Membership in The Fremont Group

The Fremont Group is a membership organization which means that we are supported by individuals and companies who support our mission. Integral to our organization is our network of volunteers and consultants. Our volunteers are analysts and project managers who donate their time for initial consultations and business reviews for our Corporate Members. They are trained in our proprietary Advisory Board of Directors system and agree to provide management consulting services in this format and at a significantly reduced hourly rate. Our consultants provide consulting services generally from their offices but also on the site of the business owner.

Sustaining Members

Sustaining Members are individuals or businesses who donate $10,000 or more in a year. Sustaining Members are introduced and recognized during our annual meetings in Denver, Colorado.

Corporate Membership

Corporate Members are businesses who donate $1000 or more in a year. Corporate Members are eligible to receive an initial consultation (or an annual business review if they have already received services) from one of our volunteers.

Associate Membership

Associate Members are members who are past Corporate Members who continue to donate a minimum of $500 per year. Associate Members are eligible for an annual business review and for the same discounted consulting services.

Individual Membership

Individual Members are members who donate $250 or more in a year. Individual Membership is also granted to Fremont Volunteers.

All members receive regular invitations to our events.  Please direct all questions to Dirk Dieters, Executive Director, The Fremont Group.

Lone Wolves Are Becoming Extinct

There was a day when starting your own business, growing the business, and thriving was accomplished by lone wolves. Independent, hard working people who rejected help and prospered. Today it is a different world. Everything changes faster and everything is more complicated. Business owners can no longer just open the storefront or office and expect the phone to ring. You can no longer take out a Yellow Pages ad, or put an ad in the local paper and think that that will drive your business. Word of mouth is now Twitter, Facebook, and who knows what. And this ignores government regulations. The lone wolf who rejects the need for help is becoming extinct.

So if it’s not a matter of “if” it is now a matter of who—or how you should get help. Old school instinct says that you need a relationship with an accountant and an attorney but when you have a leak in your plumbing you don’t call a carpenter. Accountants and attorneys still have a very vital role in the success of small business but they cannot fill all roles and their misuse can be an expensive mistake. The role of management consulting has become more and more critical. Articles and testimony abound (including some posted on this blog) to the fact that a disproportionate number of successful companies utilize the services of management consultants. Be aware however that it is not a “one size fits all proposition.”

Simply hiring a management consultant is like hiring a general manager—you will get what that person can offer and little more. Everyone has limitations—you do, that is why you are seeking help. The same applies to “experts.” Don’t be lulled into thinking that a person is smarter simply because he lives out-of-town. The old consulting axiom is that their perceived value is equal to their knowledge times their distance from your door. In fact, what owners need is a local person with whom they can develop a relationship. Someone who can be a mentor, a coach, a consultant and a friend. Someone who understands their business, the local environment and can give objective, third-party advice. This however limits the scope of their contribution to their own skills. So how do you get the best of both worlds? A local person and the advantages of a larger firm with greater resources and a greater breath of persons with specialized knowledge? This was the challenge of The Fremont Group.

The Fremont Group has addressed this issue through the use of a single person who becomes your confidant who is supported by a staff of persons with specialized expertise. You benefit by having an on-going, long-term relationship with a lead person and by having access to the skills of numerous consultants. This package is put together and designed to work within your budget. Compare the cost of hiring a full-time manager with a competitive salary and benefits that you have to pay every month—even after they have contributed to the extent of their abilities—to the investment in an advisor relationship that can be turned up or turned down to match your needs.

A one-time fix may be a one-time answer, but a relationship is the way to achieve the results that you deserve.

