As we enter the fourth month of 2013, we’ve already seen many changes in what we believed to be true late in 2012.
Europe has fallen deeper into recession, as they’ve experienced three consecutive quarters of negative economic growth. Europe tried an austerity program to get themselves out of the recession. Though austerity may reduce debt, in the short-term, it fails to move the economy forward. Instead of ushering in prosperity, attempts to slash deficits and debt have actually caused more debt by depressing economic growth.
As Europe continues to struggle with its third consecutive quarter in decline in gross domestic product, America can’t escape the impact. General Motors, for example, is selling less cars across the pond and other companies are having difficulty shipping goods overseas due to reduced demand in Europe.
However, the overall atmosphere in America has changed precipitously. We only have to look as far as the stock market, which has recently hit an all-time high, surpassing its previous peek reached in 2007. We only have to look at the car manufacturers to see that even though they’re having more difficulty selling in Europe, and various other places across the globe, total sales are the highest in five years.
Also, there’s no doubt that the real estate market is improving. It’s certainly improving from very low numbers, but still there is no doubt it’s improving. I read with interest that foreclosures were at a four-year low during the first two weeks of February 2013.
The American economy is on the upswing. However, we have to get to the point, and what we have to understand is that we have to vastly improve—to move our economy forward, to move the middle class forward, to assist the working poor, to assist small businesses in America and to finally get to the point where the American worker catches up with the American corporations. The only way we can accomplish that is through more and more activity throughout the entire economy.
So how do we do that? The first thing we have to do is change our mindset. Although, our mindset has increased dramatically since the Great Recession, our confidence level in both our leaders and our economy is still relatively modest.
We are traversing the moral high ground when we convince any of the powers at be that in order to protect American business, we need to protect all Americans. And now is the time to take action for entrepreneurs to protect their companies, their legacies, their families, their employees, their vendors, their bankers, their insurance agents and that whole environment of people who they are obligated to protect.
We have gone the last four years without taking risk, believing that all we can do is just get by. We have driven ourselves to the point of believing that the very best we can do is 50-percent less than what we could do four years ago. We must stop that.
America’s small business owners must manage every critical variable within their businesses. What are those critical variables? Certainly, they have to figure out how they produce profitable sales, but contemporaneously maximize a profitable sale. They need to get back to marketing. They need to get back to figuring out how they can maximize the revenue in their company, taking into consideration that maximizing revenue that is not profitable makes absolutely no rational or reasonable sense.
The next thing they have to do is control the critical variables of their cost—those costs being the cost of goods sold first, which is made up of their labor, their material, their subcontractors and any other expense directly related to the production of their product.
So how do they go about doing that? How do they go about controlling the next cost, which is their overhead? Their overhead is defined as all other costs associated with the business, other than the cost of goods sold and profit. How do they control their overhead? The first thing they have to do is know what their overhead is. When you ask the owner of a small business what his overhead is, he guesses and throws out a number. “Oh, it’s around 30 percent.” That number is absolutely absurd. A small business owner has to understand that the difference between his gross margin minus his overhead equals his net profit before tax. If his overhead is five percentage points higher than what he thinks, that means the very best he can achieve—if 10 percent would be the maximum profit his business could throw off—would be five percent. Therefore, 50 percent of his potential would be immediately eliminated by the fact that his overhead is five percent higher than what he thought.
When it comes to labor costs, if a business owner’s productivity is only 60 percent, versus a minimum of what it should be of 80 percent, and assuming he’s operating a $2 million-a-year company with a 30-percent labor burden, that means he’s spending $600,000 a year on labor. If he could increase his productivity by 20 percent, that would be $120,000 savings on just productivity— on just that 20 percent increase. That $120,000 in savings is, in most instances, a sum greater than what he actually takes out of the business in compensation.
What about material costs? Is he really minimizing his material costs? Is he really making sure that he’s buying from the right source, buying at the right price, receiving everything he actually thought he was buying, making sure he reduces his pilferage, his waste and his theft? Is he really making sure that the product that he’s buying is of the quality that it needs to be to turn around and sell it?
Is he making sure that he’s not getting too many rejections? In other words, if he happens to be a job shop operator, is the brass he’s buying causing too many rejects? Or the plastic he buys? Or the resin he buys? Is he making absolutely sure that what he’s buying is what he should be buying?
As a contractor, is he making sure that he’s actually managing each component? Is he making sure his bid-to-award ratio is what it should be? Is he making sure the jobs that he’s getting are the jobs he should be getting and the jobs he’s rejecting are the jobs he should be rejecting? Can he reduce his costs to reduce his price by three percent so he can get the job and still make his 10-percent profit? Is there some methodology that could have been employed to ensure that the job costing and estimating are correct? In other words, must he have a check and balance system to make sure it’s working the way it should work?
Realistically, does he have a methodology to determine his working capital, determine where his accounts payables should be, and determine where his accounts receivables are? Does he really know about a cash flow analysis? Does he really know about progress billings? Does he really know how to make sure that his working capital and his cash flow is what it should be? Does he have some reasonable understanding of how he spends his depreciation money—depreciation being money that is deducted from his federal income tax liability, but not actually spent? Does he know how he should be investing those depreciation dollars, which—on a $2 million-dollar company—might be $60,000 $70,000 or $80,000 per year? Is he investing that money back in the company or is he taking it for himself? Again, $80,000 per year might double his income.
Is he really trying to double his income? No. What he’s trying to do is build a legacy for himself. What he’s trying to do is get to the point where he as the entrepreneur—as the owner of his company—is capable of controlling his own destiny. What he really needs to do is build this monument. The problem is no one can build a monument that can last 300-400 years unless they use the right materials.
If you look at the Washington Monument, Abraham Lincoln’s statute in Washington or the Coliseum in Rome, you’ll realize how painstakingly brilliant the workmanship was and the materials used. But, if in fact they used inferior materials, there’s no way the Coliseum shell would still stand 2,000 years later.
The reality is each and every one of us has an obligation to do as well as we can in order to make sure that everyone around us benefits. It’s absolutely astonishing that the middle class in America is trying to live with 10-percent less buying power than what they did 10 years ago. In order to modify that, small businesses have to get back into play. They have to start hiring again, they have to cut their costs, increase their productivity, drive their revenue higher and begin to hire again. And they need to hire at wages that are rational and reasonable.
The argument we’re currently having about raising the minimum wage could be a horrible decision for companies like Pizza Hut that deliver products that are relatively low-priced to begin with. However, in the aggregate, no one in America can live on $8.25 an hour, $9.25 an hour or $10 an hour. You cannot live on those sums. What you need to do is create jobs where people can make reasonable incomes—$50,000, $60,000, $100,000 a year.
How do we get back to that? We get back to that by making small businesses in America prosper. And how do small businesses in America prosper? By following the rules, the rules of smart entrepreneurship: Control every one of the critical variables by knowing what the critical variables are and knowing what the actual factors are that make up each individual critical variable. Then, and only then, can a small business owner run their business the right way—run their business for maximum profit so they can decide how to reinvest those dollars back into America. That should be the goal of every entrepreneur.