The Five Equations
Every Business Owner
Must Know
Don’t let the title fool you. Here is a very non-mathematical and easy- to-read article which has five key insights on how to make your business win in the real world.
GEORGE WILSON ADAMS CPA MBA
December 17, 2021
What You Don’t Know Can Put You Out of Business
Introduction
The truth is that you don’t need to be a math expert to read this article, where I present important business insights in the form of simple, easily understood verbal equations.
You can be sure the title was deliberately chosen to filter out people who only read the title, while rewarding those who don’t shun effort and don’t shy away from a challenge. I admire those of you who made it this far and encourage you to continue. How information is presented is just as important as the information itself: clarity is crucial; confusion is costly.
If you have a business always remember that Reality (not a teacher, employer or me) will be administering an IQ test to you tomorrow. And the day after tomorrow. And next week, next month, and next year.
By necessity we are all students of adversity. We all attend the School of Hard Knocks. Perhaps you or your business got punched hard today. Learn whatever lesson this punch delivers to you. The next time Reality gives you a test (or a punch) get an A not an F. Duck the punch, and punch back hard.
Will you pass the IQ tests Reality imposes on you? For many of us our safety net in case we fail is an asphalt parking lot (or the equivalent.) For most business owners failure is unacceptable. You probably can’t afford to fail. I can’t.
Ideally, every business would be the product of a perfect design completed prior to the first day of operations. Design is one of the most important things in the entire world. If you want to build a strong bridge you must first design one.
After you complete your first design of the bridge go ahead and critique it. Look for all the pathways that could lead to failure. Maybe the rivets aren’t strong enough. Maybe the structure of the bridge isn’t perfect. Maybe the angle of the arch is suboptimal. Maybe the load-bearing ratio of the trusses is inadequate to the weight of the bridge.
Find these pathways to failure and delete them. A continuous process of design and critique will lead to the best bridge. Iterate and re-iterate your design, continuously purging it of error, weakness and inadequacy: Your bridge will get stronger and stronger before it is ever built. This is the triumph of good design.
Every business is a potential bridge to success. Few people have a business for other reasons because few people want failure. Here then are a handful of five key insights presented in the form of simple verbal equations to help you build a stronger bridge to your success. Use these insights to find the pathways that lead to failure, so you can avoid them.
And remember that if you want to succeed in the real world (where most of us live most of the time) you must be prepared to get your hands dirty. Sweat and honest dirt are the badges of honor worn by the industrious. Wear them with pride.
The First Equation:
2 + 2 = 1
Plowing profits back into your business can be a losing proposition.
Here’s why:
Consider a simple business that has no debt of any kind other than accounts payable. The owner used his personal credit cards to finance the startup costs of his new business. These credit cards have very high interest rates of 20% or more.
The owner is determined to grow his business and takes every last dollar of profit and gives it back to his company. He feels this is the right thing to do. But his company doesn’t need any new major equipment or investment at this time and so the extra cash is used to pay down accounts payable. Meanwhile the owner continues to make minimum monthly payments on his personal credit cards.
What’s wrong with this approach?
The owner of this business is making a terrible mistake. He has blinded himself to his own personal costs while obsessing over his business. Small business owners who finance their own business must consider themselves as a single indivisible economic unit. It is folly to do otherwise.
The owner of this business should rank-order all his debts (business and personal) by their AFTER-TAX interest cost stated as a percentage. After-tax cost must be used because the interest expense on some debt is tax-deductible while other types of interest are not tax-deductible.
The owner should payoff the most expensive debt that is at the very top of this rank-ordered list, whatever and wherever it is. Once that debt is paid in full then he should then payoff the debt that is second most expensive on the list, and continue with this approach SYSTEMATICALLY.
The owner must also consider risk and factor it into which debts to payoff. For example, a commercial short-term line of credit may have a lower after-tax interest cost than other short-term debt like credit cards. But most lines of credit must be paid in full for at least 30 days per year. If the line of credit is not paid off timely the owner risks losing access to this important lower-cost financing tool. For this reason lines of credit should receive a higher priority for payoff even though their after-tax cost may be less than other debts.
Accounts payable seldom bear an interest rate. Few vendors charge interest on commercial accounts payable outstanding 30 days or less. The owner is hurting himself, and his business, by paying off accounts payable sooner than the stated due dates specified by vendors. He is deploying scarce cash ineffectively. Maybe some vendors will send him a thank you card for paying his bill after only 15 days instead of 30. Maybe he is building goodwill with vendors that will useful later on. Maybe not.
