Discounts, Coupons and Customer Service

Below is a paraphrase of a friend’s issue with her business:

“I started accepting coupons from my competitor (large National chain). I have rules about minimum purchase and people want me to honor those coupons without minimum purchase and they are also bringing in outdated coupons. I also run a promotion where I give a discount of 10% off a future purchase if a customer spends over $100. They need to bring in their receipt that has a coupon. I have customers demanding the discount from my workers without the coupon, expecting them to just remember. I would rather these customers spend their money with my business, but I feel I am being taken advantage of. How do I set the rules? What boundaries should I set?”

I will start by posting a link to a great article by Bob Phibbs:

7 Reasons Coupons Don't Work

While I don’t agree 100% with doing away with coupons and/or discounts, they should be used judiciously and they should be self created. My opinion is that accepting a competitor’s coupons is not a good strategy. You have to remember that your competitors may have better buying power to get their inventory at lower rates than your business. You are also giving your competitors control over your pricing strategy by accepting their coupons. Your pricing strategy is critical to the profitability of your business and should never be put in the hands of a competitor.

I used to accept competitors coupons at my bagel stores. Some other stores in our area ran similar promotions as us, such as “buy a dozen bagels, get 6 free,” so we accepted their coupons. However, our second year into running our store, a large national chain opened up within a mile of our location. They had a big media blitz and ran a coupon giving away a baker’s dozen with no purchase necessary.

My partners and I talked it over and we were all in agreement that it would kill our business to honor that coupon. So we stopped that practice immediately, recognizing that we would probably lose some customers for changing that policy. Our rationale was that if they came to our business expecting something for free, they weren’t really customers and we could stand to lose them.

I value customers and believe in developing customer loyalty. I am also aware of the fact that I have to convince my customers that I am better than my competitors to develop that loyalty. The reality of the situation is that I can only be better than the competition in a few ways. I can have better quality, better service, more convenience and perhaps a selection that is more tailored to my local market. I recognize that I probably can’t compete on price alone, as I just don’t have the resources to be a low cost competitor. If that is all that is important to a particular customer, then I know that this will never be a loyal customer to my business.

Yet here lies the conundrum. Isn’t it better to make a discounted sale than no sale at all? It is tough running a business and every dollar of gross profit contributes to covering the overhead. If a customer has $50 worth of merchandise that cost me $30, wouldn’t it be better giving them that purchase for $45 and take a $15 profit rather than letting them walk out with nothing and no profit?

It is difficult for me to say this, but I still will. As a business owner, I have to stand firm on my pricing and not give in to discounts that are customer driven. Discounts should be driven by my decisions. If we choose to let customers dictate our pricing, we are turning over our business plan to our customers. I love my customers and recognize that I need them to make my business successful; yet they don’t understand enough about what it takes to run my business to dictate their own pricing. They are thinking only of themselves, whereas when I set my pricing structure, it was with the intent that I could give my customers a benefit and maintain profitability.

Are you still not buying my advice? Let’s project that previous scenario a bit into the future. You give that customer her 10% discount and she buys that item for $45. It is the last one on the shelf. Your next customer comes into the store and wants that same item. She is a loyal customer who has never asked for a discount. You just lost $5 in profit potential and probably a bit of good will. Or let’s say you did have another item and you sell it to that loyal customer for $50 and she finds out someone else got the same item for $45. You just lost some more good will.

Discounts and coupons can still be a tool to help promote your business, but be selective and have a clear game plan. Are you trying to speed up the turn of slow moving inventory, trying to eliminate waste of perishable inventory or are you trying to introduce a new product line? Are you trying to increase the average ticket per customer or do you want to reward customer loyalty for reaching a certain benchmark in spending? If you have a legitimate reason, discounting and/or coupons may be a good tool for your business.

To directly answer my friend’s question, I suggest that you set clear rules for pricing based on what you feel is best for your business and stick to your guns. If you are going to discount, make sure it is a means to an end, not a reaction to a customer request. Nobody can take advantage of you unless you allow it. I refer you to my previous post.

Your customers are a precious commodity to your business and you should focus on developing a service policy that makes you stand out from the competition. Don’t confuse providing discounts with providing good customer service. After all, if your business is not profitable, you won’t be able to provide great service to any customers in the future.

