- Do you want to succeed as an entrepreneur or business manager?
- Do you want your business to be profitable?
- Do you want your business to grow and flourish?
- Do you want to feel more in control of your time and feel like you are working on things that really have an impact?
Do you want your business to be worth something substantial when you wish to move on or retire?
Most people answer all these questions with an emphatic “YES!” yet few business owners or managers are deliberate or proactive about growing their business, making it profitable or managing their time better so that they are productive and effective in their leadership role. Research shows that the average surviving new business in the USA never grows past $100 000 (approximately R800 000) per annum in revenue and never takes on more than two employees. Data suggests that the situation in South Africa is even worse. South African business owners are struggling to establish enterprises that make millions in profits or allow them to become financially free.
One of the primary reasons that smaller businesses fail to grow and to create attractive sustainable profits is that business owners and managers fall into the trap of working ‘in’ their businesses and fail to take the time or effort to work ‘on’ their businesses. It is incredibly easy to get caught in this trap. You start, buy or launch a business and initially, to keep costs down, you do almost all the work yourself. You develop products, make sales, service customers, issue invoices and keep the financial records yourself. The motivation of working for yourself and being your own boss enables you to work hard and focus on delivery to clients. As you deliver to clients so you win more work, requiring you to work harder. As the owner of the business you get busier and busier, working late into the night and also on weekends, just to get everything done.
This level of activity is not sustainable. Soon you get tired, your family starts to complain and your positive upbeat attitude becomes sour and negative. You miss a few deadlines, fail to return phone calls and your clients, who were initially very impressed with your service, wonder what’s happened. Some people realise that this cannot continue so, after some moments of self-reflection, they decide to scale back and operate at a level that is more sustainable. Others just continue to operate at a frantic pace but because of declining service levels some clients leave and the business stops growing. Whichever route the owner takes, the business reaches a level where it stops growing. The business owner has been caught in the trap of only working ‘in’ their business.
To break out of this cycle, the business owner needs to make a transition from working ‘in’ the business to working ‘on’ the business. Working ‘on’ the business means taking time out from the day-to-day operations of the entity to focus on, and implement, critical bigger picture issues such as strategy, structures, systems and skills development. It is about building a platform for growth within the business that is not dependant on any single person for success. If you want to leave a legacy and make real money as an entrepreneur, then this is probably the most important lesson you can learn.
Working on one’s business takes discipline and effort. It does not come naturally to most people to work on their business; the natural default is to work in the business. There are many reasons why business owners avoid working on their businesses. Some use the excuse that they don’t have time, others say that they don’t want the operation to get too bureaucratic or corporate while others are oblivious to the difference between working in and working on a business. I believe that one of the primary reasons why so many entrepreneurs avoid working on their business is that they don’t really understand how to. A business owner may decide that from next month he is going to devote a morning a week to working on his business but when that morning comes, he is uncertain of what to do with the time so he defaults to dealing with a client or preparing invoices.
Working on ones business is a cyclical process that involves thinking and decision-making about strategy, designing and implementing new structures and strategies, and facilitating the development of new skills. These activities can be represented in the diagram on the left.
Working IN the business
Working ON the business
Invoicing, paying and keeping financial records
Nature of activity:
Do, Do, Do
Think, Design, Implement
Strategising is about taking a step back and making some decisions about where you choose to operate and how you plan to win in those areas. In running a business it is so easy to get swept up in what customers demand that you never really take a step back to question whether your business is heading in the right direction. Many entrepreneurs invest a great deal of time and energy in devising a strategy for their business when they first launch, but they never revisit their strategy once the business is operating. You are in a much stronger position to make important strategic decisions after you have been operating for a while because you then have experience in the industry and greater insight into the markets, competitors and business model alternatives.
In the strategising phase of the cycle you should spend time addressing the following issues:
VALUE: What value are we creating, how are we creating value and for whom are we creating this value? How will we create value in the future?
MARKETS: Are we operating in the right markets? Which markets will we focus on growing in the future?
COMPETITIVE ADVANTAGE: Are we winning in our markets? What can we do to have an even greater competitive advantage in our markets now and in the future?
ACTIVITIES: What are the core activities of our business? What do we choose to do and what do we choose not to do?
GOALS: What are our goals for the next 3 – 5 years? What do we need to do to deliver on those goals?
