April 2013

I first read book, The E Myth Revisited by Michael Gerber and encountered his ideas on the Primary Aim when I decided to focus my consultancy and coaching business away from big businesses and towards business owners and entrepreneurs.

This introduced me to the idea that the business owner has a unique opportunity to design and build a business that can help deliver the perfect life.

It’s an opportunity many business owners never think about so they never get to grips with designing a business that really works for them.

Your Primary Aim

Your primary aim answers the question of what you want to do in your time on earth. [continue reading…]

Break Even Point Analysis is based on the cost volume profit relationship in a business.

What Is Profit?

Profit is the difference between sales revenue and the total costs incurred in the business.

If sales revenue is greater than costs, the business makes a profit.

If sales revenue is less than costs, the business makes a loss.

The point where sales revenue equals costs is known as the Break Even Point.

That’s all fairly straightforward and obvious but you may have missed an important point.

Although the objective of a business is to make a profit, you can’t act on profit directly.

Instead your actions will influence revenue and costs and depending on how they change, your profit will change.

That’s why it’s important that you understand how your costs change or don’t change for different levels of sales volume.

The Cost Volume Profit Relationship [continue reading…]

I don’t expect business owners and entrepreneurs to turn themselves into accountants and finance experts but I do believe that there are two financial concepts that they must understand to be consistently successful.

The Two Critical Finance Issues Every Business Owner Must Understand

1. Break even point analysis
2. Cash flow forecasting, management and control

These will make sure that the owner is managing for profit and cash. [continue reading…]

Some business coaches love working with successful business owners and get a great buzz from helping them to become more successful, turning them from millionaires into multi-millionaires.

Other business coaches, including me, get much more satisfaction from helping struggling business owners to turn around their businesses when they are not performing well.

The financial rewards aren’t as good but I get more satisfaction from making a big difference to people’s businesses and lives.

Small Business Turnaround Coaching

In this article I am going to look at how feasible it is for owner-managers to work with a turnaround coach to put their businesses back into the black and to create a long term profitable business.

I’ll look at:

• Whether your business is already insolvent?
• The role of a turnaround manager.
• The compromises involved with hiring a business turnaround coach.
• Whether your business can be turned around.
• The turnaround priorities.

Is Your Business Already Insolvent?

In the UK, the two main tests for whether the business is solvent rather than insolvent are:

• The cash flow test – can the business pay its debts to creditors as they fall due?
• The balance sheet test – is the value of assets greater than the value of liabilities?

A company that fails either test can be considered as insolvent.

There is also the issue of whether the company has not paid a statutory demand (including a county court judgement) of more than £750 within 21 days.

I will write more about this but if you fear your business fails these solvencies tests, you must talk to a qualified insolvency practitioner immediately.

When you are insolvent, you must act in the best interests of your creditors.

If the business continues to trade after the point when insolvent liquidation becomes unavoidable, the directors risk serious consequences including being made personally liable for the debts and being disqualified as directors in the future.

Get the proper advice from an insolvency practitioner. It’s much better to deal with knowledge of the facts rather than uncertain fears.

It doesn’t mean the end.

Some businesses can trade out of the difficulties.

Others can go through a formal insolvency procedure like a creditors voluntary arrangement (where creditors agree to write off a proportion of the debts) or administration.

Businesses That Are Technically Insolvent

Many start-up businesses are technically insolvent but the owners have the resources and intention to stand behind the business.

Ideally, they should invest their own money as share capital to correct any balance sheet deficit where liabilities exceed assets and make loans if the company doesn’t have the cash to meet its obligations as they fall due.

Older businesses that can’t build up their retained reserves may also be technically insolvent on the balance sheet test but because of a favourable working capital cycle, they may be able to meet their debts as they fall due or at least before legal action is taken.

Again the owners should increase the share capital to cover the balance sheet deficit.

They’d also be advised to take steps to improve the business so that profit could be retained in the business to build up a reserve buffer.

The Turnaround Manager Or Consultant

Large companies hire turnaround managers or consultants, often called Company Doctors.

These hard-nosed professional managers take control over the business and do what the existing senior management won’t do or can’t do.

The existing directors and owners may be completely sidelined or may be used to implement the recovery plan of the turnaround manager.

In the article Business Turnaround Specialists: Help In A Recession I explained the five stages of business decline identified by two academics Weitzel & Jonsson.