Entrepreneurial Education

I am often asked what dictates success in small business. Normally I respond that you have to have more income than expenses. Business is really that simple. That does not mean that it is easy. Income doesn’t just happen. Not only do you have to provide a market solution, you also have to let the market know, in terms they can understand, that you are the best choice for that market solution.

Managing expenses can be equally difficult. Getting the biggest bang for your buck out of marketing dollars is just one of the challenges. There are operating costs, productivity issues and distribution costs that can easily get out of control if the business is not tightly managed. Needless to say, small business owners have quite a lot to learn if they are going to be successful.

Personally, I’ve learned a lot about small business ownership over the years as the owner and operator of my own bagel stores. I also learned quite a bit by working as a food and beverage executive for some large corporations. Most large businesses started as small businesses and their larger scale success can be attributed to the best practices they implemented and trained their managers to follow.

I started my first bagel store when I was 23 years old, along with brother, who was 21 at the time. We made our share of mistakes and our lack of business aptitude was pretty apparent in the first few months of our operations. I still remember my grandmother calling me up to ask me how the business was doing. I told her I thought we were doing pretty well.

“What are your monthly sales?” she asked. I couldn’t come up with a number. After giving her my sales from the day before, she projected it out for me. Then she started asking about my expenses. “Food costs, rent, insurance, payroll, advertising?” she asked. I gave her some figures and before the conversation was over she computed a basic profit and loss analysis for me. The whole process opened my eyes to the fact that I was not paying attention to some critical data. Believe me, the next time she called, I was more prepared with answers.

Probably the most important lesson I learned as a small business owner stems from some frustration that I was having with my younger brother. He was complaining about a worker. “She’s horrible. She’s ruining our business,” he said. “You should fire her.”

I thought about this for a moment. Why was he putting this on my shoulders? He was a partner in this business. He should fire her. He is the one who hired her. I also thought that maybe she was horrible because he expected too much from her without giving her the proper training. But then I thought about it some more. Using that same rationale, I was guilty of making my brother a partner in the business without training him as a manager. He was only 21 and just graduated college. How was he supposed to know how to do these things?

That’s when I had an epiphany. If something goes wrong, it is probably my own fault. I started to use this train of thought every time our business was faced with a problem. I chose the path of self employment. No one forced me to open up bagel stores and it was my responsibility to face the challenges that go along with small business ownership.

The responsibility of owning a small business became a very humbling experience for me. It is tough to accept blame for everything that goes wrong. Over the years, I’ve had employees steal from us, seen my store get struck by lightning, had a windstorm blow out our drive thru window and dealt with a number of serious challenges in the aftermath of the terrorist attacks on September 11th. There were so many issues that seemed beyond my control when I was running my businesses. Yet, I kept telling myself, if I were to succeed, I had no choice but to accept the challenges and find the best solutions.

I do have to admit here that it was not always an immediate realization or Zen-like approach to problem solving. I would lose my temper, get frustrated or wallow in self pity just like many others when faced with difficult situations. But eventually I would remind myself (or have my wife remind me) to calm down, accept responsibility and just deal with it.

I found the key to my own entrepreneurial education – you have to develop the solution to every problem. Blame and self pity yield no results. If you are not prepared to accept responsibility, you are not prepared for self employment.

The road to business success is simple. Get more income than expenses. Just be prepared to drive around, jump over or crash through some obstacles along the way. Erica Jong once wrote, “Take your life in your own hands, and what happens? A terrible thing: no one to blame.”

It can be humbling being a small business owner, but it is also liberating. I choose to change Ms. Jong’s quote to, “Take your life in your own hands, and what happens? A beautiful thing: there is no one to blame.”

Pricing Strategies in an Inflationary Market

Note: This was written last March, while I was working for the East Central Indiana SBDC...even though some supply costs have leveled a bit, I think this information is still relevant.

As supply costs in the food and beverage industry are inflating at alarming rates, now is a good time for effective food service managers to revisit their menus and develop some pricing strategies to position them for continued success in the marketplace. Quite a few operators are rightfully concerned about recent price increases. Still, this actually provides a nice window of opportunity to make some changes to menu prices and actually increase profit.