* * *
Once upon a time there was a very successful company called Apple Computer Corporation. Apple sold very popular and very profitable products and made enormous profits. These vast profits accumulated into a vast hoard of cash. Apple didn’t know what to do with all this cash, and so it held onto it.
Apple lived in a time of significant uncertainty and risk. It didn’t know what would happen to the economy in five years. It didn’t know what the tax system would be like in five years. And it didn’t know what its present customers would think of it and its products in five years, because the genius who founded the company and led it to success passed away at an awkward and very inconvenient time.
Apple had no clear vision or plan of what to do with $200 billion in cash. So it sat on the money, and did nothing.
Then one day an angry group of Apple shareholders confronted company management, and demanded that Apple pay out its vast cash hoard as a dividend. These shareholders knew what to do with money. Many of them had clear plans and actionable visions of how to spend it. They needed the money. Apple didn’t.
It is impossible at present to say that Apple and its shareholders lived happily ever after. We must await future developments.
For more on this real-world story (yes, it’s a true story) see:
http://money.cnn.com/2015/07/22/investing/apple-stock-cash-earnings/
| RULE 1: DEPLOY CASH WHERE THE AFTER-TAX, RISK-ADJUSTED RATE OF RETURN IS GREATEST. |
The Second Equation:
Business + Family = 0
It’s great for families to work together, unless it doesn’t work.
Nepotism costs money if your in-laws are out-laws.
A large percentage of Maine’s small businesses are family owned and operated.
On the subject of family business, I speak from experience since my wife and I have worked together successfully for many years. Family members can be great workers for a business. They may try harder, care more, and work for less than outsiders. But this is not always the case.
Some family members may treat their employment in a family-owned business as a sinecure where they know they can never be fired and can get away with working less while getting more. This is simply a fact of human nature. The issues that arise within a family business can be complex and require good judgment and moral sensitivity to evaluate.
Businesses succeed in the long run because they use reason and good thinking to maximize profits and opportunities and minimize costs and risks.
A large family business with big profits may be able to afford a few family members who would be fired if they were not family. Smaller businesses with smaller profits will have a smaller margin of error.
An under-performing family member who works in a struggling business may be better off in the long run if he is replaced with a talented and highly motivated outsider. The business may become successful and be able to afford to re-hire the family member later on. Alternatively, other family members of the business can use their share of greater profits to make gifts to this individual.
In the long run you may not be doing anyone any favors by paying an under-performing family member. Doing so deprives your family business of the services of a competent outsider who could make the difference between success and failure. Nepotism may alienate employees who are not family members: they may question whether their own work is being evaluated and rewarded fairly.
Businesses should never treat gifts as wages because wages are supposed to be fair payment for a fair day’s work. And workers should never treat wages as gifts because they are supposed to earn this money. The clear separation of wages from gifts is based on a clear separation of reason from emotion.
Wages are largely determined by the logic of marketplace competition which affects most businesses. Gifts are largely determined by emotion and close family connections. It is dangerous to mix these two together.
Reason helps business succeed in the long run. How much emotion can your business afford? The specific answer to this question determines the amount of gifts the business can pay to under-performing family workers.
In the final analysis businesses succeed primarily because of what their workers know and not who they know.
| RULE 2: DEPLOY OPPORTUNITY WHERE THE OBJECTIVE ECONOMIC RETURN IS GREATEST. |
The Third Equation:
You SQUARED = 0
Trying to double your efforts? You’ll just go in circles if you push yourself too hard. Winning at business is a marathon not a sprint.
I’ve seen many of my clients push themselves harder and harder in a drive to succeed. But sometimes the best approach is to work smarter, not harder. Working more hours per day may only result in a linear addition to success.
Worker smarter, more efficiently and more effectively may result in an exponential addition to success. This is because better thinking applies to ALL future hours worked, not just the additional effort you are trying to squeeze from yourself. In a future work cycle efficiency-maximizing insights can be used to work smarter, leading to a process of continual improvement (until diminishing returns set in.)
Every business owner faces fundamental physical constraints on how much work he or she can do. There are 168 hours in a week and 8,760 hours in a year. But you will drop dead or seriously injure yourself if you try to work yourself past your breaking point. Even elite special military force personnel have breaking points which are carefully monitored by trainers.