To effectively deliver on a strategy a business needs structure. Structure is the right people in the right positions to do what is required to make the strategy happen. Even in the smallest, simplest businesses it is important to have some element of structure and as a business becomes larger so structure becomes more and more important. If you are in a small business with just one partner, structuring involves identifying your individual responsibilities and what you are going to outsource to external service providers. In a larger business it is about giving each person in a business a clear understanding of what they are required to do and how they will be held accountable for carrying out those tasks. As a business grows a business owner can easily lose sight of what everyone in the organisation is doing and this can result in duplication of work, lack of accountability and work overload. Working on the business therefore requires the leadership to review the structures and lines of responsibility to establish an effective and efficient organisation that can deliver on the strategy.
In the structuring phase of the cycle you should spend time addressing the following issues:
SKILLS: What skills do we require in the organisation to deliver on the strategy? Do we currently have the right skills to deliver on the strategy? Where can we find the missing skills?
ROLES: How do we put people in roles that leverage their skills and enable us to deliver on our strategy? Describe each person’s roles and the responsibility that goes with that role?
ACCOUNTABILITY: How will people be held accountable for delivering on the requirements of their roles? What will we measure? Who will do the measuring? How often will we measure performance?
Systems invariably depend on people and for people to operate effectively within a system they often need to be trained. It is therefore essential to see skills development and training as a critical element of working on your business. If you don’t train and develop people then all your efforts in structuring and systematising your business are likely to be in vain. You do not necessarily need to do all the training yourself but you should oversee the training and take an active interest in the skills requirements and development of all the people in your business.
The process of working on your business by strategising, structuring, systematising and developing skills is a continuous cycle. Therefore, once you have been through the cycle after having developed or refined your strategy, created a structure, established systems and developed and trained people with the requisite skills then you need to start again with development and refinement of strategy. The more times that you go through the cycle the more your business is likely to grow.
In the skills development phase of the cycle you should spend time addressing the following issues:
PERFORMANCE REQUIREMENTS: At what level do I need the various people in my organisation to perform in order for the business to be successful?
PERFORMANCE GAPS: At what level are the people in my organisation currently performing? What are the gaps in their performance between what is required and what is currently happening?
TRAINING PRIORITIES: In what order should I address the skills gaps for maximum success and survival of my business?
TRAINING METHODS: How should I address each of the skills gaps? Which gaps are best addressed through formal training and which are best addressed through on the job coaching and mentoring? Who will I get to do all the required training?
To build a business with a real platform for growth, it is critical to identify the key activities relating to that business and to build systems that allow those key activities to be replicated effectively and often. When most businesses start out, entrepreneurs perform most of the critical activities in the business themselves. The only way that entrepreneurs can facilitate real growth in that business is to translate what they do into a set of processes that others can execute. The critical systems within a business may vary slightly depending on the nature of the industry in which the business is operating but most businesses require systems and processes that relate to marketing and selling, product or service delivery, financial management and reporting, buying, and product development.
In the systematising phase of the cycle you should spend time addressing the following issues:
KEY PROCESSES: What are the key processes that create value for our customers and/or allow our business to run effectively and efficiently?
PROCEDURES: Do we have established, documented procedures to deliver on our key processes easily and often? For which of our key processes do we still need to establish and document procedures?
AUTOMATION AND OUTSOURCING: What could we automate to reduce the dependence on people? Are there procedures within our processes that could be more effectively executed by external organisations?
Making the transition from spending all your time working in your businesses to consistently dedicating time to working on your business in not easy. It takes discipline and dedication to get this right but such discipline and dedication should yield handsome returns in the long-term. Smaller business owners should aim to spend 20% of their time (the equivalent of one day a week) working on the business. Larger business owners or managers within larger enterprises can aim to spend as much as 80% of their time working on the business. Therefore the amount of time you aim to dedicate to working on the business should depend on the size of your business and how much you want it to grow. The higher your growth aspirations, the more time you should spend working on your business.
