Building Systems or Fighting Fires
Unpacking the three leading causes for financial fires to break out
Every business owner has found themselves fighting a financial fire in their business or personal life at some point, and sometimes both at once. You are not alone. We have all been there. It doesn't mean you failed to anticipate it; it means there was a system failure somewhere within the business model. The good news is there are ways to build systems and automate most of the implementation so you can focus on growing your business. It's less stress and way more enjoyable.
Here are the three leading causes for financial fires to break out:
- Failing to prepare financially for changes in cost structure during growth
- Integration of liquidity and available credit
- Failing to properly estimate and reserve for taxes
Let's dive deeper into each of these:
CHANGES IN COST STRUCTURE DURING GROWTH
This first area can be increasingly complex as growth ramps up. For most businesses, expense growth typically looks like a punctuated equilibrium where your costs go up incrementally to inflation in wages or goods or vendor costs but mostly stays the same from month to month.
What inevitably happens is we hit a friction point where it becomes necessary to add a large expense all at once. May you're hiring a key staff member, building a second production line or adding a branch office. These events punctuate the equilibrium cost structure and force us to adapt quickly.
So, how do we attack this problem before a fire breaks out?
Your best route is to create variable cost models which allows you to come up with a general forecast for your total additional cost paired with an estimate of when the new cost may occur. This requires building multiple variants for your business financial models. For instance, you think you will need to add a second production line for your widget factory when the sales volume is somewhere between 200 percent and 300 percent fo what it is today. Your sales growth figures show you may hit that range within the next year or two, but you're not sure. You're also not sure what the labor costs for construction will be at that point and labor accounts for, let's say 35 percent of the costs. There are a lot of unknowns here. The best way to plan for this punctuation in your equilibrium is to show a range of costs occurring both next year and the following, and what that will do to your cash flow and needs for reserves or credit. It makes the planning process much more complicated, but by running your estimates in multiple ways, you mentally prepare for when it does occur.
INTEGRATION OF LIQUIDITY + CREDIT AVAILABILITY
Back to our example of adding a production line … Let's imagine the total cost is estimated at $400,000 to $600,000, and you think you will need that capital next year or the year after. Where does it come from? If you are fortunate enough, it comes from working capital accounts or purpose specific accounts to fund growth. But for most of us, we rely on either liquidity outside the business or credit to help meet our needs. Banking relationships can be a great tool as their willingness to provide access to lines of credit and secured lending is a major source for needed funds. You can also issue new debt or sell equity to investors in your circle. Ideally, you'll want to separate your personal balance sheet from that of the business and rely entirely on the business's ability to raise capital through equity or debt. But, in a pinch, you can always loan to the business personally if you need. Whichever combination of sources you use, be sure you have a game plan accessing the funds so you can meet the need when it comes.
FAILING TO PROPERLY ESTIMATE + RESERVE FOR TAXES
If this isn't one of the top three pain points business owners experience, then I can't imagine what would come out ahead. It's also one of the simplest ones to address. Having a relationships with a CPA who understands you, your business and your industry (in that order) is fundamental. Maintaining good books and records internally and providing that to them on a regular basis allows you to have productive partnership and the ability to estimate your tax bill ahead of time. From there, it's a matter of creating purpose-specific financial accounts where you regularly, monthly or quarterly transfer funds to pre-fund your tax payments. Writing the check is never fun, but it's much better than scrambling to come up with the money lat minute, or worse still, paying penalties.
These are all the critical elements of business financial management, but once you build the systems to estimate, pre-plan and pre-fund, you can put most of your financial firefighting behind you.
THIS CONTENT IS INTENDED FOR GENERAL INFORMATIONAL PURPOSES AND DOES NOT CONSTITUTE A RECOMMENDATION OF ANY TYPE.
PLEASE SEEK ADVICE FROM YOUR TAX, LEGAL, AND FINANCIAL PROFESSIONAL PRIOR TO TAKING ACTION.
SECURITIES OFFERED THROUGH DESTINY CAPITAL SECURITIES CORPORATION, MEMBER FINRA/SIPC”
Jarrod Musick is the CEO and president of Destiny Capital where he leads a talented team committed to serving clients. Musick loves the challenge of helping clients navigate a rapidly changing financial landscape. When he isn't here, you can find him chasing his twins.