These are:

1. The first stage is that managers are blind to the problems,
2. The second stage is a period of inaction as they assess what is happening,
3. Third is a faulty action stage where actions are taken but they fail because of inadequate diagnosis,
4. The fourth stage is crisis, by which time it may be too late to recover. A firm cannot sustain losses indefinitely and
5. In the fifth stage, dissolution occurs and the business is declared bankrupt.

Stage 1 can exist for a long time as the business has an inadequate system of key performance indicators and doesn’t even use break even point analysis and the margin of safety as an early warning system of the health of the business.

Eventually things get so bad, the managers can’t help but notice.

The further through the process before the turnaround manager is appointed, the less chance there is for recovery. The business runs out of resources and time.

The turnaround consultant is experienced in recognising and diagnosing the symptoms and causes of business decline and finding effective solutions. Things will stand out as unusual, odd and wrong that the owners accept as “the way things are done here”.

The Problems With Appointing A Turnaround Manager In A SME Business

1. Cost – a good turnaround manager will be expensive. This is a full time role and the person won’t be prepared to work for nothing. He or she is likely to demand a payment upfront and regular ongoing payments, a success fee and even a share in the future ownership of the business.
2. The owner has to give up day-to-day control. Most business owners have a big problem with this. The business is their baby and they don’t want to be bossed around. Ultimately the owner can sack the turnaround manager but it will be expensive and is likely to accelerate the decline and collapse of the business.
3. The business owner has to swallow his pride and accept specific, public and implied criticisms of what has happened in the past to get the business into trouble. The turnaround manager will do things very differently to the owner and will sacrifice various sacred cows.

On the positive side, the owner may be relieved that someone else is making the tough decisions and has accepted the responsibility to prepare and implement a recovery action plan.

The Turnaround Coach – The Affordable Solution For Small Businesses In Financial Difficulty

The turnaround manager / consultant will take control from the owner-manager and do whatever is necessary to move the business towards recovery.

The turnaround coach works through the owner-manager to create change in the business.

This puts the coach as the advisor and guide but leaves the owner responsible for making the final decisions and taking the necessary actions.

This may be good:

• It costs much less than a turnaround manager and may be the only help a business owner can afford.
• It keeps the business owner in charge.

It may be bad:

• The business owner has to be persuaded and encouraged to take actions that he or she has previously dismissed or postponed.
• The coach sees the business partly through the eyes of the business owner. Instead of being there every day, seeing and hearing what is really going on, the coach has to rely on the owner accurately reporting the situation. Without going too metaphysical on you, none of us see reality but our own perception of reality influenced by our values and biases.
• Recovery is likely to take longer and be less certain. The business needs expensive intensive care but it receives less.

That may sound dismissive of the role of a turnaround coach. It’s not meant to be.

A coach is much better than having no outside help.

• The coach will challenge the way you are looking at the business. The process can give you fresh eyes so that you see for yourself what is going wrong.
• The coach will help you diagnose the problems of the business and the independent and objective view will reduce the chances of getting the diagnosis wrong.
• The coach will provide new ideas and solutions.
• The coach will help you to create a recovery plan that closes the gap between where you are and where you want to be.
• The coach will hold you accountable to the plan.
• The coach will help you solve problems implementing the plan and deciding when the plan needs to be adapted and updated to the new situation.

These actions can make a very big difference to the probability of effectively turning your business around.

Can The Business Be Saved Through Turnaround Coaching?

This depends on:

• The business owner
• The business
• The market
• The coach

Some owners don’t respond well to coaching. They resent being held accountable in their own businesses and having their thoughts, decisions and actions challenged or guided.

Others thrive on having a new “business best friend” when the going gets really tough. Someone who they can finally share what’s really going on and discuss their worries and concerns without having to put on a brave face and act confidently.

The business may be in too much trouble. The market may be too tough.

I recommend you read 21 Reasons Why Your Business Isn’t As Successful As You Want It To Be and the associated articles to take a new look at what is happening in your business.

Finally there is the coach.

The person has to be right for you and your business. General management skills are needed with a strong emphasis on finance.

Please read How To Choose A Business Coach

The earlier you start working with someone to turn around your business, the more chance there is to succeed.

Does A Small Business Owner Of A Struggling Business Have Any Alternatives To Working With A Turnaround Business Coach?

There are always alternatives but they may not be very attractive.