If you are currently caught in the trap of working almost entirely in your business, make the transition over time. Start off by setting aside two hours a week to work on your business. In your first two hours review your strategy, in your second two hours examine your structure, in your third two hours evaluate your systems and in your fourth two hours consider your skills development. This will establish the platform for working on your business in month one of the transition. Then in month two dedicate three to four hours a week to working on your business and take the time to address some of the issues that were identified in the review sessions in month one. Work with other senior people in the organisation on these issues. As you move into month three, try to dedicate a full half a day a week to working on your business and continue to increase the time you spend on these issues over time until you are working on strategy, structure, systems and skills development for a full day a week.
The effect of moving from a place of working entirely in your business to a place where you regularly dedicate time to working on your business will be amazing. You will realise a year down the line that you have a happier, more empowered, more focused workforce. You will discover that customers that you personally had nothing to do with are raving about your company’s service. You will discover that you have more time for yourself and are able to approach work in a more balanced fashion and that the business is growing in a sustainable and profitable way. A well-known business philosopher, Jim Rohn, says: “If you go to work on your goals, your goals will go to work on you. If you go to work on your plan, your plan will go to work on you. Whatever good things we build end up building us.” It is for this reason that we need to remove ourselves from our businesses to work on our businesses if we truly want our businesses to work for us so that we can make millions and leave a legacy.
Make an Impact! Make a Fortune! Leave a Legacy!
Some believe that entrepreneurship relates only to people who are starting and growing a new business. Yet time and time again I am struck by how the principles of entrepreneurship have application within many different settings.
Entrepreneurship is primarily about the creation of value and the concept of value creation has relevance within many different spheres of society. We need people who are willing to take risks and be innovative in order to create new value in government, business, education and the non-profit sector. Thus, the principles that are consistently applied by successful entrepreneurs can be used in many different circumstances to enhance the world in which we live and to enable individuals to make a significant contribution.
For the bulk of Jack Welch’s career he was employed by one of the world’s largest corporations, General Electric, yet it would be difficult to argue that he was not entrepreneurial. Tom Boardman used the entrepreneurial principles he learnt in establishing Boardman’s furniture store early on in his career to turn around Nedbank, one of South Africa’s largest financial services institutions. Nick Binedell showed entrepreneurial flair as an academic professor in establishing and growing the Gordon Institute of Business Science. Therefore, no matter where you find yourself, if you are able to apply and implement the following fundamental entrepreneurial principles, you are much more likely to be successful and to leave a legacy.
Establish and define a compelling purpose for what you are doing
The world’s greatest entrepreneurs establish a purpose for themselves and their business that focuses on more than just making money. The Google Guys see their purpose as organising the world’s information and Walt Disney felt his purpose was to make people happy.
People are compelled by purpose; they are energised by being part of something that they feel is bigger than they are. They want to work for something that they feel is meaningful. Therefore, if you wish to really succeed in you career, whether you are in a large corporation or in a small start-up, whether you are in government or an NGO you need to work hard to clearly understand, define and focus on your purpose.
Establish a point of differentiation that gives you a sustainable competitive advantage
Entrepreneurship is about being innovative and creating an advantage by being distinctly different from competitors. Doing more of the same will seldom, if ever, make an entrepreneur truly successful. Anyone who wishes to create long-term success needs to build distinctive points of differentiation. In a career, you need to establish a set of skills and competencies that set you apart and make you irreplaceable. It is by becoming irreplaceable that you are able to command higher compensation and yield more decision-making power within a corporation, government institution or any other organisation.
Focus on the creation of value for your chosen market
Entrepreneurs launching a new business need to focus intensely on giving their chosen market something that they need and want, if they wish to have any chance of surviving. It is this intense focus on the needs and wants of the customer that enables them to create value. Anyone who wants to succeed in a career needs to understand what he or she can do to create value for the organisation for which they are working. Take the time to understand what is valuable to your organisation and then focus intensely on delivering whatever that is effectively and consistently.
Work on your situation, not just in your situation
A related article in this magazine highlights how critical it is for entrepreneurs to work ‘on’ their business and to avoid the trap of just working ‘in’ their business. Working on your business involves stepping back and taking time to review strategy, establish structures, build systems and develop skills. In your career it is easy to get so wrapped up in what you are doing on a day-to-day basis that you never take the time to consider where you want to go and how you are going to get there. Working on your situation involves regularly giving yourself the time and space to redefine your goals and establish a plan for achieving those goals. It has been shown time and time again that those people who take time to reflect on where they have been and readjust where they want to go are more likely to be successful and have an impact than those who get caught in the trap of just working, working, working without ever reviewing where they going or what they doing.