Why I chose to work with an outside advisor …

Posted January, 2011 on the Brighton Windsor web site

  • I want to have fun again running my business. I want to feel the same happiness and excitement as when I first dreamed up the idea of owning my own business.
  • I want my family, my employees, my banker and accountant, my colleagues, – everyone – to view me as a knowledgeable, informed decision maker who is in control of their business and not the other way around so I have not only their respect – but self-respect and pride.
  • I want someone to show me how to have longevity in my business – to build a legacy that spans multiple generations. I want someone who can take an objective look at my business, and give me the straight talk on what I’m doing right or wrong and help me develop a game plan on how to fix it.
  • I want someone with empathy who can relate to my challenges, offer solutions and treat me like an equal partner when doing so. I want someone who challenges me to “step outside the box” so I can move beyond my own comfort level and complacency.
  • I want a safety net to fall back on but then a good shove to keep me moving forward. I want cutting edge technology, information on the latest industry trends, and solid business information and tools so I keep up with my competition, meet the demands of my customers, and keep growing so my business doesn’t become extinct.
  • I want a business navigation system that keeps me on the right track and “recalculates” the route if I veer off.
  • I want balance in my life to enjoy both my personal and professional life and I need security in knowing my operations are fine tuned so I can go away on vacation and things will run as smoothly as when I’m there. When I leave for the day – every day – I want to turn the key and keep it all locked inside the four walls of my business until I once again turn the key the next morning and begin a new business day with the anticipation and expectation it will be a good day.
  • I want to provide my employees with a secure, positive and healthy environment where they can grow and flourish and help the business do the same. I want to instill in them a sense of pride and integrity and appreciation for their contribution to our success.
  • I want our customers to know we are in business for them first and to make money second for without them and their loyalty we cease to exist. I want to establish solid, respectful and mutually beneficial relationships with my vendors so the links of my supply chain remain unbroken.
  • I want the American dream.

Source: A Brighton Windsor Group client’s perspective

How come only successful companies use consultants?

“I know what’s best for my company.  There’s nothing some guy can tell me—he doesn’t know my business.”

An engineering student was in college, and he was assigned a project to design a concrete structure three stories high. His classmates set to work, grouping themselves into teams and discussing various approaches. This student thought he could do a better job of the project working alone instead.  A few weeks went by, and he worked tirelessly on his design. In the end, he thought it was pretty good, and expected accolades – and a good grade. So, he turned it in and waited for the professor’s response.  The next week, he gets his design back. On it, the professor had written: “Building falls down. Many people die. You flunk.”  Turns out, the student had neglected to include some crucial weight-bearing supports in the structure, and, had it actually been built as designed, it would have collapsed….According to our 2009 State of the Industry Report, only 15 percent of companies will hire a consultant this year. That’s a tiny fraction of the overall industry. And in a more recent straw poll of Lawn & Landscape readers, a vast majority – 88 percent – said they spend nothing on consultants.

Now, I believe that an owner knows what’s best for his company. But I also know that a fresh set of eyes and some tough questions can make almost any idea, project or organization better. Bruce T. Moore Sr., president of Eastern Land Management, in Stamford, Conn., doesn’t look at hiring a consultant as someone come to meddle with his business. He’s sees it as hiring an ad hoc adviser. “In many cases they can also act as a board of directors and provide an outside perspective of the business status for increased growth and profitability,” Moore says of bringing in consultants.  The idea is that, by involving other people and other perspectives in your enterprise, you build a stronger organization and eliminate some of the risk of your company collapsing. In the end, the building stays up, many people are happy and you pass.

Chuck Bowen, Lawn & Landscape—full article at http://www.lawnandlandscape.com/lawn-landscape-0910-building-stronger-business.aspx

Your building might not collapse but your company might.  You are an expert in the technical aspects of your business and it is unlikely that anyone will be able to tell you how to build a better product—but are you an expert at building financial controls, organizational structure, sales system and the management system for your your company?  Like the engineering student, you probably built this working alone.

Only 15% of companies will hire a consultant this year—but then 70% of all small businesses go out of business in their first five years and 70% of the remaining businesses die in their next five years.  In successful companies an annual budget of 5% of their gross revenues is invested in outside consultants.  The investment can be categorized as out-sourced management and in the long run is much more effective and less expensive than hiring management employees. Visit the attached link to the same issue of Lawn & Landscape Magazine for examples of how small businesses use consultants.

http://www.lawnandlandscape.com/lawn-landscape-0910-outsiders-perspective.aspx

WHY YOUR COMPANY IS OUT OF ALIGNMENT AND WHAT TO DO ABOUT IT

Focus is the alignment of the value center of ownership with the company’s management, employees, vendors and customers.

The owner just can’t figure out why his employees lack “common sense.” Management is excited—they have created a process of measuring and monitoring an activity yet even after it is implemented, the bottom line of the company drops. Employees are frustrated because they have to face customers who have been treated poorly. These all can be symptoms of a disease we at The Fremont Group call “alignment disorder.”

When your tires are out of alignment it costs you money and endangers your life. Your tires wear unevenly and have to be replaced prematurely. Your control of the car while breaking is compromised putting you and your family in danger. Worst of all, when you really accelerate your steering wheel shakes and you con lose control causing a major accident. The same thing happens when the interests of your employees are not aligned with the interests of the company. When it is in an employee’s best personal interest to take an action that is not in the best interests of the company you have an alignment disorder.

