Do you count the cost of complexity?
WITH a team of employees and a dynamic and competitive market, you will find that your business tries new initiatives and launches new products regularly.
If a product sells reasonably well, or a cost-cutting initiative appears to reduce the bills, it usually remains as part of the way the business operates. However, over time this can lead to a ‘process bloat’ – i.e., so much complexity in the way your business operates that you need additional overhead.
Each year, you should team up with a management accountant and review the true profitability of non-core initiatives such as these. A new product line might appear to generate a gross profit, but when the full cost of re-fitting a production line, creating new marketing and dealing with a new set of customer queries is factored in, it isn’t worth the expense.
The focus should be on a fully costed bottom line benefit rather than a straightforward ‘revenue minus direct costs’ approach, to give fresh visibility over the knock-on impacts the complexity causes. As a result of the review, a restaurateur might discover that expanding their menu has increased the amount of food waste per dish, the length of time it takes to train a new chef and has reduced the speed of food delivery. A holistic review should seek to identify both the financial and non-financial impacts of complexity.
Many businesses find that they can secure long-term growth in their profitability by focusing on running a lean core operation rather than adding many bolt-on extras to their core product or service.
Is the financial engineering of your business sound?
Financial engineering is a fancy term which refers to the way your business is owned and financed. In short, financial engineering takes place when a wealth adviser proposes a new (and usually more complex) way to finance your company, to achieve lower costs of capital or lower taxes.
The most common form of financial engineering in the UK is to take on some affordable debt. Affordable in this case could be measured as the amount of debt that would still result in a low interest to profit ratio, in other words, debt that can be easily managed and would not result in significant bankruptcy risk.
The advantage of debt is that UK corporation tax is only levied on business profits after loan interest is deducted. This means that returns to debt holders are corporation tax-free, and amount to a subsidy for debt finance.
If one source of finance is subsidised in this fashion, it makes sense to include it in your financing mix, allowing you to release equity finance (e.g., by dividend) which you could invest elsewhere for additional returns.
Some business owners would never take on additional debt for the sake of financial engineering, out of principle, but more savvy businesses see the value in reducing their weighted-average cost of capital in this fashion. Professional investment management advice from a wealth manager is essential before re-financing your business.
Are you reinvesting cash surpluses or withdrawing from the business?
When a new business finally reaches the milestone of generating positive cash flows, it can be tempting to withdraw the profits and finally take an income from the business. This will feel like a sweet reward after the initial phase of unpaid effort has ended. However, this removes the vital fuel that fast-growing businesses need – cash.
The question you should be asking yourself is, do I want small sums now or large sums later? This is the real choice at hand, as each additional pound you invest to grow your business should increase the scale of the business. You’re not so much sacrificing the income, as deferring it in the hope it will be repaid many times over in the future.
If you withdraw all earnings, you will be constrained to the current organic growth rate of sales. With additional spending on advertising, marketing, or even useful bolt-on acquisitions, you could expand at a much faster rate.
Having surplus cash is a nice problem to have, but it’s also an uncommon one because the reality is that businesses quickly find an effective way to use the cash to produce positive returns.