Being successful as an entrepreneur is a simple formula. You need to sell things for more than they cost so that you make a profit. Any money you spend in the process of generating revenue causes you to make less profit. Entrepreneurs therefore learn to spend as little as possible in order to avoid going into the red. Within a larger corporation people often lose sight of this simple equation causing them to spend irresponsibly without having anything to show for it. If you develop the habit of spending without thinking, you will be eroding value over time. You may be able to get away with this for a short period of time but it will eventually catch up with you. If you continuously think and act like an entrepreneur, questioning every item of spending, over time you will develop good, wealth generating habits in both your personal and your business life.
Warren Buffet said: “Chains of habit are too light to be felt until they are too heavy to be broken.” If, in your career and your life, you get too used to doing things in ways that do not create value and waste time, money and other resources, your career will be trapped on a downward spiral that will be very difficult to break out of. If, however, you try to think and act like an entrepreneur, focusing on purpose, differentiation, value creation, effective use of time and frugality, then you are likely to establish habits that will set you apart, causing you to be successful and leave a legacy.
What To Measure To Make Sure Your Business Won’t Crash And Burn
Let your customers measure success for you and you’ll have a better idea of how to reach your goals.
If you don’t want your business’s spurts of success to end up just a flash in the pan, you need to measure your business progress against your goals. This allows you to adjust your plans for future success accordingly. But how?
Back in the nineties, NASA designed an interplanetary weather satellite to orbit Mars. However, it deviated from its planned trajectory and was destroyed in the atmosphere, simply because of a minor miscalculation; a result of the NASA team and their contractor using different systems of measurement.
By the same token, business owners need to determine what metrics to use to measure their progress, before they can work out what still needs to be adjusted to get them to their ultimate goals. Many businesses know this, but many don’t know they’re doing it wrong.
Connect with your customers
Most organisations use the same key performance indicators such as sales, customer retention, and product quality to track their progress. What’s the problem with this picture? They’re measuring where they are now in relation to where they were before, leaving the question of where they want to be, and how to close the gap, to guesswork.
Why waste time testing one strategy after another when you can find all your answers in one place: With your current and prospective customers? They’ll tell you exactly where to aim and what to do to get there. This is why customer surveys are the proverbial toolkit of business progress tracking.
A customer survey is simply a series of questions that you ask your customers, to gauge their satisfaction, so you can hold on to them and collect ideas about how to improve your business offerings.
There are a number of ways to distribute these surveys, but it’s no surprise that social media is trumping phone calls, text messages and emails as the preferred platform for customers to communicate with businesses and brands.
Engage with your customers
What you choose to ask your customers is entirely dependent on what goals you wish to outline and track. That’s the easy part, but it’s significantly harder to gauge the effectiveness of social media campaigns, because you need to know what to look for. You can measure awareness of your business using metrics including volume, reach, exposure and amplification.
Retweets, comments and replies will tell you how engaging your content is, and you can keep an eye on traffic by tracking URL shares, clicks and conversions. Plus, there is a plethora of additional plug-ins to this from ORM and sentiment tracking tools for deeper analysis of this data.
Related: Does Your Customer Service Care?
The catch is that in the past, businesses had to compete for space — on billboards, in magazines, during ad breaks on TV — but now it’s all about timing. So the first challenge is making sure your social media post questions are being seen by as many of your customers as possible.
On the flip side of the coin, people don’t have to have any previous experience with your brand to interact with you on social media, so another challenge is calculating which of your respondents are actually viable customers.
Leverage your data
You’ll need to tap into the analytics that speak to who your followers are, and then focus on finding ways of channelling them on social media, based on their geographical location and the kind of content they are most likely to consume.
Then test your social media measurements against your key performance indicators. Yes, we’re back where we started, but this time you’ll be armed with what you need to leverage this data, in order to achieve your business goals.
How Do I Go About Valuing My Business?
Francois Otto, Head of Corporate Finance and Jonathan Wernick, Corporate Finance Transactor, Sasfin Capital give advice on how to value a business.
Francois Otto, Head of Corporate Finance and Jonathan Wernick, Corporate Finance Transactor, Sasfin Capital give advice on how to value a business.