Alignment disorder is when an employee can make more money by working slower and accumulating overtime pay rather than getting the job done efficiently or when it is more important not being blamed for a problem than fixing it. A sales person lying to a customer to get a sale; employees leaving at 5:00 with a project a half-hour from finishing; or the raise given to the one who complains the loudest are all examples of alignment disorder. Bringing a company into alignment first requires that you clearly identify what the company is trying to accomplish. Alignment disorder is often a symptom of an owner who has not clearly communicated to his or her employees what is really important—or a company that says one thing but practices another. Of course once this mission is clearly stated and communicated, systems, procedures and controls must also be introduced which incentify the positive behavior and punish behavior not in conformance with the corporate objective.

What truly is important to you and your company? Money is obvious. If we don’t make a minimum, mandatory profit any other altruistic ideals you might have cannot be achieved. Although it is possible to forget that we need to earn a profit, our work at The Fremont Group rarely encounters this omission. (Possibly because companies that ignore profit are not in business long enough to become our clients!) It is much more common for us to encounter companies that have lost their “value center.”

There is only one reason for your business to exist—to make your life better. We preach this as the “First Commandment.” The obligation of your business is to make the life of the owner better. The things that are making your life better should be identified and built upon; the things that are making your life worse should be identified and eliminated. If however you do not clearly identify your “value center” as making your life better, you will miss a significant portion of this axiom. Everyone has a value center beyond just earning the maximum profit possible. If we did not we would make all “cost-benefit” decisions resulting in acting upon anything that would save the company a nickel regardless of the human consequences. Joe would be fired after he got old or hurt because he could be replaced cheaper. Agreements would be breached if it would save money. Customers would be provided cheaper goods if we could “get away with it.” Few owners (and none of our clients) would totally agree with this approach. There is a “higher agenda” for almost all of us. The litmus test of your value center is easily determined. Take a sheet of paper, as much time as it takes and write out your epitah—how do you want you and your company to be remembered after you are gone? Profit will be included but list at least five additional values that you want you and your company to be remembered for. When you finish you have defined the value center of your company. This now must be transmitted to your organization.

The transmittal of your value center to your organization is required to create alignment and focus. When your employees clearly understand your value center and are incentified to act in accordance with it they suddenly acquire “common sense.” This transmittal is an on-going process. It starts with the hiring process, continues in specific training, is reflected in your incentive plan and most of all is observed by all in the actions of the owner. Just as the parent who tries to teach his children not to lie as they call in sick to work to go skiing, the example of the owner is more important than the rhetoric. When the value center is defined the owner must be sure that they are identifying values that they are prepared to live by themselves.

During the 1990’s many consulting firms made money by convincing businesses that they needed to write a “mission statement.” Had it been done effectively much of the company’s value center would already have been identified. As Steven Covey wrote in The Seven Habits of Successful People (and many others have paraphrased) it is important to “start at the finish.” Most mission statements are either “forward-looking” or current attempts to define the mission of the business. We have already defined that the reason that every business exists is to make the life of the owner better but what is the purpose of the business? What are the things other than money that really will make the life of the owner better by fulfilling their true objectives? This is the value center.

It was also common for companies to create mission statements by committee. Bring in your management team, have them work with a consultant for a day (or more) and come out of the room with a well-written mission statement. Put this mission statement on the wall in the lobby and go about your business. This approach is an abdication of the leadership function of the owner. The troops look to the general for leadership. They expect the general to have a plan—a clear vision of what is going to be done. Then they expect to be informed as to what their role is in this plan. They don’t want to hear the general be “wishy-washy” about the plan and ask them what they want the plan to be. The common element of all leaders is they have a plan; they clearly communicate their vision or plan to their subordinates; and they act decisively upon that plan.[1] It is therefore the leadership responsibility to clearly define the purpose of the company. This is not a group activity—this is a look into the heart of the leader. If the owner does not do so, the company can never have the focus required to be successful without relying upon luck. Time spent by an owner identifying their value center is akin to time spent planning a project—every hour spent in planning saves two on the job.

A clearly defined value center creates in an organization a new definition of “success.” Most of us are not trying to be just the company who makes the most money; most of us have some values that must be complied with in making that money. As an owner we must accept a new definition of success that complies with these values. The attainment of this newly defined success brings about real fulfillment. To be accomplished we must train our people in its meaning and we must at all times demonstrate to the organization the priority of these statements through our daily actions.

