Most small business owners and entrepreneurs find themselves overwhelmed with duties ranging from janitor to Chief Executive Officer. With so many duties to perform, small business owners do not have the time to study reams of financial reports in order to effectively manage their business. What I have learned through the years is that I can manage a lot more efficiently and effectively if I manage by “rules of thumb”.
Wikipedia defines rule of thumb as “a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination.”
So why would it make sense to manage by a method that “is not intended to be strictly accurate or reliable for every situation”? Well, because it is easily learned, easy to remember and easy to apply. Having certain financial “rules of thumb” can help you identify problems in your business very quickly and show you where you need to focus your attention. Then, you can drill down into the financial reports to pin point where the problem lies and which issues need to be addressed.
One of the major benefits of using a really good accountant is the enormous amount of information they can give you. This is why I always tried to hire the very best. There was a time when, each month, my director of finance would hand me 150-200 pages of numbers in very neat rows and columns. At first, I spent a lot of time studying these numbers so I could manage better. However, I quickly realized that as good as she was, and what she was giving me, as valuable as it was, was totally overwhelming and there was information I needed that was missing. For example, how do these numbers compare to the budget and business plan we created prior to the first of the year?
So, we got together and created a two to three page “Key Factors Report” that took key numbers from the standard reports, converted them to ratios and “rules of thumb”, and then compared them to the budget, month-to-date and year-to-date. It took no time to review these reports. If something was out of line, I saw it immediately rather than having to dig through hundreds of pages to find it. Once an issue was identified, I could then drill down to that area of the report to understand why it was out of line. As a result, I was able to manage more effectively, respond to problems earlier, resolve issues quicker, and move on.
What inspired me to write this article was a website I recently stumbled upon; Rules of Thumb. It lists thousands of rules of thumb. Some are old and may not apply as well as some of the others. Nonetheless, I found them entertaining and would like to share a few with you:
- SELLING A BUSINESS
The sale price of a small business is between seven and ten times the average profit of the last three years.
- MAKING YOUR IDEAS CLEAR
A clear idea is one that fits on the back of a business card.
- GETTING WORK DONE
People do best when they’re working at 80 percent of their capacity. At 50 percent, they get bored. At 100 percent, stress gets them.
- CHOOSING A BIDDER
Throw out the highest and lowest bids. Average the rest and choose the one closest to the average.
- STARTING A NEW BUSINESS
Do not start a new business unless you can wait at least one year before realizing a profit.
- THE 80/20/30 RULE
If you get rid of the 20 percent of your customers who cause 80 percent of your headaches, your profit will increase by 30 percent.
A consultant should spend two-thirds of his or her time consulting with clients and one-third lining up new work and doing PR.
- KEEPING YOUR CUSTOMERS
Complainers are more likely than dissatisfied non-complainers to do business again with the company that upset them, even if the problem is not satisfactorily resolved.
- KEEPING YOUR CUSTOMERS
Between 54 percent and 70 percent of customers who complain to a company will do business again with the company if their complaint is resolved. That figure increases to 95 percent if the customer feels the complaint was resolved quickly.
- KEEPING YOUR CUSTOMERS
The average customer who has had a problem with a company tells nine or ten people about it.
- KEEPING YOUR CUSTOMERS
Customers who have complained to a company and who had their complaint satisfactorily resolved tell an average of five people about it.
- WORKING WITH A NEW CLIENT
A job with a new client will take about 25 percent longer than the same job with an established client.
- BALANCING THE BOOKS
When the books aren’t balancing, if the amount they are out of balance is divisible by 9 then there is a transposition error in your figures.
- STAFF MANAGEMENT
If you have to call a meeting to tell everyone that you have an open-door policy, you have already failed as a manager.
- GETTING PAID
When dealing with notorious non-payers, always charge twice as much as the job will actually cost, then get half the money up front.
Okay, you got me. These were not the rules of thumb that made such a big difference in how I managed my businesses. Still, I enjoyed reading them and wanted to share them with you because some of them are quite practical.
The rules of thumb that I am talking about are unique to your business and can only be determined by building a thorough budget/business plan. As I mentioned earlier, you need to think in terms of key factor ratios. Why ratios? Allow me to explain.
Let’s look at marketing expenses as an example. When you budgeted for this expense, the total was probably based upon some variables like commissions (which will be more or less, based upon what is actually sold), and some fixed costs like signage (which will be the same regardless of the actual amount of sales). If there is a substantial amount of fixed costs, marketing becomes more efficient as sales grow. Therefore, a good ratio or rule of thumb to monitor would be “marketing expense as a percentage of revenue.”
Assuming you have created a realistic budget that produces the desired results, how does your actual ratio compare to the budged ratio? If it is as expected or better, there is no need to spend a lot of time drilling down to each line item. If results are not as expected, or worse, then this is another story and you can drill down to the appropriate line items to figure out what went wrong. It’s not that important if you went over budget in marketing expenses if the ratio is as expected or better.
You will be surprised at the amount of great information you can put on just two to three pages if it is limited to key factors (totals) and various important ratios and rules of thumb that apply to your business. However, I have found one major problem in utilizing this system when I counsel with many small business owners. They don’t have a budget or business plan! Yikes! How in the world can you manage anything if you don’t even know where you want to go? I believe this is called “managing by the seat of your pants” which is not a method I would recommend to anyone.
Anyway, I hope you have found this article useful and somewhat entertaining. If you would like to contact me, you can do so by emailing me at firstname.lastname@example.org or visiting my LinkedIn page.
Posted by: Mike Clough