If you have ever thought about raising capital for, or selling, your business? Perhaps one of the most difficult questions you have had to ask yourself is “How much can I sell my business for?” Regardless of what anyone tells you, determining the value of your business is a subjective process.
The value of business in one person’s hands can be completely different to another. However, there are a variety of methods to determine the value of a business. Some methods are fairly simple and others are a bit more complex.
Perhaps the simplest method that can used to value your business is to determine its Net Asset Value (“NAV”). This simple method entails subtracting the value of the liabilities from the value of the assets.
Another method that can be used to value a business is to apply a specific multiple to a financial metric. This method is referred to as a comparative valuation or “MULTIPLES” approach. For example, a company’s net profit could be multiplied by a specific number to give you a value of the business.
The number which you multiply the earnings by is referred to as a “Price Earnings” or “PE” multiple. The size of this number will depend on the business in question, for example its growth prospects, its size and the industry in which it operates, just to name a few.
The final approach that can be used to value a business is the discounted cash flow (“DCF”) method. This method adopts the philosophy of “Cash is King”.
Under this method, the business is valued using cash flows that the business is expected to generate. Cash flows can take the form of future dividend payments or, if the business pays a small or even no dividend, cash flows can take the form of profits generated by the business after adjusting for future capex, investments in working capital and taxes payable.
As this method values a business using the cash flows it is expected to generate in the future, a discount needs to be applied to these future cash flows (to reflect the uncertainty thereof), the size of which increases the further out in the future the cash flow occurs. The aggregate value or sum of these discounted cash flows represents the estimated value of the business.
Related: Here’s How To Value Your Business
The three valuation methods (NAV, MULTIPLES or DCF) mentioned above can yield different values for a business and deciding which method to use will often depend on the purpose of the valuation as well as the specific business being valued.
This exercise is normally the first step in raising capital or selling your business, to provide the owners with a sense of value. This value is theoretical until such time as a willing investor agrees to a transaction.
This is where a good adviser will assist the owners, through effectively marketing their business, to optimise the value achieved by the owners with the added benefit of ensuring the terms of a transaction are fair to the owners (e.g. reasonable earn-out conditions and warranties).
How You Can Use Your Creditors To Fund Your Business Growth
Everything you need to know to keep your cash flow positive, use your creditors to fund your business, and make your numbers work for you.
The success of a business is often judged by its rate of growth and its number of employees. The problem is that both a business’s rate of growth and its size come with their own demands and consequences, which are often ignored in the pursuit of more and more growth.
The reality is that not all growth is created equal. If your business doesn’t have scale, you can end up growing yourself into trouble — or even out of business.
Even more important is positive cash flow. Is that great new contract bringing in money, or costing you money? Shouldering an upfront cost for growth down the line is all part of the growth journey, but only if the numbers make sense and you know when your investment will turn to profit.
Here’s the secret to growth: It can be self-funded. Yes, there are venture capitalists, private equity firms, angel investors, bank funding and a host of other ways to access finance — but you can grow a large, successful organisation without any of these.
The trick is to know your numbers. Here’s how you can practically apply the rules of positive cash flow to your business.
The Power of Cash
In 2012, Amazon’s share price was $173. By 2016 this had grown to $725. Walmart, arguably the biggest retailer in the world, went from $59 to $70 in the same period.
But take a look at Table 1 for the revenue growth of both companies between 2003 and 2012 (a trend that has continued).
How can Walmart’s stock price have hardly increased, while Amazon experienced impressive growth over the same period, despite the fact that Walmart’s revenue growth far outstrips Amazon’s (in absolute, not percentage terms)? Is Walmart’s stock undervalued, and Amazon’s overvalued? Even accounting for growth off a low base, how can we explain this?
The share price is simply the net present value of future free cash flows generated from the efficiency of an organisation in managing cash to generate more sales.
In other words, Jeff Bezos’ focus on his cash conversion cycle has meant his business is incredibly cash-positive, which has in turn positively impacted Amazon’s stock price. Although Amazon is a highly unusual business with its negative cash conversion cycle, and its actual liquidity is somewhat contested by the investment community, it’s a great example of getting customers to fund growth.
The Cash Conversion Cycle
We agree that it takes money to make money. A business, even one with a tight, scalable business model, will consume more cash in its growth phase than in its steady state, or execution phase.