In order to transmit your values to employees you not only need to live these values but you must also train your employees in them and incentify them to act upon them. If it is in their financial interest to make a sale using methods outside of your value center you have a structural issue. If they simply don’t understand how they should prioritize competing interests you have a training issue. The mere demonstration that you are willing to invest in training employees regarding these values makes a huge impact upon the organization. It is easy to say “do what is right” but when the company “puts money where their mouth is” the impact is undeniable. That impact brings your employees into alignment with your value center. It creates a focus within the organization. It puts everyone “on the same page.” It makes you more money and it brings about a fulfillment that transcends your bank account. It makes you successful.


[1] We need look no further than the Katrina disaster in New Orleans to see an example of poor leadership. There was no plan, there was no communication of the plan and no decisive action. A strong leader would have immediately appointed a single individual to act in accordance with the values that had been instilled in them decisively pulling together all of the available assets of this country. There would have been second guessing but a strong leader accepts second guessing. Six months later instead of trying to explain and avoid blame lives and a city would have been saved.

Business Boot Camp—Are You Ready?

Are you ready for 2010? Has the last year gone as you planned? Measure twice; cut once is an expression that applies just as aptly to your business as it does to construction. You may not have achieved all you thought you would in 2009 but don’t let a lack of preparation be the cause of a repeat in 2010. You can decide to do everything possible to change in 2010 or choose to just see what happens. Start off right.

December and January Only

In December and January The Fremont Group offers their “Business Boot Camp” You will be assigned a consultant who, in one week, will tear your business apart and lay out a plan for SUCCESS IN 2010. They are not “yes men” so be prepared. The Fremont Business Boot Camp is not a seminar—it is an intensive implementation package designed to implement change; not talk about it. If you are not committed to change you should not enlist.

Who is eligible:

Your company must have more than 5 employees and have been in business more than two years. (Call for separate camps for start-up and small firms.)

You must be a “working owner” who is open to change.

You may not have more than 100 employees.

What you will get:

  • Your entire company will become focused and “on the same page.”
  • Obstacles to achieving your results will be aired, addressed and the entire organization will be utilized to eliminate those obstacles.
  • Employee productivity will increase through “buy in” and proper use of accountability and incentives.
  • You will have a clear game plan that is designed to “win the game.” You will no longer be the football coach with a game plan that says, “if everything goes right we will only lose by a touchdown.”
  • What the bank wants to know and how to present it.
  • You will have a foundation for long-term success.
  • Your organization will have a new appreciation of your role as owner of the company.

How you will get it:[1]

Monday

Morning: Introduction to staff and tour facility. Meet with owners and key employees and distribute Minding My Own Business questionnaires. Gather financial information.

Afternoon: Identify your goals for 2010 and become familiar with your operations. Gather questionnaires and any additional information needed to complete a SWOT analysis of the company.

Evening: Consultant completes financial analysis and analysis of the company and analysis of company morale and organizational issues.

Tuesday

Breakfast: Consultant and Head of Accounting

Morning: Meet with owners to review their analysis of current financial position. Present Accounting 101 to owners and financial staff (if required). Establish company budget and KPI’s. Assign Head of Sales to prepare a summary of the company’s “Sales System” for presentation on Wednesday.

Afternoon: Review the findings from the Employee questionnaires and interviews with owners. Contrast those findings with the owner’s perceptions. Identify current methods of employee accountability and incentives and develop the framework for desired methods of employee accountability and incentives.

Evening: Owners take Consultant and key personnel to dinner—informal discussion.

Wednesday

Breakfast: Consultant and Head of Sales

Morning: Review with owners the presentation of the current “Sales System”

Review company goals and re-write them as required. Present SWOT analysis for discussion (Strengths; Weaknesses; Opportunities and Threats). Determine how these should be presented to the staff.

Afternoon: Company meeting. Present SWOT analysis. Review findings of the first two days. Solicit input from the organization. Conclude with the establishment of a management committee (companies with more than 10 employees) and their first meeting.

Evening: Consultant completes first draft of Action Plan.

Thursday

Breakfast; Consultant and Head of Operations.

Morning: Meet with Management Committee (or owner in companies with fewer than 10 employees) to identify the five greatest issues facing the company and potential solutions. Review with owner and head of sales critique of the “Sales System.”

Afternoon: Meet with owners to develop a plan to address those issues. Develop a complete Action Plan for 2010. Establish benchmarks for progress.

Evening: Consultant prepares formal Action Plan for presentation.