Work is performed in an optimal way when both effectiveness and efficiency are maximized. Business owners should get the most valuable work done, at the least cost, without killing themselves.
Effectiveness in business is the degree to which key goals are achieved.
Efficiency is a crucial measure of productivity because it compares actual results to ideal results.
For many tasks (but not all) the last hour of work is the least effective and the most efficient. This is because the worker may be physically exhausted by the time he reaches the end of a busy workday. But the accumulated experience of working on a single task all day will give the worker insights into how he works such that whatever is done during the last hour of work can be the most efficient.
The breaking point for the body will differ from the breaking point for the mind. But the two are closely related. Good planning will avoid all breaking points and the dangers they pose to health.
One of the most important tasks of all is to study how you as a business owner- manager perform a given task, whether it is managing employees, the finances of the business, strategic planning, or controlling costs. Task monitoring is a Meta- Task: a master tool to manage other tools. As a business owner you too are an employee of your business and you must evaluate yourself continuously.
It is essential that all business owners review their work and intentionally seek out ways to improve their own effectiveness and efficiency while protecting their health. In this sense, you, the owner and manager of your own business, must be your own worst critic. Of course, you can’t fire yourself for poor performance. But you CAN replace your thinking and try new and better approaches.
One final point on this subject: One of the greatest assets of your business, whatever it is, is YOU. Your health is an asset the same as any other. Protect it.
| RULE 3: BUSINESS OWNERS SHOULD DEPLOY THEIR OWN WORK TO MAXIMIZE EFFECTIVENESS, EFFICIENCY AND THEIR OWN HEALTH. |
The Fourth Equation:
Pretty Good ≠ Good Enough
Most small businesses are run by seat-of-the pants intuition, which is pretty good most of the time. But what happens when pretty good isn’t good enough?
Most small businesses are run by seat-of-the-pants intuition. Shrewd, competent business owners get by with this approach. But running a business this way is very similar to playing chess while thinking only one move ahead: it works until it doesn’t work at all.
Small businesses compete with other businesses regardless of what industry they are in. You may believe you’re OK while your nearest competitor is pushing forward with better thinking and better planning. Your competitor’s success could mean your failure.
Better thinking for your business starts with the assets you already have, which may be invisible to you. You may be using QuickBooks software (or something similar) to handle the accounting, billing, and customer management for your business. These software programs typically accumulate a treasure-trove of data that can be used to help you run your business better.
But raw data seldom helps anyone. It must be transformed through work, analysis and experience into something far more useful: Knowledge.
Business knowledge is a collection of actionable insights that help you run your business better. If you have a retail business answer these questions: What were your top ten selling products last month? What were the ten worst selling products? Do you have dust on your inventory? Dust on inventory costs money and is an expensive mistake.
Who are your three closest competitors and what are they up to? Do you know their names and locations? What is their business strategy compared to your own? Are they succeeding? Why? Are they failing? Why?
Wal-Mart, the best retailer in the world, has made a science out of their business and has superb logistical and pattern-recognition systems which promote and sustain their success. Wal-Mart DOESN’T use seat-of-the-pants type thinking to run their business. Nor should you.
The world is getting smarter, tougher and more competitive. Seat-of-the-pants thinking is becoming increasingly obsolete. There is no advantage whatsoever to being a dinosaur.
Maybe your business is doing extremely well. Congratulations! The blunt truth is that you should fear success almost as much as failure. Success promotes complacency and contentment with the status quo. Complacency is a toxic and highly addictive drug. Avoid it by remaining focused on identifying risks and opportunities for your business regardless of how well or poorly circumstances are for you today.
Winter is coming. Mainers know this in their bones. Your season of success is bound to be followed by new challenges and problems. Prepare for them now.
Seat-of-the-pants type thinking is, really, ad hoc situational thinking where business owners feel pressured to make a quick decision now so they can move on to the next task. This is almost always a mistake. You may be digging your own grave with this approach. The quick decision you made last week may come back to haunt you tomorrow.
The best approach is to impose a strategic pause: stop and think BEFORE you make a major decision. Add one time unit to the time you spend making a decision. The time unit you add will vary depending on the importance and consequences of the decision you are dealing with: it might be one extra hour, one extra day or one extra week spent considering the decision.