Assuming that a full time turnaround manager is out of the question, the business owner can:

• Do nothing. It doesn’t sound sensible but that’s exactly what happens in many troubled businesses. There are the twin problems of 1) total denial of the problem and 2) blind hope of a miracle solution.
• Do it on their own, possibly with the help of business books and courses. In one way this is good but it is time intensive when you should be taking action.
• Work with the help of a friend or relative. This can be good or it can be terrible. Sometimes friends are kind and encouraging when they need to be blunt and truthful. You may have experienced that for yourself if you’ve ever shown any marketing to a friend and heard nice things back and it flopped. Sometimes the friends can be very experienced and knowledgeable in business but not always.
• Join a mastermind group of other entrepreneurs. This can be an excellent idea for successful businesses but it’s probably not going to work fast enough for you.

If you think that your problems come from having an unbalanced management team e.g. you’re great at sales but hopeless at finance and administration, it might be an alternatie to hire a part time finance director.

Coaching is expensive and the business is short of financial resources.

I think it’s worth it to increase the chances of finding business success in the future.

But then, as a coach, I am biased.

The Business Turnaround Priorities – Establish the Position, Generate Cash, Cut Costs And Build Revenues

You might be wondering what you will do with a turnaround coach.

I believe the work falls into four main areas:

1. You will need to establish the position of the business. What is the financial situation? Is it already insolvent and should you be talking to an insolvency professional? What are the underlying causes of the business problems?
2. You need to get in control of your cash flow and generate more cash. It gives you more time and reduces the day-to-day stresses. Some may say generating cash is your #1 priority but decisions that are correct the right side of insolvency may be wrong if the business is beyond redemption.
   
3. You need to cut costs. It’s not nice but reducing your cost base (which you are in control of) means you have less problems persuading customers to buy (which you don’t control).
4. You need to build revenues. Cost cutting will only take you so far and to create a long term viable business, you need to get your startegy and marketing right.

I Wouldn’t Start From Here

Business turnaround is a bit like the old joke of someone stopping their car and asking for directions only to hear “if you want to go there, I wouldn’t start from here.”

It’s much better to make sure your business doesn’t get into trouble than to have to get it out.

Company A sees the problems early and can slowly and surely make changes, testing ideas to see what works and what doesn’t.

Company B has to create a much bigger change in direction and momentum. Because of the accumulated losses, it will have fewer resource and more pressure to make things happen with less time available. While there are some things that are basic common sense and the business owner won’t regret changing, there may be some risky gambles necessary. They may work, they might not.

Company C has ignored all the warnings and collapses.

If you’re are somewhere between company A and B, you should seek out help as soon as possible. Start talking to people. Face up to your situation.

If your company is between B and C, you need to talk to an insolvency professional. It doesn’t necessarily mean your business is finished because of the formal recovery procedures.

I introduced the idea of the Ideal Profit Formula in How To Target Your Ideal Profit based on the formula for calculating break even points.

This calculates a sales revenue value or volume that, based on the accuracy of the underlying assumptions, gives you an idea of what’s needed to give you the profit you want.

In this article, we’ll dig deeper into what the sales revenue value means in practical terms.

The Three Ways To Grow A Business

One of the best known ways to look at business growth is the Three Ways To Grow A Business Model.

This gave us the insight that sales revenue is made of three factors that multiply together:

1. The number of customers
2. The number of times they buy in a period
3. The average spend each time they buy

The big revelation is that when most business owners think about increasing sales revenue, they think about ways to attract and convert more customers (factor 1) and ignore the other two, often much easier to improve, factors.

Targeting Your Ideal Sales Value

The Ideal Profit Formula gave us an idea of the value of sales revenue, this next stage breaks down that total across the three elements of the ways to grow a business model.

Comparing what’s happening in your current business with how you’d like to reach your ideal sales revenue identifies the gap in each factor and lets you focus on how the gap can be closed.

What’s Happening In Your Current Business

The easiest number to calculate is often the average sales value per transaction.

This is

total sales revenue
total sales transactions

Obviously you use the same period of time for both.

The next easiest number to get to is the number of different customers who bought in a period.

If you’re good with a spreadsheet, you can download the sales transactions into a worksheet and then use pivot tables to count the number of different customers.

Otherwise, you may have to go through and count up who has been buying. If you have a lot of customers, this can be time-consuming. Try to find a quick way to do this because I’m going to want you to do this regularly.

Try not to use the number of open accounts on your sales ledger / accounts receivable computer program.

This is because you’ll realise that you have many customers registered who have not bought. They are lapsed customers and are useful names to know if you want to try to reactivate them.

If you get into the habit of looking at active customer numbers, you’ll realise that there is valuable information looking from period to period.