While I would like to provide a tried and proven formula food service managers could use for pricing their menus, the fact is that menu pricing is more of an art than a science. There are just too many different factors that come in to play and probably one of the biggest mistakes managers make is to price their menu offerings based on formula rather than thinking about some of these factors.Any business that is considering their menu prices should not only consider their supplier costs, but also a competitive analysis and some form of consumer price sensitivity research.

Having spent over 18 years as a manager in the food and beverage industry, I have heard so many of my colleagues make this erroneous statement – “You have to maintain a food cost of 33% or less or you can’t make it in this business.” Many food service managers take this to heart so much that they figure out their ingredient costs for an item and then multiply times 3 to get their menu price. This is a foolish pricing strategy, as there is significantly more involved in developing a successful menu.

The first thing to remember in pricing strategy is that it there is a difference between food cost/gross margins and gross profit. Gross margin is the percentage of the difference between your selling price and your supplier cost divided by the selling price (food cost is simply 100% – gross margin %)

Gross Margin = (Selling Price – Supplier Cost)/Selling Price

Gross profit is the dollar amount difference between the selling price and the supplier cost.

Gross Profit = Selling Price – Supplier Cost

The most important thing to remember is that gross profit is what pays the bills, not gross margin!

Below is an example of two restaurant managers with a company that owns a small chain of fine dining establishments. In this scenario, their supplier raised the cost of a bottle of their most popular wine from $6.00/bottle to $9.00/bottle. Each manager has a different strategy for dealing with the price increase.

	Original Pricing	Restaurant 1	Restaurant 2
Supplier Cost	$6.00	$9.00	$9.00
Menu Price	$20.00	$30.00	$24.00
Food Cost %	30%	30%	37.5%
Gross Margin %	70%	70%	63.5%
Gross Profit	$14.00	$21.00	$15.00

In Restaurant 1, the manager believes in maintaining his margin, so he raises his price to $30.00 per bottle. All is good in his world, as he is now making $7.00 more per bottle of wine than he was before and he is still maintaining his 30% food cost.

Restaurant 2 features a savvier manager. She knows her customers and is afraid that with such a steep increase, more of her customers will skip the wine to keep their dinner bills down. She still raises her prices to increase her gross profit, but her increase is not nearly as much as her counterpart at Restaurant 1 and she is losing a bit of her margin.

Chances are that Restaurant 1 will lose some sales because their price increase is so steep. Restaurant 2 is more likely to maintain the same volume of units sold. They compare notes at the end of the following month and find the following results:

	Restaurant 1 Last Month	Restaurant 1 This Month	Restaurant 2 Last Month	Restaurant 2 This Month
Wine Bottles Sold	100	50	100	100
Food Cost %	30%	30%	30%	37.5%
Gross Margin %	70%	70%	70%	63.5%
Gross Profit	$1,400.00	$1,050.00	$1,400.00	$1,500.00

By keeping her price increase at a lower level, Restaurant 2 did not lose any units sold and made $100 more dollars than the previous month even though her gross margin decreased. Restaurant 2 made $350 less than the previous month, even though he maintained his margin.

This is obviously an oversimplification of what can happen in these difficult times, but as prices go up from suppliers, menu prices will have to go up, as well. If not, an establishment will have to get a lot more customers to make the same amount of money that was being earned prior to the supplier increases. At the same time, an overreaction and too much of a price increase may make it easier to lose customer loyalty to competitors who are not as aggressive with their price increases.

In developing a strategy to deal with higher supplier costs, food service managers should remember to focus more on profit than on margin. For many establishments that have a loyal customer base, it is fairly easy to site articles that are showing 200% - 300% increases in supplier costs and then tell customers that a price increase was necessary, but that the increases were kept to a bare minimum.

With a bit of attention to consumer spending habits, the competition and supplier costs, smart operators have the opportunity to turn the proverbial lemons into lemonade.

The Sky Is Not Falling!

“The sky is falling,” Chicken Little said to anyone who would listen. For those not familiar with this fable (this is not the Disney version), Chicken Little came to this conclusion when an acorn fell on her head. She then went and told this to anyone who would listen. Her friends all joined in this refrain until they came upon Foxy Loxy who agreed to help them. The animals were so scared of the impending doom that they let down their guard and followed Foxy Loxy, who said she was leading them to help. Chicken Little and her friends were never seen again.

