The #1 Reason For Failure of Businesses Over Two Years Old

The #1 Reason For Failure of Businesses Over Two Years Old

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There are two key reasons why it’s so difficult to gather and use really high quality financial data for making critical business decisions. Firstly, the tools for transforming financial data into useful information are somewhat complex.

The people who know how to transform basic data into meaningful information typically have lots of training and are often really smart; therefore they charge a lot of money for their services.

Hence, smaller private businesses often cannot get access to such people.

Secondly, for financial data to be meaningful, it needs to be analysed in comparison to something else.

Many private businesses typically don’t have access to the performance metrics of other firms in their industry. Such information is proprietary, therefore even if a business owner can do the advanced calculations to transform financial data into useful information, they don’t get the full benefit of it because they have nothing to compare it to.

This creates a real conundrum for you, a concerned, ambitious business owner:

 

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You want to get the right information to make the best business decisions possible, but you can’t afford to keep hiring high-priced consultants, and you have nothing to compare that data with, even when you do analyse it.

Enter Gareth Ochse and Kenneth Kalmer with ValuationUp, a new online financial analysis and strategy tool for privately-held businesses.

ValuationUp is a web-based platform, designed with a simple, intuitive and familiar interface to allow entrepreneurs and business owners to independently track and interpret critical financial metrics about their business on an ongoing basis.

This not only provides you with valuable information to make much better business decisions, but it also educates you on your business and helps you understand performance relative to other organisations.

The ValuationUp founders have come up with a powerful way for business owners to think about transforming financial data into meaningful information. In this article, they share aspects of their framework to provide a roadmap for thinking about when and how financial data can and should be used to better manage a business.

In unpacking their framework, we will consider three key questions:

  1. What insights can you get from financial data?
  2. When are financial insights valuable?
  3. And who should care about key financial insights?

What key insights can you get from financial data?

Imagine that you are a doctor and you need to diagnose a serious ailment of a patient. The easy option is to ask the patient a few questions, poke and prod in a few obvious areas and then deliver a diagnosis. Although this option is easy, it’s probably not the most effective.

We would prefer a doctor to do the appropriate blood tests, ask deep and insightful questions and perform the necessary scans.

Similarly, if we want to understand a business we need to perform a proper analysis of the organisation’s financial data. Ochse and Kalmer point out that such an analysis will provide insight in four key areas: Performance, price, potential and priorities.

Each of these four areas open unique insight to properly understanding the business. Failure to properly use financial data to evaluate these four areas can create
serious ‘blind spots’ for a business owner.

Related: Staring Down Failure

1. Performance

How well is a business currently being run, benchmarked against its industry peers?

Insight into business performance comes from transforming financial data into ratios.  However, performance ratios in isolation are not very useful. Ratios need to be compared to ratios from prior years, to see whether performance is improving over time. Ratios also need to be compared to other organisations to see how the business compares to other similar enterprises.

To do this, a manager must decide what performance measures are most important for their business, collect data for the current year and prior years and from similar businesses, transform the data into meaningful ratios and compare the ratios across time and between businesses.

The advantage of using a consultant or a service such as ValuationUp is that they often have templates for doing all these calculations and access to benchmarking data, thereby making performance measurement much more meaningful and insightful.

For example, ValuationUp has built a dataset of nearly one million financial statements across 1 000+ industry groups to benchmark financial performance of firms against industry peers.

They allow you to immediately assess whether your firm is under-performing across most metrics by comparing performance to 50th and 75th percentiles.

2. Price

What is the business currently worth?

Valuing a business is no easy task. Therefore most business owners have no real idea about what their business is worth until they try to sell it (and even then the price at which their business is valued may be vague and ambiguous). Financial professionals have invested heavily in coming up with highly sophisticated ways to value businesses.

The problem is that most of these methods require a PhD in finance to be properly implemented.

They require firms to project cash flows into the future and then discount future cash flows back down to their current day values, while adjusting for the risk of such cash flows – no easy task.

Yet, knowing the value of your business can be very meaningful, especially if you are able to track value over time so you get feedback on what activities, clients, products and services are adding value to the business and which might actually be destroying value.

At a minimum it’s worth getting your business valued once every few years so that you know the size of the ‘asset’ you are managing and whether it is truly growing.

It’s even more valuable to have regular (eg. monthly) insight into the value of the business so that there is a tighter feedback loop between action and impact — the action that you take in the business and the impact it has on the value of the business.

3. Potential

What could the business be worth in future?

The third focal area for really understanding the financial data from a business is assessing what the business could be worth in the future. Most business owners have an idea of what they want their business to be worth at some point in the future.

However, for many people this is merely a dream and linking that dream to reality is almost impossible.

But, with a tool that dynamically models the value of a business, it’s possible to assess what the business might be worth in the future.

The ValuationUp dashboard splits the business into short-term, medium-term and long-term variables, all visible at a glance. This allows the user to understand the trade-offs between optimising a short-term metric (eg. liquidity) with a long-term one (eg. firm valuation).

4. Priorities

What actions are required for a business to achieve its financial potential?

Financial data can be used to assess the impact of operational actions on financial measures.

Managers can assess how action to change variables such as inventory days, marketing spend, debtors’ policies or product mix impact a firm’s valuation.

In so doing, managers can garner deeper insight into the actions that should be considered key priorities as they move forward in building a business to create value.

Although insight from financial data is useful almost all the time in managing a business, there are key pivot points in the life of an enterprise when astute financial insights become highly salient. Ochse and Kalmer point out four key times when such insight is critical.

How To Survive a Price War. Click Here

 

Greg Fisher
Greg Fisher, PhD, is an Assistant Professor in the Management & Entrepreneurship Department at the Kelley School of Business, Indiana University. He teaches courses on Strategy, Entrepreneurship, and Turnaround Management. He has a PhD in Strategy and Entrepreneurship from the Foster School of Business at the University of Washington in Seattle and an MBA from the Gordon Institute of Business Science (GIBS). He is also a visiting lecturer at GIBS.