The number of customers in the last period

Plus new customers acquired

Minus customers who have stopped buying

Equals number of customers in the current period.

The length of the time period used for this customer reconciliation should be based around the number of times customers buy. If your customers buy on average every two months, then you can use a period of two to three months. If you use too short a period, you will have many lapsed customers but it won’t be valuable information because it’s part of your customers’ natural cycles.

You can calculate the average number of times customers by with this formula:

Total number of sales transactions
Number of customers who bought

You will now have the three numbers for the period:

1. The number of customers
2. The number of times they buy in a period
3. The average spend each time they buy

Because these numbers are important, check that they are right by multiplying them together.

You should finish up with the total sales revenue or close to it if you have rounded some numbers.

Using The Three Ways To Look At Your Ideal Sales Revenue

You can look at the sales revenue you want to give you your ideal profit in terms of what’s happening in your business.

In the future, you can:

• Look to reach the sales growth by increasing one of these three numbers while holding the others constant. This will give you a very focused strategy.
• Think about improving all three measures by similar proportions
• Think about all three measures changing by different proportions (including decreasing some to make it easier to increase others).

If you focus on one measure, your growth is linear and it’s easy to calculate how much your targeted factor needs to improve.

E.g. Current sales revenue

• Customers 1,000
• Transaction value £250
• Number of transactions 3
• Total sales revenue = 1,000*250*3 = £750,000

Ideal Sales Revenue based on your Ideal Profit Formula calculation is £1,400,000

Then if you target new customers with the others staying the same, the number of customers you need is 1400000/(250*3) = 1,866.7

This is an increase of 86.67% which is the same increase as jumping from £750,000 to £1,400,000.

If you plan to change all three growth factors by the same amount, things get more complicated because of the exponential growth – a 10% growth in each gives a 33% growth in total sales revenue.

To give you an idea of how this works:

Increasing all three by 10% gives you 33% growth.

Increasing all three by 20% gives you 73% growth.

Increasing all three by 30% gives you 120% growth.

Or to put it another way:

If you want to increase sales revenue by 50%, you need to increase each growth factor by 14.5%

If you want to double sales revenue, each growth factor will need to increase by 26%.

You’ll have to do your own arithmetic if each growth factor is changing by a different number but remember you’ll only have to decide targets for two of them to reach your targeted sales revenue total.

Target 3 = Ideal Sales Total / (Target 1 * Target 2)

Moving Forward Into Your Marketing And Customer Strategies

If you know how many customers you need to reach the sales total you want, you can start looking at:

• How to retain customers for longer (to reduce the number of lost or lapsed customers)
• How to attract more customers.

When you start thinking through your strategies and tactics for new customers, you’ll recognise that again, this breaks down into two numbers.

Number of leads generated * % of leads converted

If you decide that you need to increase your new customer acquisition from 2 customers per week to 8 customers as part of your move towards your ideal sales and profits, you start to see insights into what you can do.

So if you get those 2 customers from 8 enquiries, you have a 25% conversion rate.

If you want to get to eight new customers:

• You can look for ways to improve your conversion rate to 100% but that’s extremely unlikely;
• You could look at increasing the amount of marketing you do or improving your existing marketing to increase your leads by a factor of four (from eight to thirty two each week); or
• You could look at ways to improve both, say double the leads you get from eight to sixteen and double your conversion rate from 25% to 50%

The issue then becomes how do you do it?

Why don’t your leads convert at the moment (see Win Loss Analysis).

This isn’t the article to go into details.

My point is that by drilling into the numbers and understanding what it all means to set a financial goal, you start making the improvements you need to make much more specific and tangible.

It’s terribly vague to think in broad terms like “we want to get our sales revenue up to $1 million” or “we want to double the business”.

It doesn’t move you into action.

Specific numbers linked to action plans (with completion dates and allocated responsibilities) and firm intentions are needed.

This way you start managing your business intentionally as it moves towards set goals and targets.

You get clear feedback.

X is working, congratulations but can it be improved more?

Y isn’t working as well as expected. Why not? What can be done to make it work in the way you expected?

A Different Type Of Business Planning

This is intentional business planning and management.

I’ll talk more about that soon.

How intentional are you in the planning and managing of your business?