To listen to some small business owners, you would think the sky is falling. High oil prices, commodity prices and the credit crises are a series of issues that are like the acorns that bonked Chicken Little on the noggin. These are real issues and they should concern small business owners. Still, “the economy” is the proverbial sky that is falling and entrepreneurs would be the wiser if they paid less attention to the gloom and doom hype in the media and more attention to the market conditions relating to their particular businesses. Too many small business owners who bemoan the economy are not paying enough attention to their economies.

On a macroeconomics level, the economy may be taking some hits. I am not an economic expert, so I am not going to define or analyze recession indicators, stock market trends or Federal Reserve issues. Instead, I am going to use the basics that I learned at Rutgers University in my freshman year Microeconomics class (see Dad, I did put my education to use!). By definition, the noun economy refers to “the system of production, distribution and consumption.” Every business has a unique economy. Each has its own system of producing products/services, means of distributing their products/services and customers who utilize their products/services.

Maybe on a macro level, trends are showing that we are producing less, distribution costs are higher and consumer spending is down. But is that really the case for your business? What have you done to analyze your production capacities, supply costs, your operating expenses and your pricing strategies? Has your business really seen a decline in customers over the past few months and have your really expended all options in identifying new customers?

I think of Steven Covey's bestseller, The Seven Habit of Highly Effective People and his discussion of two concentric circles. The outer circle is the “circle of concern” and the inner circle is the “circle of influence.” His sage advice is to urge people to live within their circle of influence.

Gather data on trends that are happening to your economy and come up with a game plan to best prepare your business for the future. Think on a micro level and start with the basics. What products/services can you bring to the marketplace? Can you expand your areas of distribution? What does the marketplace need that you can provide?

In other words, stop worrying about the sky falling; you can’t do anything about that. Instead, focus the problems you can solve. So an acorn fell and knocked your head. Put some ice on the bump, plant that acorn and start an oak tree nursery (by the way, I also studied Landscape Plants at Rutgers…oak trees are genus, Quercus, but I digress).

I found this article by Mindy Charski to be particularly on the money:

Starting a Small Business in a Bad Economy

I like the closing quote attributed to Rufus Frost, "There is business out there; it's just who's going to get it, really." You can either spend your time worrying about what’s not there anymore or you can spend your time getting some of what is there. I dare to say the latter is the only option.

Magic Story

As a new resident of the North Country, I am doing what most people who relocate to a community do…I am exploring the area. I have the opportunity to meet wonderful people and visit exciting new places.

With this exploration, comes the exposure to many business owners, both large and small. After all, our family is filled with consumers. We need groceries, clothes, sporting equipment, toys, haircuts, medical check-ups, dental work, eyeglasses, restaurants, etc…well, the list goes on and the purpose of this post is not to make me cringe at my household budget expenditures; The point is that I am a potential new customer for many small businesses and this is an opportunity for me to share some perspectives on marketing.

Whenever I talk about marketing, I use a quote from Dale Carnegie, “human beings are not creatures of logic; they are creatures of emotion.” To get a customer to purchase from your business, you have to appeal to their emotions. In my initial contacts with some businesses, I am actually quite surprised at how many businesses don't seem to care whether they make a sale to me or not. I've actually gone to a few places with every intention of making a purchase, only to change my mind because there was no effort from the sales staff to provides some attention or even acknowledgment of my presence.

Marketing is not just putting an advertisement in the newspaper, on the radio or creating a business card. That may be a component of it, but there is more to marketing then sending out a message. The goal of your marketing efforts should be to generate sales. To be more effective in generating sales, your business should have a “Magic Story.”

A magic story is a short description of what your business has to offer. It should be focused on how your business can benefit the customer. You are on the supply side of the economic chart, but unless there is demand, you are not going to make a sale. Your magic story should help enhance the demand.

Consumers have a choice of where they spend their money. Your goal as the business owner is to give them a compelling reason why they should spend their money at your business rather than at a competitor’s business. So if I were to walk into your establishment, what would you tell me to make me a customer?