Friday

Breakfast and Morning: Meeting with owners to review presentation of Action Plan to the company. Presentation of the Action Plan in full company meeting. Wrap up.

How to enlist:

Call The Fremont Group at (303) 338 9300 and tell them you are ready for Boot Camp. Registration Fee is $5995 plus $500 for non-local travel; $100 for local travel. The travel and $4,000 non-refundable deposit is required to hold a date; balance due at the first meeting. Preferred method of payment is PayPal (thefremontgroup@yahoo.com). Companies with 5-19 employees receive a 15% discount.


[1] The agenda assumes that you business has a person who is the head of accounting; head of sales; and head of operations. In smaller companies the owner may double as this person. Other “tweeks” in the agenda normally have to be made to accommodate the unique situations in each company.

The value of planning

by Neil Friedman
The business plan is your statement of purpose for your business. You can’t forget the reason to be in business.

Every football coach tries to devise a winning game plan. Even the best athletes will fail if they don’t have a game plan that is designed to maximize their strengths and minimize their weaknesses. Concurrently, that game plan must take full advantage of an opponent’s weaknesses and make every effort to negate their strengths. In the business world, the best game plan (business plan) coupled with superior execution will deliver a winning effort—a profitable and growing enterprise.

A business plan is your roadmap to a viable and profitable business. Too many view it merely as a document to acquire an investor or financial institution to fund their dream, but if it is properly used, it can be the difference between success and failure. There is a reason why so many preach that it is an important part of your success, so don’t neglect it. Used as a tool in your company, a business plan should be a frequently utilized document that helps keep you on track and headed towards the goals you have set.

The business plan is your statement of purpose for your business. Simply stated, the purpose of any business is to make money. A goal of any business is to not only grow sales, but more importantly, to grow net profit. A successful business is a well-managed company that has a preplanned profit. No business can exist over the long term without consistent and growing net profit. Therefore, you shouldn’t increase sales without growing profit. It is far easier to manage a million-dollar business making $100,000 net profit than it is to manage a multi- million-dollar business making that same $100,000.

Business is based upon providing a quality service and product to customers. Most business owners are typically not taking advantage of all the available customers in their service area who are seeking a quality company that keeps their promises and charges a fair price for reliable work.

The lifeline of any business is the energy and commitment that its employees display on a daily basis. A business cannot prosper without the energy and commitment necessary from all its employees. If you cannot tell someone specifically what you expect from them, then you cannot expect specific performance from them. Planning, projection (allocation) and measurement are invaluable tools and are required in any business.

Accurate information and measurements are also mandatory for any business, as they are vital to success. The operations of a business must be measured, evaluated and controlled. Knowing the value of the products and services offered is vital to the health of any company. How can a profit be made if each item in the product mix doesn’t have a known breakeven point and preplanned profit?

Members of a business have a responsibility to themselves and to the company. In addition, the business has the right to be run as an efficient and profitable company so that the employees can be taken care of now and in the future.

If the previously mentioned statement of purpose is addressed in your business plan and the plan is followed, you will be successful. Therefore, it is important to create a business plan and use it.

Included in a business plan should be a specific marketing strategy. You know what you want to do to make money, but you must find those who will pay you to do it. This is where your marketing plan comes in. The marketing plan is a process and, just like any process, you have to start somewhere, but where? How about at the end? To get where you want to be, you have to know where you are going. So where are you going? What is your goal? Where do you want to be in five, 10, 15 or 20 years?

After establishing a goal, the next step in the marketing plan is to understand where you are at this point. What is the current state of your business? Is it a leaking rowboat or a luxury cruise ship? If you must transform that leaky rowboat into an efficient ship, then the process will take more time and be more laborious. Getting started is easier once you have an understanding of the current state of the business. Simply start with a goal. The route to the goal is what the sales and marketing plan will decide. If you have any doubt about the goal, straighten that out first.

It is extremely important to note that if you currently have no goal, you need to set one. This is the end toward which all your effort is directed. The route to the goal must be dictated by the product or service provided. Determine who needs or wants the product or service that is to be provided. Finally, determine how to “build a better mousetrap” by becoming the best in your service area.

It is important not to shortchange any step of this process. If you do, it may take longer to complete the project as you find that incomplete research simply will not suffice. You must have the tenacity to perform a documented and regimented routine to have a marketing plan that works — and that plan takes a considerable amount of work. The following steps must be taken in the development of a plan. This is not a roadmap for developing a sales and marketing plan, but a brief outline of the process.