I see a number of different approaches taken to business planning by business owners:

• Many don’t plan. They operate their business on a day-to-day basis and struggle. There is some truth in the saying “If you fail to plan, you plan to fail.”
• Some prepare financial plans because their banks require them to do it to either get a new bank loan or to continue to support their bank overdraft. However, this is just a numbers exercise to keep the bank manager quiet and there is little intention of commitment to implement the plan. Perhaps there is the misguided hope that because financial success is in the forecast, it will happen.
• Some think about what they want to do in the business and put together a profit forecast and cash flow forecast to give them a budget to monitor and assess their progress against.
• A few use a better, more productive way to think about their business.

Intentional Business Planning

Intentional business planning means starting with what you want to achieve and working backwards, challenging yourself on how you can do it.

In the last few days I have introduced this idea of intention business planning in two articles:

How To Target Your Ideal Profit

How To Target Your Ideal Sales Value

In these, you start with what you want to achieve and you work backwards through your key performance measures to reveal what you need to do to achieve the plan.

I’ve written and talked many times about the best idea in the famous book The E Myth Revisited by Michael Gerber is the concept that you must manage your business intentionally.

If you don’t, it will manage you.

Instead of the business working for you, you find yourself trapped working for the business.

And it’s an extremely hard, tough and demanding taskmaster that is never satisfied with what you do.

According to the E Myth approach and I completely agree, managing your business starts with deciding:

• What you want to achieve in your own life? What do you want your legacy to be? What do you want people to say about you? This is your Primary Aim.
• How will your business support your Primary Aim? What is the deal? In the same way that your employees only work with a clear contract that specifies responsibilities and rewards, you need to focus on your Strategic Objectives.

If you need a salaries and benefits package of £200,000 p.a. to live the life you want, how are you going to design a business to deliver that money?

On this topic, you might want to read How Much Should You Pay Yourself As The Business Owner?

When you manage intentionally, you’re very clear about what you want to achieve. You’re not accepting whatever the world throws out you.

You get there through intentional business planning.

Work Backwards From What You Want To Make Happen

You work backwards from the profit you want via the sales (and contribution) targets that means your business has to deliver all the way back to the real drivers of your business performance.

When you’re clear about how many qualified customer leads you need each week, you will look at your marketing in a very different way.

It stops being a “spend and hope” activity and starts to be an “intentionally plan, action and expect” activity.

Again, the intention of starting with what you want to make happen and working backwards to how you can make it happen is the thing I find most appealing about the Seven Sentence Guerrilla Marketing Plan.

What Will Happen In Your Business If You Don’t Make Changes?

Your business will have a momentum at the moment. Change is always happening.

It may be positive with your sales revenue and profits increasing month of month because of your existing marketing.

It may be negative because you’re losing customers faster than you’re gaining them or prices are being forced down because your products are struggling to compete because there is a price war in progress because of the difficulties of trading in the recession.

I encourage you to identify these trends and project your business performance based on these trends.

Gap Analysis – The Difference Between What You Want To Happen And What Is Likely To Happen

If you’ve done your intentional business plan and your trend projection, you will have two financial forecasts for your business.

The first is what you want to happen.

The second is what is likely to happen if you don’t make changes.

The difference is the gap and working out how you can close the gap by taking specific actions is called gap analysis.

If your business already has momentum moving in the direction you want, the gap may be comfortingly small.

A few tweaks and minor improvements in what you do and how you do it may mean that you can close the gap easily and you’ll reach the “business of your dreams” sooner than you thought.

Just don’t be too complacent.

You need to be clear about your critical success factors and key performance indicators so that you can monitor your business and make sure that improvements are happening as expected.

However, if the trends indicate that your business is going backwards, the gap between what you want and what it looks as if you’ll have can be frighteningly large.

This exercise can be a real wake-up call.

Although you may get stressed, be comforted by the idea that you’ve been altered to the problem early and you can take the actions needed to turn around your business.

Start brainstorming how the gap can be closed. Get your team involved.

Record as many ideas as you can before you make any kind of critical assessment.

Some ideas may sound crazy as soon as you hear them (or they spring into your own mind) but one of these might be the springboard for some genuine innovation.

Then go through and assess the better ideas. Get your team members to select their ten favourites and pool votes to see which have the most support.

• What will it cost in terms of time, effort and money?
• What is the lapsed time from starting to finishing. Some ideas may not need much work time but because of lead times (e.g. a special brochure at Christmas) may not work quickly.
• What results can you expect? I like to estimate high, medium and low and compromise halfway between low and medium in the forecast. That’s because most forecasts I see tend to be biased on the optimistic side.
  

Eventually you will build up a series of action items that will help you to close the financial gap.