Touch on emotions. What descriptors will you use to describe what makes your products or services special? You would be amazed at how a few well chosen words can make the difference between getting someone to know about you and someone wanting to do business with you. Love, delicious, savory, safe, beautiful, artisan, handmade, crafted, comfortable, sleek, smooth, passion are just a few examples of “power words” that tend to garner an emotional response from people.

You also want to be a good editor in creating your magic story. Can you tell me what is special about your business in two sentences or less? Most customers have a short attention span. Be concise and to the point. And remember, the point is to be customer focused.

With everything in marketing, it is important to test your choices with a sampling of potential customers. After all, you don’t succeed in business by making sales to yourself. How do others respond to your message?

I encourage you to work on your magic story. Create excitement, desire and sales!

“Advertising is the “wonder” in Wonder Bread.” Jef I. Richards

Rich Business, Poor Business Part III

In my last post, I talked about ways to use Assets as a tool to make better business decisions. On the other side of the balance sheet are Liabilities and despite the negative connotation that is often assigned to them, they can be a friend to your business.

Below are definitions of the most common liabilities:

Current Liabilities

Current liabilities are obligations your business has to pay in a current period of time (usually within one year). Typical current liabilities include:

• Notes payable (12 months of loan payments)
• Accounts payable/trade credit
• Sales tax payable
• Accrued payroll
• Payroll taxes payable
• Gift Certificates/Gift Card Redemptions

Long Term Liabilities

Long term liabilities are simply obligations that mature in greater than a year’s time, such as term loans (greater than a year) and mortgages. For some larger corporations, bonds would also be considered a long term liability.

You may have noted that both definitions contain the term “obligations.” I have heard quite a few different sources refer to liabilities as “other people's money” or “OPM.” I don't think that is an appropriate descriptor. Liabilities are funds that are supposed to be paid back; borrowers are using their own money, they are just receiving it ahead time from other sources. Those who do not pay back their liabilities on agreed terms could end up with a poor credit history or even in bankruptcy court, making it much more difficult to get access to liabilities at a future time.

Through my position as a business counselor, I have obviously come across people who have bruised or damaged credit and there are often extenuating circumstances that attributed to those issues. While I can sympathize with such clients and try to help in anyway possible, such clients should also understand the lender’s position that it is difficult to extend credit to those who have failed to meet obligations in the past.

Another thing to remember about liabilities is they are usually extended to businesses at a cost. Whether that cost is interest, finance charges, late fees or penalties, financing activity usually generates expenses. Any plans to borrow money should include an analysis of whether the business model will generate profitability at levels that exceeds the financing costs.

In a previous post, I made the statement, “the goal in building wealth is to have a higher net worth, which means to have more assets than liabilities.” Please do not interpret this to mean that you should try to eliminate liabilities from your balance sheet. Again, the key to building wealth is to have more assets than liabilities, but sometimes you need to utilize liabilities to get more assets onto your balance sheet.

“Rich” business owners are apt to utilize liabilities quite often to grow their businesses. Their key to success is that they are very judicious in how they leverage their capital and have a good understanding of the difference between current liabilities and long term liabilities. They do their best to utilize current liabilities to preserve cash and finance inventory and accounts receivable. They utilize long term liabilities to finance fixed assets.

Another thing successful business owners do before taking on debt is to analyze some key ratios before making their decisions. The three tools they used most often are a debt ratio, a current ratio and an acid test analysis. The purpose of all of these ratios is to measure how much of their business is leveraged to obligations.

The debt ratio is simply your total liabilities divided by your total assets.

Debt Ratio = Total Liabilities ÷ Total Assets

Anything greater than one is a sign that your business is over leveraged with financing. It also means that your business has a negative net worth (“poor business”). In his book, Don’t Squat with Your Spurs On, Texas Bix Bender writes, “if you find yourself in hole, the first thing to do is stop digging.” Any business that has a negative net worth should do some serious evaluating of profitability potential before taking on more obligations, as this may be a sign that the business does not have enough earning power to meet their obligations.

The current ratio looks at just your current assets and liabilities.