Give yourself extra time to digest and consider the problem. Make yourself the calm at the center of the storm. Extra time now may buy you immunity from regret later. Use the extra time you seize wisely and effectively. Foresee the consequences of your intended decisions BEFORE you act.
| RULE 4: REPLACE AD HOC SITUATIONAL DECISION- MAKING WITH SYSTEMATIC DECISION-MAKING. IMPOSE A STRATEGIC PAUSE: STOP AND THINK BEFORE YOU ACT. |
The Fifth Equation:
A Great Chef ≠ A Great Business Manager
Every small business owner must accomplish two tasks
simultaneously: Do the work well and run the business well.
Once upon a time there was a great chef who worked as an employee for a mediocre company. His employer didn’t think much of him, and used and abused him senselessly. But the customers and fellow employees of this great chef loved him and his great cooking. He acquired a loyal and devoted following because he knew his work well and loved what he did.
Then one day this great chef decided to start his own restaurant. He believed in himself and his work. He was an expert at cooking and could make the finest cuisines, soups, stews, and desserts. He was convinced that success was inevitable.
But the day this great chef started his own business was the day he suddenly needed a completely different set of skills. He needed to know about accounting. He needed to know about taxes, financial management, how to borrow money from a bank, meeting payroll, negotiating contracts with vendors, hiring good employees, and planning the master strategy of his business. In short, he needed a new set of skills that had absolutely NOTHING to do with being a great chef.
As a CPA I have personally seen businesses fail merely because they had lousy bookkeeping. These failed businesses lost track of accounts receivable and didn’t know which customers owed them and how much. Contempt for paperwork created catastrophe. They were buried alive by the paperwork they hated so much.
They would throw out insurance refund checks along with other crucial unopened mail because the owners of these failed businesses “hated paperwork.” As an accountant and MBA I can tell you for a fact these are infamous last words that are only good as an epithet.
Those who hate paperwork are condemned to be punished by it.
The great chef, with an expert level of knowledge of cooking, who wants to open his own restaurant, needs to be a good manager of his own new business. He must manage the paperwork of his new business, or hire competent people to do it for him.
This is a fact which confronts every new business owner. You have to master TWO independent, unrelated skills: (1) Know how to do the underlying work of your business, whatever it is; AND (2) Know how to run your business effectively and efficiently. BOTH skills are essential.
As a CPA and MBA I’ve seen individuals who excel at the underlying work of their business but who don’t have clue how to run a business. And I’ve seen great business managers with a keen sense of how to run a business who don’t understand the intricacies of their particular business, whatever it is.
| RULE 5: ACQUIRE OR HIRE THE MANAGEMENT SKILLS NEEDED TO RUN YOUR BUSINESS EFFECTIVELY AND EFFICIENTLY. |
Conclusion
You will soon be tested on your knowledge of these equations and the related Rules which give you the optimum solution. But it won’t be me giving you the test. Reality will test you. You’ll wish it was me because I’m an easy-going, reasonable guy. Reality, on the other hand, is tough, ruthless, and unforgiving. But I think you know this.
Chances are you, the reader of this article, are a business owner. (I hope so). While your business is a bridge to success always remember that you, the owner, are also a bridge to a better future.
Five years from now some version of you is studying, criticizing and remembering everything you are doing today. Will your future self judge you harshly and say you failed? Or will he or she be proud of your efforts and say you did your best? Never let down your own future. The future is the place where you are going to live and, hopefully, succeed. Reality will test you today, but it is the future that will ultimately pass judgment on your performance.
You don’t need faith to believe in the future. All you need is a clock. Find one, and stare for a while at the moving hands that count out the seconds, minutes, and hours. You can see time passing. You can physically see your own future arriving on schedule. This is a fact you can count on as your future self is counting on you.
Stand there and stare at the clock until you believe in your own future. Stand there all day if you must. Neglect your other duties if necessary because this is a crucial lesson. Learn it. Master this truth. Prepare to face your own future. Be ready for it:
Chance favors the prepared mind.
Louis Pasteur
The future will exist. You are rushing into it like a freight train with irresistible force and unstoppable power. All you can do now is try to alter the path that leads to your future. Those who refuse to believe in the future won’t have one . Will your future be better than now or worse?
The answer is up to you. Your future is watching, and waiting. Carpe Diem!
Photo Acknowledgements and Credits: © Can Stock Photo Inc. / PicsFive / Composition & Modifications by Shawn Hill | VASTmicro
George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339
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