You can prioritise based on the return on investment or return on time. I’d choose whichever is your biggest constraint.

If you’re always short of time, then you need to make sure that your time is spent on the most productive activities. If money is a problem, then you need to focus on the return on investment.

What If You Can’t Close The Gap?

The idea of using gap analysis and identifying the actions needed to close the gap is very logical but you may struggle to think of enough things to do to close the gap.

That may be because you haven’t made a realistic enough assessment of your business issues and problems.

Read 21 Reasons Why Your Business Isn’t As Successful As You Want It To Be

Alternatively you might need some help to close the gap.

I can think of three approaches:

1. You find yourself a very good business growth, marketing, profit improvement training product. This will help open your eyes up to many things you could do in your business.
   .
2. You join a mastermind group and share ideas with other business owners.
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3. You work with a small business coach or consultant (like me) – How I Can Help Your Business Make More Money

Every business is different but there are at least five essential components to entrepreneurship:

1. Ideas – a clear vision of the future and ideas for turning the dream into reality
   
2. Management skills – the ideas need to be implemented effectively and efficiently
   
3. Time and commitment – the focused time the entrepreneur is prepared to invest in the business.
   
4. Money – it often requires an initial investment to build a business to a level where it can generate cash on an ongoing basis and the entrepreneur needs to be able to provide or raise the cash. Other tangible assets might also be used to support a business like a property.
   
5. Relationships and reputation

You may be tired of hearing that 50% of small businesses fail within the first two years and 80% within five years (source Michael Gerber) but each of these factors play a role in contributing to the failure rates.

The Power Of Ideas

If the idea is not good the business will not get off the ground. In the UK, the BBC has a TV show called “The Apprentice” as a group of wannabees compete to have a £100k a year job with entrepreneur Sir Alan Sugar.

Last week’s show featured a terrible idea. The two teams were asked to create a new celebration day for the greetings card industry and one team came up with the Environmental Awareness day when we were also supposed to send people we know a paper card encouraging them to conserve the world’s natural resources.

The Apprentice team thought we should use resources to encourage people not to use resources!

Not exactly sensible and not fun either with the lecturing tone of the cards they designed.

But other ideas are great.

For example, who cannot admire the idea of Starbucks which totally changed the concept of coffee and has swept across the globe. I don’t get the Starbucks concept myself but I admire the idea which has inspired so many people to spend a small fortune on coffee.

Management Skills

In Business Failure and Bad Management, I explained that insolvency experts believe the overwhelming cause for business failure is that the management team is just not up to the task. Too much talk, too little action. Too many bad decisions and not enough good ideas.

Management skills make a huge difference and that’s why the business management support industry is thriving from the thousands of books through to extensive ongoing coaching and consultancy programs.

Time and Commitment

Many business owners I talk to are amazed just how much there is to do when you are starting a new business and how many hours it needs to do everything that must be done.

Better management skills and experience can make life easier (you waste less timing making mistakes and then having to recover) but clear goals, prioritisation and time management discipline are essential.

But you can outsource tasks which are outside your strengths and you should delegate to any staff you have so that your hours are kept within reasonable limits.

Money

It seems that you need money to make money and it is certainly much easier to spend than it is to earn.

Many businesses make a loss in their first year although it is a concept I am not keen to encourage. If you plan for a loss, it creates a ready-made reason for you to lose money.

More justifiable is that a growing business usually needs cash to finance the business. You may need to buy equipment and stock and your customers are probably going to expect to pay you after your suppliers expect to be paid. The bigger your business gets, the more “working capital” is needed and that’s why fast growing businesses are often profitable but need to keep raising extra finance. (See Secrets Of Getting Your Bank Manager To Say Yes if you need a bank loan).

Entrepreneurs may bring other resources and tangible assets to the business to lower the start-up barriers. For example the entrepreneur may own a property where the business can operate. At the lowest level, this is working from home which millions of people do but the entrepreneur could own an office building, a warehouse or factory unit as an investment.

Since property usually requires signing a formal agreement, often with a significant commitment into the future, the chance to avoid these risks can give the business a significant advantage over competitors who are starting up.

Relationships and Reputation

I thought about separating out relationships and reputation but your reputation is at the very centre of your ability to build strong relationships with customers, suppliers and other people who can help you to build your business.

The best way to look at business in terms of likely potential for extra sales, profit and growth would be to be able to compare your key performance measures to your main competitors.

This is a process called competitive benchmarking.

