How To Identify And Avoid Toxic Business Errors

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In nature, a number of substances that we eat or drink are necessary to our health, but they can become toxic when ingested in large amounts—these include salt, sugar, vitamins, minerals and even water. When our bodies are healthy, they provide warnings when we get too close to that limit. But in business, it is not always so easy to recognize when we are getting too much of a good thing. The following six common practices can be toxic to your business when not properly controlled, applied or moderated.

CONFUSING BOTTOM LINE PROFIT WITH FINANCIAL HEALTH is a common mistake entrepreneurs often make. They receive a financial report that shows a profit on the bottom line and they assume that means their company is healthy financially. Do not fall into the trap of confusing profit with cash. Your monthly profit and loss (P&L) report might indicate your company made a profit, but it is always necessary to examine the balance sheet comparison report and/or the sources and uses of funds report to see what truly happened to that profit. These reports will often show that all of those profit dollars (or possibly more) are now tied up in higher accounts receivables (still in your customers’ pockets, not yours) or are now sitting on your shelves in larger inventories. It is very common to find companies with growing profits on their P&L statement have run out of cash to make their payroll, pay 941 taxes, lease payments, etc. You must look at these other financial reports to get the broader picture of your company’s financial health.

UNDERESTIMATING THE COST OF SUCCESS. Entrepreneurs often fail to consider the additional cash needed to take on new, profitable business. For example, I once worked with the owner of a successful trucking company who was given an opportunity by one of his best customers to enter into an exclusive contract to replace the customer’s delivery fleet with his own. My client was understandably thrilled with the prospect of a solid $1.25 million in new business. He planned to lease 10 new tractors and 25 new trailers to support this business and had already forecasted that the rates he had projected would net him more than a five-percent net profit. However, I discovered he had failed to consider how much cash would be drained from his current operation by taking on this new business. When I helped him calculate the cash required to make the initial first and last months’ payments on all that equipment—to buy the fuel and to pay the 10 new drivers for the 60 days before he received his first payment from the customer —he quickly realized that the $100,000 he had in the bank would immediately disappear and he would quickly run out of cash. He was still able to take on the additional business, but only after he found the working capital needed to support that much growth.

MISSING OPPORTUNITIES DUE TO AN OBSESSION OVER MARGINS is another common mistake. While a successful manager will always know what his gross margin is on every job, it is a mistake to become obsessed with protecting a specific margin to the point where you become blinded to quality opportunities. I have often heard statements such as, “I refuse to bid on that work because the margins are too low,” or “I won’t take on any work where I can’t get X percent margin.” Most pricing models and programs encourage this thinking because they are built around a set of static assumptions that may or may not be valid for your company at the current time. A successful manager will examine a combination of factors, including how much time the job will take, how much of your capacity it will use during that time, how much work you already have in the pipeline, how much gross profit that scheduled work will generate and, most importantly, how many dollars of gross profit you need to cover your overhead expenses during that time. By definition, overhead is a fixed expense that has to be paid either from gross profit or directly out of your pocket. If the scheduled work will not generate enough gross profit dollars to cover your overhead expenses, then any additional gross profit dollars from the new work is desirable because without it, you will lose money. If you find that the work already in your pipeline will generate enough gross profit to cover your overhead, but you still have the capacity to take on more work, then every additional dollar you can collect over your direct costs will go straight to the bottom-line net profit.

DRIVING YOUR COMPANY USING JUST THE REAR -VIE W MIRROR . Small business owners know that driving a car in this manner would be very dangerous, but many wait to make important decisions until they receive the latest set of financial reports from their accountants. While those financial reports do contain important information, they only report what has already happened days, weeks and maybe months past. When you are driving your car, you are spending most of your time looking out the windshield at what is coming at you and at the dashboard monitoring your speed, fuel, engine temp, etc. You can significantly improve your business by developing a management “dashboard” or a set of measurements/ metrics of the most important elements of your business that can be used to predict future performance. Several of these measurements/metrics include the number of sales calls per day, week, month; the number, size and type of opportunities to quote or bids received; the bid versus award ratios; estimated gross margins on work awarded; labor productivity; and the level of work in the pipeline or backlog. By accurately tracking these types of metrics over time, you can quickly spot (and react to) trends that are developing, such as decreasing productivity and sales call activity, being awarded a higher-than-normal percentage of bids (the market is improving and you are leaving money on the table), etc.

