Every business owner wants to maximize profitability and cash flow. But, many owners don’t know where to start or what to do. Confusion sets in. Which levers do we pull to improve profitability and cash flow? The uncertainty leaves many confused, frustrated, and sometimes paralyzed. It shouldn’t be so hard to manage a business.
Many businesses start with the owner being the sole source of labor. We are familiar with the firm’s value proposition and are intimately involved in sales/marketing, operations, and finance. We call this the high performance/cheap labor model. However, there comes a time when the firm outgrows this model, and they start adding labor. When they add labor, they go from a cheap labor model to a normal labor model. If sales don’t shift to accommodate the fixed cost of additional labor, profitability and cash flow may suffer.
I have a client who’s been in business for 20 years and has been quite successful. Recently, this CEO added a VP of Operations and VP of Sales last year at a total cost of $300,000. This firm makes about a 20% gross profit margin. This change in their operating model has allowed the CEO to delegate management of these two areas to her direct reports. However, she also needs to increase her revenue by $1.5 million to cover the fixed cost. She made a conscious decision to grow. However, growth always requires cash, and this firm must adjust to increased overhead of $25,000 per month.
I have another client who has been in business for about the same amount of time. They made a similar investment of 3 VP level positions three years ago and this firm has figured out how to scale their value proposition. They have grown at an average of 30% per year in revenue for the past two years and have gained 4% on their gross profit margin.
In the first example, this firm has been operating with a high performance/cheap labor model and is in the process of converting those increased fixed costs to increased profits. But time will tell if the people investment has paid off. In the second example, this firm has clearly navigated out and is working in the high performance/normal labor model. They are experiencing increased revenue and profits.
Many businesses outgrow their model and will experience these types of growing pains as the company grows. One key to remember is that language of business is accounting, and every owner should watch their financial reports to see how they’re performing. Looking at these reports will help you monitor those growing pains and take you from financial confusion to financial clarity.