But, you don’t want to ever spend more money than you need to — or can reasonably afford to. This is true whether you’re self-funded or spending someone else’s cash, but particularly if you’re funding your own growth. Dealing with unplanned funding can be costly, time-consuming and it hampers growth. It also bogs you down in stressful admin when you could be focused on the elements you love and that excite you.
There are two questions that you should have asked yourself as you embarked on your growth journey (note: if you’ve never asked these questions, you need to surround yourself with like-minded business people who can help you find and ask them):
- For what period of time is my money tied up in inventory and other current assets before customers pay for the end product or services?
- How much cash do I need to finance each unit of sale and what is the amount of cash generated by each unit of sale?
I guarantee you that Jeff Bezos knows the answers to these two questions. Not his accountant or financial director — Jeff himself. You can’t abdicate the numbers of your business to someone else. Understand the difference between delegation and abdication. You don’t need to be doing your business numbers but you absolutely need to know what they are. This is one of the most important metrics of your business.
Let’s go back to our example of Amazon (see Table 2): Bezos’ cash conversion cycle (measured in days), oscillates between -40 and -8 days. That’s the secret.
In other words, Amazon uses other people’s money to fund its operations. That’s an extremely valuable business model, as its share price demonstrates.
Walmart’s cash conversion cycle is also a very respectable 11 days. As a business model it’s not quite as valuable as Amazon’s, but there’s a reason why Walmart is an international leader in its industry. It takes this behemoth organisation just 11 days to convert $1 into something worth more than $1. It then recycles that original $1 a further 35 times per year. Walmart’s margins are not high, but the compound growth is very powerful, as we’ll see later.
Let’s Get Started
Step 1: Understand your business
To better understand the components of your operating cash cycle and your cash conversion cycle, take a look at Diagram 1.
Operating cash cycle (OCC) is the period of time between when you start the assembly of all the required inputs into your production line, and cash comes back into the business as payment for the sale. Remember, if you’re a B2B business, there’ll be a delay between when the customer starts using your product and service, and when payment is made as well. This difference is referred to as accounts receivable days. Likewise the time between when your production starts (having received inventory) and the moment your business pays for this inventory, is the accounts payable days.
Cash conversion cycle (CCC) This is the period of time that working capital is tied up. It’s the time between when cash was converted into one of the inputs for your production line, and when the product is converted back into tangible cash, handed to you when customers pay you in real money. It’s the difference in time between your operating cash cycle and account payable days.
Self-financing growth rate (SFG)
This is the crux of this article. Your SFG rate is the rate at which growth can be sustained by cash generated by your business without any external funding.
Step 2: Working out your cash conversion cycle
Where can you access the figures you need to determine your own OCC, CCC and SFG? First, use data spanning a 12-month time period. This has two advantages: You have a better chance of sourcing accurate data if it comes from a signed off financial statement, and you can dampen the noise caused by seasonality.
Work with your balance sheet and income statement.
Working out conversion days from balance sheet
|Asset||ZAR amount on (000)||Equivalent days||Liabilities||ZAR amount on (000)||Equivalent days|
|Cash||10||Accounts payable||99||Calc A|
|Accounts receivable||384||Cal B||Loan
|Inventory||263||Calc C||Current liabilities||149|
|Current assets||657||Retained earnings||183
|Plant & equipment||25||Capital contributed||350|
|Total assets||682||Total liabilities||682|
Working out conversion days from income statement
|IS line||ZAR amount on (000)||Day equivalent||Ratio|
|Line||ZAR amount on (000)||Day equivalent in (000)||Ratios in %|
|Revenue / Income||2 000||= 2 000/365 = 5 479||100|
|Cost of sales||1 200||= 1 200/365 = 3 288||60|
|Operating expenses||700||= 700/365 = 1 918||35|
|NPBT – net profit before tax||100||5|
Based on the above example and figures, we have determined the following information:
- This business generates R5 479 of income per day at a cost of R3 288 per day.
- Calculation A: We owe a total of R99 000 to our suppliers, which at
R3 288 per day is ~ 30 days from
99 000 / 3 288
- Calculation B: We are owed R384 000 from our customers, which at
R5 479 per day is ~70 days from 384 000 / 5 479
- Calculation C: The amount of inventory we have paid for and need to turn into a sold product in equivalent days is ~ 80 days from 263 000 / 3 288.