TRUSTING TOO MUCH AND VERIFYING TOO LITTLE. Former President Ronald Reagan coined the phrase “trust but verify” when he was dealing with the Soviet Union negotiating nuclear weapons testing and reductions. This is a practice the majority of small business owners neglect. In large enterprises, you will find many resources devoted to writing and reviewing procedures and auditing compliance in an effort to avoid fraud, theft, waste, inefficiency and common mistakes. In your business, you are forced to place more trust in the integrity, ethics, loyalty and competency of your employees at every level. That places your company at higher risk, especially since so many small business owners have over-inflated opinions of their superior judgment of character. Don’t fool yourself like so many of your peers have. The following are several relatively easy practices that can go a long way toward minimizing your risk.

  • First, don’t place your employees in a position where they are tempted beyond their ability to resist. Remember, many employees are living paycheck to paycheck and likely believe that you are growing wealthy from their hard work. When you place them in control over company assets (cash receipts, checking accounts, inventory, credit cards, purchasing, hours worked, etc.) and make it obvious there will be almost no oversight or auditing, you are creating ideal conditions for turning an otherwise honest and loyal employee into a thief.
  • Second, take a serious look at each of the following potential problem areas by asking yourself what different procedure or practice you would implement if a new hire was assigned that task. Split up or double up important tasks, and make a separate individual responsible for auditing or checking the work or job. Do not allow the person who approves and writes checks to pay bills also sign those checks. Never have the person who writes the checks also balance the bank statement. Make sure your checking account requires two signatures when large checks are cashed. Start requiring the use of written purchase orders to document who is purchasing what for delivery on which date and under what terms of sale, etc. Have another individual receive and compare the materials to the purchase order.
  • Finally, figure out a way to independently verify the hours worked, especially when off-site. Make sure employees know that random checks or audits of cell phone bills or GPS records are being performed. Just knowing that you are paying closer attention will help keep everyone honest.

CREATING INCENTIVES THAT WORK AGAINST YOU is another common mistake. Too many small business owners don’t take the time to examine the compensation plans they create for their employees. Most will establish an hourly pay rate they think is fair for the job and count on supervisors or employee loyalty to keep their labor costs as low as possible. However, many owners fail to consider that most of those employees are living very close to the line, and a few extra dollars on their paychecks would sure come in handy when making ends meet. So, what is the only way that worker can make those few extra dollars? The answer is by working more hours, especially working overtime hours. In this weak economy, that probably means slowing down and stretching out the work. In essence, the employer has created an incentive plan that works exactly opposite of his best interests.

While you probably can’t eliminate hourly pay plans, it is often possible to offset their negative effects by adding a strong performance-based incentive pay plan on top of that hourly wage. This is easier said than done, but with proper planning and control, it is possible to create extremely effective plans based on “gain sharing.” Gain sharing involves the company making a realistic determination of what level of performance it would take by the employees to increase company profit and then “sharing” a significant portion of that gain with them when they reach or exceed that goal. When executed well, such plans can completely transform organizations into lean, efficient operations where the workers are active partners in achieving success. However, poorly structured or implemented plans have the potential to backfire on management.

All of the previously mentioned mistakes begin as good ideas and practices, but can turn toxic when they are not monitored, audited, challenged and adjusted in a timely manner. The key to avoiding them is to constantly test your assumptions and monitor your key business metrics. Cash flow, working capital, overhead coverage, sales activities, backlog/pipeline of work and labor productivity are great starting points. Determine what other information is important to predicting the future of your business and find a way to measure and track it. Have the information collected for you weekly, review it as soon as it is available and act promptly to correct any potential problems while they are still developing. Thomas Jefferson wrote, “The price of freedom is eternal vigilance.” I believe that sentiment is equally true of success in business.

About Ron Wilson 1 Article
Ron Wilson is a senior business consultant and project manager. Following a 30 year career as an entrepreneur, Ron has spent the last six years assisting over 100 small business clients with a wide variety of needs.

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