Current Ratio = Current Assets ÷ Current Liabilities

This ratio indicates a businesses’ ability to satisfy obligations in the next year. For this ratio, any number less than one is an indicator that your business is leaning towards being over leveraged with too many current liabilities. It is not necessarily an indicator that a business will fail, but it does mean that it is in a position where your business could not meet all current obligations, even if all inventory was liquidated and accounts receivable collected. Should this be the situation, a business would have to have projected profitability, or access to some other capital source, within a year to cover those obligations.

The acid test is another tool that is used. It is the same as the current ratio, except inventory is taken out of the sum of current assets. The reason this is done is because wise investors recognize that most inventory is not always easy to convert into cash. So the acid test is:

Acid Test = (Cash and Cash Equivalents + Accounts Receivable) ÷ Current Liabilities

Like with the current ratio, a ratio greater than one is desired. Should a business have a lower percentage ratio, it may be difficult to access short term capital.

As business counselor, I have often come across balance sheets (including for my own business) that have had debt ratios greater than one and current ratios/acid tests with ratio numbers significantly lower than one. Why does this happen? The reasons vary. There could be legitimate, temporary challenges, catastrophic single events or just a history of small mistakes in judgment. It is critical to remember that a balance sheet is a snapshot of a given point in time and circumstances may change dramatically in the future.

Again, I provide the reminder to forecast what could happen before making rash decisions. Look for ways to match long term liabilities to your fixed assets and increase liquidity. If you are going to tap into a credit line for some short term liabilities, hopefully you have assessed that you are going to make quick sales, turn more inventory or collect on receivables before the debt matures. There are often quite a few options available to better manage your financial position, if you invest the time to gauge the impact of your decisions.

In all cases, the key to success is to utilize liabilities only to finance assets that will generate net income. Leveraging financed money to cover operating expenses is what gets most small business owners into trouble. Once that money is spent, it is gone and the borrowed money will probably generate more expenses. The hole will keep getting deeper unless there is something on the asset side of the balance sheet generating income. Whether it is a current asset like inventory that will turn, a fixed asset that produces a product, or even an intangible asset like intellectual property relating to services you sell, your assets will have to generate profitability if you are going to increase net worth.

Feel free to post comments with questions or suggestions and remember to pay attention to your balance sheets when making business decisions. Risk is inherent in all business decisions, but the more you calculate those risks, the more likely you will achieve success.

Rich Business, Poor Business Part II

As noted in my previous post, the balance sheet can be a management tool, not just a snapshot of your net worth. Not only should you look at your business balance sheet today, but you should forecast what you want it to look like one month from now and take active steps toward achieving those goals.

To do that, let’s start by looking at the asset side of the balance sheet. Assets can be broken down into the following components:

Current Assets

Current Assets are considered assets that have a tangible value and can be converted into cash fairly easily. They are used to measure the “liquidity” of a business, in most cases by comparing them to current liabilities (debt obligations within a fiscal year). Current assets include:

• Cash in Banks
• Inventory
• Accounts Receivables
• Stocks/Bonds/Securities

Fixed Assets (Long Term Assets)

Fixed assets have a tangible value and are generally considered assets that will not be converted into cash in the next fiscal year. Some examples of fixed assets include:

• Real Estate
• Building Improvements/Leasehold Improvements
• Operating Equipment
• Furniture and Fixtures
• Vehicles (sometimes this is considered a current asset)

Intangible Assets

Intangible assets have value, but cannot be touched. Some examples of intangible assets include:

• Trademarks/Copyrights/Patents
• Goodwill (Usually value derived from profitable operations, but can also be assigned for customer lists or market research data regardless of profitability of operations)
• Franchise Rights/Non-Compete Agreements/Sales Contracts/Letters of Intent

“Rich” business owners will pay attention to all asset lines on their balance sheets and ask two key questions:

1.Is this asset producing income?

2.Is this asset appreciating value?

If the answer is “no” to both of those questions, then the successful business owner will look to convert that asset into another type of asset that will produce a positive and measured result.

In looking at current assets, successful business owners recognize that the only truly liquid asset is their cash. So they continually strive to maintain a good handle on accounts receivable by collecting monies owed diligently and keeping their receivables to an absolute minimum. The same goes for inventory. The less inventory on hand, the more liquid their current assets remain.