Our original ‘as-is’ timing diagram now looks like this:
We still need to account for operating expenses, including salaries, utilities, rent, marketing costs and so on, and we can safely assume (but check this for your business) that bills arrive uniformly over the 150 day OCC period, meaning some will be paid immediately (day 1) or have to wait (day 150). On average this is 75 days.
You should now interpret the information as follows;
- The OCC is 150 days, but because the business has 30 days to pay its suppliers, the CCC is 120 days. In other words, cash is tied up for 120 out of 150 days (80% of the time).
- In terms of operating expenses, we assumed a uniform distribution over the period whereby some creditors would be paid immediately and some would have to wait for the 150-day cycle to finish. On average, this leaves us with 75 days or 50% of the OCC.
Related: Mobility, Security And Your Business
Step 3: Unlock capital in your business
We now know for how long our cash is tied up, but we still need to determine how much is tied up. Using the ratios in the original income statement, we can now answer the following: What amount of cash is needed to finance each unit of sale, and what is the amount of cash generated by each unit of sale?
Cash conversion at work on your IS
|Income statement line||Per ZAR||with CCC factoring||effective per ZAR|
|Cost of sales||0,60||80% (120/150)||0,48|
|Operating expense||0,35||50% (75/150)||0,18|
|Total costs||0,95||Cash tied up per 1 ZAR of Sales Revenue||0,66|
|Profit before tax||0,05|
|Free cash generated per ZAR of Sales||0,05||Cash needed for each OCC||0,66|
Putting it all together
Let’s look at what you now know about your business:
Self-funded growth rate
|The cash generated from 1 ZAR of sales||By looking at the income statement ratio||0.05|
|The time in days of your OCC||Calculated from holdings inventory days + accounts rec days||80 + 70 w= 150|
|The CCC time to cycle cash used in the OCC||Calculated from OCC – accounts payable days||150 — 30 = 120|
|The cash tied up in each OCC for a 1 ZAR sales income||Restated IS with CCC factored in for OpEx and inventory||0,18 + 0,48 = 0,66|
|Your per cycle growth rate||Free cash that can be added to the OCC cash requirement||0,05 of 0,66 -7,57%|
|How many cycles can be completed in a year?||Days in year available divided by OCC||365/150 = 2,43|
|Assume a productivity factor for safety||90% as a reasonable contingency for strikes etc||2,43 x 0.9 = 2,19|
|Compounded annual self-funded growth rate||(1 + SFG) OCC cycles – 1) = (1 + 0,0757) 2.19 – 1 =||17,3%|
Driving growth in your business
So, how can you use this information to drive growth in your business?
First, your debtors book must exceed your creditors book. Then, if we just shorten our accounts receivable days from 70 to 30 days, the following would happen:
- The OCC is now 150 — 40 = 110 days
- CCC is 110 — 30 = 80 days
- Cash needed for cost of sales is 0,60 X 80/110 = 43 cents
- We have not targeted operating costs yet, which remain at 18 cents
- Round everything up and we now need 62 cents instead of 66 cents (6% improvement)
- Your per cycle growth rate is 5 cents/62 cents = 8% growth rate
- How many cycles can you do in a year now? 365/110 = 3,3 cycles; up from 2,43!
- This is a 36% improvement
- Add a contingency of 95%, which gives us 3,13 cycles
- Compound this over a year: (1+ SFG) nbr of cycles — 1) = (1 +0,08) 3,1 -1) = 26% from 17% originally.
That’s 9% growth and nobody noticed a thing!
- That large corporate account that you cherish and that one of your sales executives is overly proud of landing may well be destroying value in your business. Why? Because large corporate accounts tend to get over-serviced (and I doubt you allocate those costs properly) and tend to pay you late.
- Growing with a greater number of smaller customers, steadily over time, within your means and without being bullied delivers more value and less stress.
- There are easy and clever ways to add lots of value to your business, that cost very little to implement, but you do require an understanding of how cash gets tied up.
- Delegate, don’t abdicate. No entrepreneur is ever great at sales, production, operations and cash management, so get people who can complement your skill set, and allow you to do what you enjoy. That said, you can never hand the numbers over to someone else. Receive assistance if you need it, but know your numbers!
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