It is a systematic comparison of your business with competitors and businesses like yours from other parts of the country (world) in particular critical success factors and key performance indicators.

Imagine learning that an average competitor makes £100k profit per year before owners remuneration but your business only makes £30k.

Imagine the power of knowing that the best competitors have sales of £150k per employee while your business generates £65k per employee.

That would make you think hard about your business and the methods you use in your business, wouldn’t it?

Unfortunately this information isn’t publicly available in the UK which I regard as a disgrace.

I don’t agree with the abbreviated accounts that can be put on public record because it means that one business can’t find out how another business is performing. Some people regard this confidentiality as a benefit but I see it as a curse.

Are There Other Ways To Access Competitive Benchmarking Information?

Sometimes a trade association will carry out a benchmarking study.

If you’re offered the chance, I urge you to take part.

The DTI in UK tried to create a very valuable service called the Benchmark Index. It has since passed into private hands.

I was very keen on this idea and trained to be an advisor/facilitator but unfortunately the scheme has rarely hit critical mass in enough different industries.

Still I couldn’t let a good idea stop me, so I held my own private benchmarking study into marketing practices for business coaches, executive coaches and life coaches. In total, I got 262 coaches to share details with me.

There is no reason why you couldn’t do something similar, either yourself or by paying a professional like myself to create the survey and write the final report.

If you get invited to take part by someone else, it is well worth paying some money to help fund it. The information you get will bring considerable insight into what is happening in the market.

One of the nice things about being a business owner is that, as your own boss, you’ll never need to ask for a pay rise.

You’ll have to answer the question…

How Much Should I Pay Myself As The Business Owner?

You will have conflicting feelings as you wear both the hats of the employee and the employer.

As the employee, the salary and benefits package you receive will determine your standard of living.

Benefits include things that you could buy as a private individual but the business pays on your behalf. In the UK this includes costs like company cars and medical insurance.

As the employer, you’ll be aware that there are many other calls on the money a business has at its disposal:

• Your staff want to be paid more.
• Your suppliers want to be paid faster and they want higher prices.
• Your customers want you to reduce prices and add more free services or better service.
• And of course, the taxman will want his fair share.

The Opportunity Cost Approach Of A Business Owner’s Salary And Benefits Package

I’ve discussed the opportunity cost approach in the article

How Much Should An Entrepreneur Or Small Business Owner Earn?

I’ve also had a much deeper look at it in my free report, The Profit Tipping Point.

The gist is that there are two market rates available to act as your guide when thinking about how high (or low) your salary should be:

• How much you can earn doing something else. It doesn’t really make much sense that you should build a business that pays you a lot less than you could earn if you worked for someone else.
• How much you would have to pay a general manager or chief executive to manage your business if you weren’t there.

As you can see, the twin hats of employee and employer are coming together here to give you an approximate range of how much you should pay yourself.

There is also the issue of how much is the work you are doing really worth. I mentioned earlier paying yourself as a chief executive but what if you’re doing much of the work of an administrative assistant.

It’s hard to justify a salary the equivalent of £100 per hour if you spend much of your time photocopying and filing!

The Three Big Questions To Answer When Deciding Your Own Pay

The three questions to focus on are:

• How much do you want?
• How much can the business afford to pay you?
• How much are you worth?

That third question is not a particular problem if you own your own business 100%.

It becomes much more of an issue if you have one or more other partners or investors in your business.

Suppose you find yourself involved in a management buyout. One person has been the CEO earning £100k p.a. and there are three other senior managers who used to earn between £40k and £60k p.a.

You have provided different amounts of the finance based on your own personal financial situations and to cover the inequity, you’ve agreed that any profit above the base salary and agreed bonus will be paid as dividends back to the people who provided the finance.

Since you’re all working full time in the business, do you all receive an equal salary or do you recognise the market assessment of your previous worth?

I suspect your answer and assessment of fairness depends on whether you are the CEO or one of the other managers.

Do You Pay Your Salary First Or Earn The Profit First?

This is a controversial issue and you will read different views on the best approach. I’ll try to present a fair summary and give you my own particular solution.

If I could think of clever names, I’d create a 2 x 2 matrix to show the main four situations with Profitability Before Owners Salaries on the one axis and Owners Salaries and Benefits on the other.

There are four basic situations:

• High Profit – High Salary
  
• High Profit – Low Salary
  
• Low Profit – Low Salary
• Low Profit – Profit Salary

Let’s take a look at each in turn.

