Monday, April 16, 2012

Professional Brawn, and Why You Need Some

In a recent interview, I was struggling to find a term to describe someone who had worked their entire career on building up a strong foundation of knowledge, contacts, successes, and failures; someone who had learned a bunch about being successful in business the right way, who knew how to build and foster mutually beneficial relationships, and who was humble enough to still hunger to learn, change, adapt, and evolve. And, someone who was anxious to bring others with them on their journey, to teach them, train them, mentor them, and ultimately be replaced by them.

How do I sum all of that up into one term? And out of my mouth came brawn. But that sounded like only brute force, the roll-up-your-shirt-sleeves and get the work done element that would result in physical brawn, and neglected giving credit to all of the intellectual and emotional prowess required for everything mentioned above. So I put the word professional in front of brawn and thought I might be onto something.

Whatever you call it, we all need it, and we all hope everyone we hire has at least some of it.

Tuesday, April 10, 2012

Fixed Cost Coverage Ratio

It’s been a long day with lots of customers interacting with your team and buying many of your products and services. Your staff seemed busy and you felt productive. But did your business actually move forward or backward? Did you win or lose today? Here is the main number you should track every day in your business to answer these important questions.

The number of times your business covers its fixed costs each day is the how you determine if you win or lose, and that is called the Fixed Cost Coverage Ratio. In order to derive this critical number, you need to calculate your daily sales volume and divide it by your break-even volume. I will explain how to figure this out for your company.

Variable Costs
You need to start by determining your variable costs. Variable costs change based on your daily sales, and they are expressed as a percentage. This usually includes materials, direct labor, and staff wages that are paid based on production. On average, let’s assume this number is 30% for your business. This means that for every $1 in collect-able sales you produce, you pay $0.30 to the variable parts of your business.

Contribution Margin
For the sake of this article and the example below, I will assume that the variable cost percentage subtracted from 100% equals the contribution margin, or the percentage of every dollar of collections that is left after paying the variable costs to cover the fixed costs. In this example the contribution margin is, therefore, 70%.

Fixed Costs
Now we need to discuss fixed costs. Fixed costs do not change, regardless of your daily sales volume, and they are expressed as a flat dollar amount. This usually includes your rent, insurance, salaries and wages not tied to production, utilities, marketing, etc. I suggest business owners include all of their compensation in this number, regardless of what the compensation might be called (i.e. salary, dividends, guaranteed payment, interest, etc). Let’s assume your fixed costs are $50,000 per month.

Break-Even Calculation
To determine break-even, we need to divide the fixed costs by the contribution margin ($50,000 divided by 70%), which equals about $71,500 of monthly production required to pay your variable costs and barely have enough left to cover your fixed costs. This means you did not make any profit during the month.

To be more specific, if your business is open 20 days per month, you need to produce $3,575 per day to break-even. But hopefully you didn’t decide to own your business just so you could break even. The goal is produce as much more than $3,575 per day as is possible.

The Ratio
The concept of the fixed cost coverage ratio is to determine how many times your production each day can cover your fixed costs. By dividing your daily production by the break-even, you will know your ratio. If the ratio is one, then the business is being run at break-even. If the ratio is above one, then you are profitable. If you drop below one, then you lost money that day.

For example, if you sell $5,363 in a day, your break-even coverage ratio is 1.5 ($5,363 divided by $3,575). This is a good, profitable day. If the next day you only sell $3,225, then your break-even coverage ratio is 0.90, meaning you lost money that day.

Empowered with this daily metric, you no longer need to wonder how you did each day. I recommend you revisit your variable and fixed costs quarterly to make any appropriate adjustments to your calculation. As you improve this ratio, you’ll find your cash flow and profitability increase significantly.

Tuesday, April 3, 2012

Get Out From Behind The Desk

While waiting for a plane in Frankfurt, Germany last week, I noticed the following advertisement. With my copy of Eric Ries' book The Lean Startup in one hand, I snapped this photo with the other:
This insurance company pulls a line almost directly from Eric's book, with an insurance and risk management spin on it: "If you want to understand risk, you need to get our from behind your desk." This ad wants to appeal to their customers, trying to change the mindset that insurance companies aren't just buildings full of stiff employees who don't understand how the real world works.

In his book, Eric spends a lot of time trying to convince entrepreneurs and founders of startups to get out of the office and get real feedback about what needs your customers have and what they would be willing to pay to solve them. But this is where many fail to really understand the message.

You see, most interpret this concept of "talk to customers" as a dialogue wherein the customer is asked what they need and what they like. But this causes a huge problem, primarily because the customer is not an expert in the area where they have pain and they are far from qualified to address exactly what they need.

So, this concept of getting out of the office is more about understanding customers, hearing what their challenges are, and deciphering what the root causes of those challenges are. As noted in the picture above, you want your customers to have a sense that you 'get' their problems and that you know how to help them. The way to achieve that is full of skillful question-asking and careful, attentive listening.