but the customer was no longer placing orders with Data-Link. "Given all this," I asked, "can you get back in the game?"
They weren't sure. The special sales came in via the Internet, and nobody could predict when one would show up. The best they could do would be to improve their chances by upgrading their website and working on their search-engine placements. But they said there was another opportunity they could go after. A few months earlier, the gun-case manufacturer had told Bobby and Helene that they were missing out on sales because Data-Link was not an approved vendor of the General Services Administration. The Stones had submitted an application shortly thereafter and won GSA approval, opening the door for sales to the armed forces and various federal law enforcement agencies around the country. "We're doing a couple thousand a month in GSA sales right now," Helene said. "The average sale isn't as big as the average special sale, and the gross margin is lower, but the opportunity is basically limitless."
"So where are you going to get the biggest payoff over the next five years?" I asked.
"Well, obviously GSA," Bobby said, and Helene agreed. So did I. By and large, the special sales were one-shot deals. The sales to government entities, on the other hand, had the potential to become repetitive. That meant Bobby and Helene could build a business around it. In fact, their GSA sales were up to about $40,000 per month the last time I checked. But what made me happiest about the episode was their ability to answer the question of what to do by themselves. They could answer it because they knew their business. They had a firm grasp of the numbers and used them to make a smart decision. That's what happens when you educate yourself the old-fashioned way.
Norm Brodsky is a veteran entrepreneur who also writes The Morning Norm at Inc.com. His co-author is editor-at-large Bo Burlingham.