Review and Assess

  • First, analyze the company (an objective look at the strengths, weaknesses, opportunities and threats facing the company). Review how well you actually do what you are in business to do. Analyze what you have been doing to market your products or services.
  • Review the major functions within the company and those companies that provide services to you.
  • Review the sales process, sales trends, delivery of your products or services and pricing. Look at the results for your company and how you stack up against your competition.
  • Assess the company’s market reputation.
  • Within the business and target market, make sure that the positive and negative opportunities are reviewed and assessed.

With the help of your sales staff, determine where you are targeting your sales effort. What are the markets and objectives and who are the decision makers?

Plan the strategies that position your brand to effectively dominate the market. Every company has a brand or brand name whether they know it or not. Can you accurately and precisely define your brand?

Set the target for an effective communication policy.

Establish or review and validate or change the following:

  • The product or service name;
  • The product packaging;
  • The product or service pricing;
  • The method of distribution;
  • The method of selling;
  • Promotion and event policy and planning;
  • Advertising themes and possible media to be used including Internet;
  • Merchandising methods and policies; and
  • The handling of public relations for positive and negative events.

Establish an advertising/marketing/sales budget, methods to analyze its effectiveness and the timetable for it.

Put the plan into effect.

Evaluate the plan and provide systems to monitor and, if necessary, to alter the plan.

Business is a continuous series of processes. It doesn’t matter if the process is marketing your brand or making factory production flow as efficient as possible or controlling accounts receivable. All must be managed and be part of a planned business. Having a plan and properly executing it can be the difference between success and failure.

Developing a business plan takes time, considerable thought and decisive action. Once again, it can spell the difference between success and failure. This is not a one-day exercise—it is your company.

The Fremont Business Operating System

Attendees at a “Minding My Own Business” Workshop have been exposed to the Fremont Business Operating System.  This system is the baseline for all management consulting performed by affiliates of The Fremont Group.  It starts with a clear identification of your goals—and the goals of your spouse.  What is it that you really want from your business.  Once the reason for your business to exist is identified, a financial model of your business must be created.  What results are required in order for you to obtain your goals?  Many small business owners operate like the football coach with a game plan that reads, “if everything goes right we will only lose by a touchdown!”  That coach won’t keep his job for long and the business owner who doesn’t have a game plan designed to win the game won’t survive long either.  From the development of the financial model it can be identified (1) if the goals are obtainable; and (2) the results that must be accomplished in order to obtain the goals.  This model then becomes the cornerstone of the company.  It is the basis for organizational structure—what results are required from each position, the communication and evaluation of those results, accountability, and incentives.  It creates the profit plan and the sales plan.  It is the basis for pricing—the use of break even pricing and the establishment of pricing models.  The financial model is a road map that you modify as you make wrong turns—after all, man plans and God laughs.

Put together, FBOS is your strategic plan.  Owners who operate without it can be successful—particularly if they are lucky—but those who operate with it and diminishing their reliance upon luck.

Note–Fremont Business Operating System, FBOS and Minding My Own Business are registered trademarks of The Fremont Group

Accounting 101 For Business Owners

This document is a basic primer for business owners with no accounting background (or particular aptitude!) Have your own Income Statement and Balance Sheet in front of you while you read this. Pick out the different parts on your statement as they are presented.[1]

Your financial statements

A company keeps two basic financial statements—an Income Statement (also known as a Profit & Loss Statement or P&L) and a Balance Sheet. These should be produced internally for your review at least monthly. To understand the difference between the Income Statement and a Balance Sheet look at a photograph on your wall. What do you see when you look at that picture? You see the “things” that were in front of the camera lens at the moment that the picture was taken. Imagine that instead of a camera the photographer had had a video recorder. What would you see then? You would see the “activity” that took place during the period of time that the camera was on. Your Balance Sheet is the photograph; your Income Statement is the video.

Balance Sheet

The Balance Sheet is a summary of the things that your company owns (things including debt) at a particular moment. It can change the next moment if you sell something that you own or bring in more “something.” The Balance Sheet has 3 parts: Assets; Liabilities; and Shareholder’s Equity. Assets are anything that you own. Liabilities are anything you owe. Shareholder’s Equity is a subtraction problem. Imagine that you have a house worth $250,000 and a mortgage of $200,000. What would be your equity? $50,000. You obtain this by subtracting the value of what you have from what you owe on it. This is how your Shareholder’s Equity is obtained. It is as “real” as the equity in your house. The report is called a Balance Sheet because it has to “balance.” In other words, the Assets minus the Liabilities equal the Shareholder’s Equity. Conversely, Shareholder’s Equity plus Liabilities equal Assets. It “balances.”