Of course, some businesses will require having inventory and accounts receivable. The key is to ensure that they are at acceptable levels in relation to the business. Each industry varies with regards to acceptable levels and it is worth it to study comparative ratios. Excuse the self-gratuitous plug, but your local SBDC can be a great resource in helping with this type of analysis!

Still, the key to managing inventories and accounts receivable is the same. Pay attention to age and value. With regards to accounts receivables, forecast whether a 90-day invoice will be converted into a deposit next month or whether it is more likely to become a bad debt or require that it be written off. Also consider charging finance fees, so you are at least generating some income on that asset.

With inventory, think about how often it turns. Unless you hold an inventory that appreciates in value, you may benefit yourself by selling it at cost or below cost and using the proceeds for items that will turnover quicker. I know a lot of retailers who have this huge aversion to discounting, but inventory that doesn’t move is costing your business money instead of fulfilling the purpose of generating income.

What you do with cash in the banks, stocks, bonds and other securities depends on the advice of your wealth management advisor, so I defer to their expertise. Still, think about maximizing appreciation, income and liquidity!

As with your current assets, your fixed assets still relate to an analysis of whether they are generating income or appreciating in value. The main difference is that is much more difficult to convert a fixed asset into cash, so your return on investment analysis needs to take that into account. If you have fixed assets that are not performing and generating enough income, you may be faced with the difficult decision of either developing alternative uses for those assets or, in some cases, doing an analysis of whether you should cut your losses by not operating that asset, rather than operating at limited capacity. The key is to forecast the results and do a cost/benefit analysis.

In my opinion, intangible assets are the most difficult asset to deal with. That is because their value is, well…intangible. It is a perceived value. Gaining a return on investment, on goodwill and intellectual property is complicated because it is so difficult to assess value to creative thinking, sweat equity, and/or the past buying habits of customers in a fickle marketplace. I will say, however, that there are some successful business people who have benefited from selling intangible assets that exponentially appreciated in value, but unfortunately, there are probably just as many less successful business owners who paid the price for overvaluing the market potential of intangible assets. The dot.com boom and bust is a perfect example of this.

My hope is that I am not boring readers with these posts on accounting principles, as I still have to get into the liability side of a balance sheet in a future post.

As David Letterman once said, “There is no business like show business, but there are several businesses that are like accounting.” I dare to say all businesses relate to accounting, as you have to know how to keep score if you are going to play the game.

Rich Business, Poor Business

I've titled this posting based on the bestseller by Robert Kiyosaki, “Rich Dad, Poor Dad.” If you have not read this book yet, I suggest you take a trip to your local library or book retailer and get a copy. Pardon the pun, but it provides a wealth of good advice on finance that I am going to apply to small business operations.

A good deal of this book focuses on understanding the concept of a balance sheet. I have to admit, as a young small business owner, I made the mistake of not paying enough attention to my balance sheet. To be honest, I did not truly understand the concept of a balance sheet until about 5 years into my career as a business owner.

For those who are not familiar with a balance sheet, it is based on the basic accounting principle that:

Assets = Liabilities + Net Worth

Using an arithmetic formula, this also equates into:

Net Worth = Assets – Liabilities

The goal in building wealth is to have a higher net worth, which means to have more assets than liabilities. The most important thing to remember about the balance sheet is that it is a snapshot of a given point in time. Every single business transaction you make will change your balance sheet in two places, hence the term “double entry accounting.”

Obviously, your goal in business is to increase the amount of assets on your balance sheet without increasing your liabilities. But new assets don't just appear magically onto your balance sheet. They can be introduced in three ways:

1. New investment from ownership
2. Appreciation in value of assets (i.e.: you have gold in inventory that you bought at $700/ounce and gold is now worth $900/ounce)
3. Net income from business operations

There in lies the key to using the balance sheet as a tool to make better informed business decisions. Something needs to happen to increase your businesses' assets. While it is true that some assets can appreciate in value, the reality is that most assets tend to lose value over time. Things like vehicles and operating equipment will depreciate in value. Inventory tends to “leak” over time and the older your accounts receivables get, the more likely that they are going to be converted into bad debt. The “rich business” owners know that the key to success is to invest in assets that will generate more net income.