Situation 1 – The Business Earns A High Profit And The Business Owners Earns A High Salary

Here the business is performing very well and the business owner deserves the rewards of the success.

Taking a generous but affordable salary and benefits package out of the business is the ideal situation.

The format of the profit extraction is best agreed with your tax advisor to minimise the overall tax paid by the business owner and the business. Anything else damages your overall wealth.

Situation 2 – The Business Earns A High Profit But The Owner Pays A Low Salary

Some business owners don’t want lavish lifestyles with big houses and fancy sports cars and may not see any need to pay themselves a big chunk of the profit.

This makes sense if the business has third party borrowings that can be reduced or if the business needs the money to expand.

It’s also OK to have some rainy day money in the business that protects its future.

However, it is unwise to leave too much money in the business. Basic wealth management principles emphasise the need to spread risk with a diversified portfolio of investments.

Businesses can suddenly run into financial trouble because of changes in the wider political, economic, social and technological environment.

If you take money out, you always have the choice of investing it back in the business.

Situation 3 – The Business Earns A Low Profit And The Owners Earns A Small Salary

The business owner has adjusted the salary to reflect how the business is performing by not taking out any more than it can afford.

Many will argue that this is responsible ownership, cutting the cloth to make sure that the business remains viable while steps are taken to improve profitability.

Others say that the business owner should pay themselves first. Before employees, before suppliers, before the government. They argue that the owner didn’t go into business to live on a subsistence wage.

Situation 4 – The Business Earns A Low Profit And The Owners Earns A Large Salary

In this situation, despite the fact that the business is struggling, the owner continues to take out a high salary that the business cannot afford.

Some argue this is the right thing to do. It shows the business is making a loss and that should motivate the business owner-manager to take corrective action.

Others say this is irresponsible and threatens the future of the business because the owner refuses to recognise the real situation and is blindly continually to live a lavish lifestyle despite the business problems.

I want to delve into this debate much deeper.

First I’ll declare my own position so that you can allow for any bias.

I believe a business owner should cut back salaries and benefits. In fact, I go further. I think the business owner should take out a small amount to live and then take a bonus when the business is doing well. This way, the rewards automatically adjust for the performance of the business.

Does Your Salary And Benefits Package Make Sense Financially?

I’ve seen business owners do two strange things to fund their salary payments when the business is just starting or struggling:

1. Invest a significant amount at the start and then pay a generous salary in the early months before the business gets into profitability.
2. Make regular loans back to the business to top up the cash flow and to keep the business within its bank overdraft limits while drawing a big salary and large benefits.

This doesn’t make sense financially.

In the UK, when a person earns a wage or salary above a low level, it has to pay PAYE (income tax) and national insurance (social security costs). The business also has to pay employers national insurance.

While rates vary depending on the value of salary, you can find the business owner trapped in a situation where it lends the company 100% and receives back as salary 50% to 60% and pays the remainder to the government.

This is crazy.

It’s wealth destruction and financial suicide.

What Will Cause The Most Pain To Help You To Focus On Fixing The Underlying Performance Problems?

This sounds masochistic but the best solution to the “how much should you pay yourself as a business owner” question, if your business isn’t doing very well, is whatever the salary that will motivate you enough to take the right actions.

The downsides of the issues with solutions 3 and 4 are obvious.

If you pay yourself a high salary while profits are low, you are eating into the time you have to turn your business around by consuming valuable resources. Worse, you may not know you’re doing it if you don’t have regular financial information or perhaps you’re in denial about the situation and you don’t care because you believe the business will get back to profitability on its own.

If you pay yourself a low salary and your business trades just above the break even point after paying you a pittance, you may put up with the situation for years.

That’s exactly the trap many business owners find themselves in.

They believe they are being financial responsible by cutting back on their own pay and benefits but they don’t find the motivation to make changes. Instead, they get used to the struggle.

Saving money, in their personal and business lives, becomes the norm. They refuse to speculate to accumulate.

It’s one of the reasons Why Don’t Business Owners Buy More Business Advice.

It’s well established that the desire to move away from pain motivates people to action. If it doesn’t, then the problem isn’t painful enough.

People tolerate all kinds of problems until they reach the time when they say “enough’s enough.”

Nearly every business can be improved if you’re motivated, if you diagnose the problems correctly and you find the right ideas yourself or you get help.

To help you make the right diagnosis, please read 21 Reasons Why Your Business Isn’t As Successful As You Want It To Be

What Do You Think?

Do you have a policy for how much you should pay yourself?