Your Assets and your Liabilities are sub-divided into two parts—Current and Long Term (or Fixed). An Asset is anything that you own. A Current Asset is an Asset that in the normal course of business would be converted into cash in the next six months.[2] Current Assets will include: Cash (obviously cash is already “converted” to cash); Accounts Receivable[3] (you will collect your AR from your customers in the next six months); Inventory (you will convert it into product which will sell); and you might have one or two other categories. The total of your Current Assets indicates how much cash your company will have to use in the short term.

 

A Fixed Asset or Long-Term Asset are those things that you own that in the normal course of business would not be converted into cash—desks, chairs, computers, trucks, equipment, etc. Most of these Assets are not sold, rather they wear out and therefore each year your accountant lowers their value. This is depreciation.[4]

A Liability is anything that you owe. A Current Liability is a debt that you have to pay in the next six months. A Long-Term Liability is a debt that you don’t have to pay in the next six months.

Who Cares?

You should care because the Shareholder’s Equity is akin to the equity in your house. It is the “book value” of your company. One of your objectives should be to increase the Shareholder’s Equity of your company. Other than yourself (and shareholders) there are three other people who care—buyers, bankers and bonders (the three B’s). Potential buyers care because your Balance Sheet details the things that they are buying. Bankers care because it gives an indication of whether or not you can repay a loan (see Current Ratio). Bonders care because they need to make sure that you are solvent enough to complete a bad project.

Current Ratio

If you take only one thing away from this discussion of your Balance Sheet, learn to understand your Current Ratio. Review our definitions above. One category indicates how much money your company has scheduled to come in during the short-term. Another category indicates how much money your company has going out in the short-term. The Current Assets show the money coming in[5] and Current Liabilities shows the money going out. To calculate your Current Ratio, divide your Current Assets by your Current Liabilities. Obviously we want to have more money coming in than going out (and so does a bank before they lend you money!) Therefore if you divide your CA by your CL you want the quotient (answer) to be greater than 1.0. If it is a decimal below 1.0 then you have more money going out than coming in—this is one of the tests of insolvency. In most companies a Current Ration of 1.5 to 2.5 is best but it varies so be sure to discuss this with your consultant. Although your bank will not tell you this, your Current Ratio can also be too high. As a business owner you would prefer to have a lot of Fixed Assets as these are the things that make you money. Equipment, trucks, computers, etc are tools that drive the business. You really don’t make money off of Current Assets—cash, receivables, inventory, etc. However banks want to see a lot of Current Assets (very high Current Ratio) to assure them that their loan payment will be made.

Income Statement

Most people pay more attention to their Income Statement because at the bottom it shows your profit or loss. We all know that we want profit so we look there first. As the Balance Sheet is divided into three parts, the Income Statement is divided into four[6] parts: Sales (or Revenues, or Income); Cost of Goods Sold (or Direct Costs); Overhead (formerly General & Administrative Costs); and Profit (or Loss).

Most small businesses keep their books internally. They make entries with each transaction and classify them according to the type of expense or income. Their program then automatically generates the Income Statement and Balance Sheet reports. Unfortunately GIGO applies—garbage in; garbage out. The reports are good enough for your accountant to take the data and do your taxes but generally not good enough for managerial purposes.[7] After we explain your Income Statement, you will understand some of the managerial purposes that it can serve if it is properly structured. As the transactions are entered they are placed on the reports according to your Chart of Accounts. Your Chart of Accounts determines which of the sections of your Income Statement or Balance Sheet the transaction is found. If you Chart of Accounts is inaccurate, your financial statements will not help you run the business.

Your Income Statement is not developed by the computer—it is built through your actions. This is a critical concept. Every time that you make a sale or pay bills, your are “building” your Income Statement.

REVENUES = the total amount of all of the invoices that you give to customers.[8]

COST OF GOODS SOLD = the direct cost of providing the good or service—the things that you bill the customer for. Included are the Labor, Materials and other costs that you would not have if you did not do the job (or make the sale). In a sense Direct Labor is a good thing—you have paid someone to produce your product which you sold to make money.

MARK UP = is the amount that you have charged your customer in excess of what it cost you to produce it. This amount is then applied to Overhead and Profit.

To summarize, every job (or sale) you make pays the cost of producing the product or service (COGS), allocates some of the mark up to overhead and some of the mark up to profit.