Here is a simple example. After opening my second bagel store, we did pretty well. Aside from my salary that I was taking from the business, at the end of the year, there was an additional $20,000 in my share of the profits. Having been the driver of the company minivan for the past few years, I decided to use this opportunity to put a down payment on a brand new Mustang GT.

A little more than a year later, my wife and I were expecting our second child and the Mustang just wasn't looking like the smartest of decisions. I was schooled quickly on the concept of depreciation when I traded the Mustang in for a new mini van and only received $10,000 trade equity.

Had I reinvested this $20,000 into new revenue generating assets or even into an interest bearing account, our business would have had more revenue and more liquidity the following year. I would have been in a better position to support my growing family with this business. By taking that $20,000 distribution for personal use, I removed the new asset that my business had generated to my balance sheet from operations. The other assets we had depreciated in value, so even though my business did well, we actually lost total net worth compared to our starting point once we distributed those earnings. That put us at a disadvantage once we started making better decisions and tried to expand our business. We didn't have enough net worth available to grow our business.

Don't get me wrong, I am not trying to make business owners feel guilty about enjoying the fruits of their labor. I am just encouraging them to think before they act. At the least, a business should pay attention to their balance sheet and have a small gain in net worth every year. If not, the long term success of the business will be jeopardized.

I will continue with another post soon that will discuss some more details of what “rich business” owners pay attention to on their balance sheets to make better informed business decisions.

You Can't Cut Your Way to the Bottom Line

With all the talk about the economic slowdown in the news, businesses are scrambling to find the best strategies to deal with the challenges of increases operating costs (mostly due to inflation in the energy & commodities markets) and anticipated decreases in consumer spending. Business articles talk about how now is a good time for small business owners to tighten their belts and watch their discretionary spending.

I’ve personally read a number of articles that suggest cutting advertising budgets and hours of operation as a means to cost savings. However, I caution all small business owners to think carefully about the consequences of cost cutting before you take action.

Developing a contingency to deal with the economic slowdown is a very smart strategy for every small business owner, but the key to a good plan is to dedicate time to forecast the expected results of each decision. Another thing to keep in mind is that it is highly unlikely that your business can maintain profitability levels strictly through cost savings.

Unless you have been a completely inefficient manager of operations for your business, your expense lines are there for a purpose, which is mainly to help you generate revenue. You need to understand that the rash reactions of cutting expenses may result in cutting revenues that might have remained with your businesses had you not made those expense cuts.

To help highlight this point, there is a well-known story that relates to a chain of quick oil change services. It is said that a corporate financial officer noticed that an average service center spent $5,000/year on coffee and donuts for customers in the waiting area. The corporate officer sent a memo to all the retailers telling them to stop offering free coffee and donuts to give a quick $5,000 per year increase in their bottom line performance. The retailers who complied with this advice averaged about a 10% reduction in sales performance. Apparently some customers valued getting free coffee and donuts while waiting for their vehicles more than this financial officer thought and the customers either reduced the frequency of their visits or went to a competitor instead. With the average business unit doing $500,000/year in sales and making a 30% margin on sales, the average retailer would have realized a $10,000/year net loss in profit by following this advice.

I once served on an executive committee for a large corporation in the hospitality industry and we discussed similar cost savings strategies at our monthly forecasting meetings. As ideas for expense reductions were brought up, our wise general manager would always say, “You can’t cut your way to the bottom line.” She would always encourage us to be creative in looking for new revenue opportunities.

So as you proceed with a strategy to deal with the economic slow down, remember, there are only three things you can do to increase your bottom line performance:

• Decrease expenses

• Increase prices

• Increase volume

There are implications to applying each strategy, and the intelligent business owner will think about each opportunity.

I wish I could offer a catch-all strategy that would work for every small business, but life is just not that simple. Each enterprise has a unique business model that is affected differently by the changes in the economy.

The one common suggestion I can offer is to research customer spending habits, come up with a plan for your business and project expected outcomes before taking any action. And remember to think about adding to your revenues, not just decreasing your expenses.

As Winston Churchill once said, “Let our advanced worrying become advanced thinking and planning.”