Your Chart of Accounts must put each transaction in the proper section. Labor for example must be divided between COGS and Overhead. A company without an accurate Chart of Accounts cannot properly price their product.[9]

As I have shown, your Income Statement is “built” through your transactions. It is produced in the following format:

REVENUE

– COGS

GROSS PROFIT (subtract COGS from Revenue)

– OVERHEAD

NET PROFIT

Your Overhead is your fixed costs. These are expenses that you will have even if you don’t make a sale. (The expenses that you have because of the sale are COGS.) Your GOGS is a percentage of the Revenue. Your Overhead is fixed. Gross Profit is the amount of each dollar that comes in that you are able to spend on Overhead and Net Profit. For example if you sell a product for a dollar that costs you 50 cents, you have a gross profit of 50 cents or 50%. You now have that 50 cents to apply to Overhead and Net Profit. Since your Overhead is a fixed amount, your break even is the number of 50 cents you have to bring in to pay that fixed overhead. If your overhead is $100 it takes $200 of sales to break even.[10] Therefore your break even is your fixed Overhead divided by your Gross Profit percentage. Knowing your break even is not optional—how else can you develop a rational sales and marketing plan? And without accurate numbers how can you determine your pricing structure?

Budget and Cash Flow

Your Income Statement is used to develop your Budget. Your Budget tells you what you can afford; your Cash Flow Forecast tells you when you can afford it. The Budget is critical in pricing and in developing excess-profit based incentives for your employees. Your Cash Flow Forecasting is how you run your business. You need to have developed a six-week cash forecast that shows your expected cash balances at the end of each of the next six weeks. There are virtually no generic software programs which adequately budget or project cash flow.

 

Profit Plan

 

There are four “expenses” that have to be paid out of Net Profit. Therefore each company has a certain minimum, mandatory percentage of profit that they require in order to remain viable. The net profit must be enough to pay: (1) your debt service; (2) new asset purchases; (3) the amount of cash you plan to retain; and (4) your taxes. The funding of your Profit Plan for these four items is for break even purposes just another expense.

 

Summary

In order to have financial control of your company you must have an accurate Income Statement, Balance Sheet, Budget and Cash Flow Forecast. These are tools required for Pricing, Sales and Marketing Plan, Employee Accountability and Incentives, Cash Management, and other managerial uses.


[1]You may notice that in some cases your statements may not match the presentation. These are adjustments that should be made in your chart of accounts. Until these adjustments are made, much of the analysis of your financial statements is impossible.

[2] Much of this document is an over-simplification. It is accurate enough for our purposes.

[3] This assumes that you are keeping your books on an accrual basis and not on a cash basis. Your internal books should be kept on an accrual basis as this more accurately shows your true financial position. You can keep your internal books on an accrual basis for your management and allow your accountant to file your taxes on a cash basis which is often more advantageous. The difference is when you post income and when you post expenses. On a cash basis you post income only after you have the cash and post expenses only when you pay them. On a cash basis you would not have AR or AP. In an accrual basis you post income when you have earned it and expenses when you incur the obligation. This creates AR and AP.

[4] Note that the government allows you to “expense” your depreciation. This means that you are able to reduce your income by the amount that your assets reduce in value. (In reality there are tax schedules that dictate how fast your Fixed Assets “wear out” or in other words how much of a deduction you are allowed to claim for tax purposes.) This creates a “book value” for your asset which is often different from the “market value” and is almost always different from the value of the asset to your operations. For example, a truck might depreciate over 5 years. This would allow you to deduct one-fifth of the value of the truck each year from your Income Statement for tax purposes. On your Balance Sheet the value of the Fixed Asset would reduce by one-fifth each year until it reached zero after five years. Obviously the truck would still have “market value” (you could sell the truck for something) and obviously the truck would have value to your operations, but for tax and Balance Sheet issues, it would no longer have any value.

[5] This ignores your operations and just gives you the current status.

[6] In some instances it is appropriate to add a fifth part to segregate selling costs.

[7] The best analysis of this is found in “Minding My Own Business” by Dirk Dieters available on The Fremont Group web site from the publisher (best price) or on Amazon.com. The relevant section discusses “managerial accounting.”

[8] This of course is on an accrual basis.

[9] Every company has a “product.” In a typical service business that “product” is a unit of time. The charge for that unit of time determines the price.

[10] Now you should be able to see why you must have a proper chart of accounts. Without it you cannot properly compute your break even—nor do some of the other critical management calculations.

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