Strategy, especially strategy for business, has proven to be a lucrative market for those tasked with developing, writing about, and talking about strategy. Disruptive innovation, blue ocean strategy, fast follower innovation, and incremental innovation all represent terms and ideas that have champions, critics, books, and large audiences. These different ideas and tactics clearly do offer value to management teams across a wide variety of industries, but that is not the particular focus of our conversation. These ideas and concepts are mostly applicable for large corporations that have the resources, both financial and human, to dedicate to the development and implementation of multifaceted strategic initiatives. What ties these different strategic theories and concepts together, however, is the requirement that all strategic ideas are driven by quantitative information. Now, while we are not going to focus on overly complex strategic ideas of concepts for our conversation, it is important to recognize that these ideas can, and do, apply to businesses of all sizes in all variety of industries. Before we dive into the specifics of strategic planning or thinking, we need to understand the following reality—corporate strategy requires that the leaders of the organization understand the operational, financial, and customer facing implications of strategic decision making.
While the acronym ESG, representing environmental, social, and governance, continues to receive increased attention in the financial markets, and attract investor dollars, the idea might seem to be a bit far-fetched for most small to medium businesses. And at a certain level, the wholesale overhaul of internal and external operations and performance is somewhat out of reach, but that does not mean the entire conversation should be ignored. Strategic planning, building the business, and attracting new clients and business require that entrepreneurs acknowledge the entire business landscape they operate within. While the debates and information around social effects, governance issues, and environmental compliance are top-level issues and information, these are arguably even more important for entrepreneurs and small to medium size enterprises. Let’s take a look at how these (at first) theoretical concepts apply to businesses of every size.
1. Environmental—while a small business might have, fortunately, not have to deal with serious environment compliance issues, every entrepreneur should always be on the lookout for opportunities. Look at Tesla, which has taken advantage of every opportunity in the form of tax credits, rebates, and other sustainable energy types of credits.
2. Social—the importance of social engagement and interaction in the current marketplace cannot be overstated, whether it is done on a local level with the local chamber of commerce or on a more ambitious and national scale. For example, the simple act of showing up at local commerce meetings can create a business presence in the community and also lead to an increased profile.
a. Don’t forget, obviously, which we will be discussing later on, that developing an online profile (both on Twitter and Facebook for example) is a cost effective way to engage with current and future customers.
3. Governance—depending on the size of the business, small or medium size businesses may not have the internal corporate structure to effectively change and manage governance, but that does mean it does not apply to the business.
a. Think of it as internal control, which we will dive into moving forward, and this concept influences every business of every size. In essence, for our conversation the following statement is true—business has to be treated as business.
Finance Basics for Business
So, what exactly is internal control, and how does it really apply to you and your business? We will be covering that and more as we review some of the most important basic financial terms and concepts that every entrepreneur should know. One key aspect to keep in mind is that your business will not function appropriately without an appropriate internal control and governance structure. Think about how your organization, small business, or other enterprise functions with regards to cash payments, receipts, and extending trade credit?
Trade credit: Taking a short break from the narrative, let’s talk about trade credit for a minute. Usually categorized as accounts payable or accounts receivable, trade credit represents the ability of an organization to function without using cash to pay bills or receive cash payments from customers. Trade credit represents the lifeblood of many organizations—think of it like this—how often do you pay with credit versus paying with cash?
While large businesses and other organizations might have the financial resources and personnel to implement large-scale internal control programs, most small to medium size businesses simply do not have the resources to do so. While that is true, it does not mean that your business is any less deserving of internal controls, or that you should ignore the potential pitfalls and opportunities around internal controls. This topic might not sound like a particularly exciting topic, but if we take a step back and look at the big picture we can identify the core mission of internal controls to your business. Specifically, that core purpose and mission, as it relates to internal controls and your business, is to successfully execute a few key items:
1. Improve operational efficiency of existing operations and assets
2. Safeguard assets, both physical and intangible, including an online presence
3. Put into place controls over cash and other intangible assets
Now that we have identified the top three goals and objectives of internal control as it pertains to business and your business goals, let’s drill in deeper to analyze how these objectives apply to you and your business. Internal controls should focus on streamlining internal performance and efficiency of assets, specifically how to eliminate waste and find areas for improvement. It is important to keep in mind that internal control does not have to just do with compliance issues, but also items such as inventory turnover and management. Linking back to economics and your business strategy we can examine the following scenario and how it underpins how your business planning and strategy will play out:
If your business is planning a new business objective, or even just stocking up for a holiday sale or special you are going to have to purchase inventory, manage inventory levels, and rotate the products as sales start rolling in. Additionally, and on top of managing the inventory that you already have in stock, you are going to have also predict and manage the reordering process associated with new inventory to fulfill sales. Economically speaking, the flow of inventory in and out of a business can have a tremendous effect on how the enterprise will perform and on the working capital on the business. What is working capital you ask? Let’s take a look at a quick definition that we can use moving forward.
Working capital: For the purposes of our conversation and discussion of economics and business, working capital is defined as just (current assets − current liabilities), which is how an organization can pay its suppliers, employees, and other bills. But what are current assets and current liabilities, both of which are components of working capital? Drilling down briefly, we have some short definitions that we can use moving forward:
a. Current assets—think of current assets as items like cash, accounts receivable, and your inventory (which ties up cash)
a. Remember that every dollar tied up in inventory is a dollar you cannot use elsewhere.
b. Current liabilities—current liabilities can be thought of as accounts payable, taxes payable, and other types of short-term debts
a. This represents the ability of an organization to use goods and services without paying cash for these items.
Financing Strategy
Everything costs money, and this is equally as pertinent for business decision making as it is for personal finances. Whether you are focusing on improving your personal financial position, thinking of starting a business, or seeking to improve the financial position of your startup, understanding finance will always be a good thing. Finance can be intimidating on a personal level or whether you are thinking of improving your business financing options, but it does not have to be this way. With the availability of apps, online web platforms, and other mobile first tools and technology, there is no shortage of options available to the entrepreneur.
In an age of digital technology, business analytics, and virtual reality it might be tempting to ignore the reality that all technology and improvements to product or service offerings require financing. Let’s take a look at a simple example of how a better understanding of how finances can help a business management team make better decisions. Let’s assume that a medium size business is trying to roll out a new online platform, complete with a robust website, social media team, and several employees to manage and grow this platform. Several options are available to help finance this initiative. The ability to evaluate the best option for the business involves several factors, and we are going to take a look at these items below.
1. What are the fees, expenses, interest, and other expenses associated with the various financing options?
2. Is this source of finance renewable (think of a revolving line of credit), or a one-time deal, such as trading ownership for capital?
3. Do the financing methods under consideration provide opportunities for crowd funding or other forms of online/virtual engagement?
4. Are the terms of the financing dependent on the success of an individual project, or the financial health of the business as a whole?
5. Does the financing, or revolving lines of credit, has any sort of key man risk provision? In other words, is the deal linked to a certain individual remaining at the organization?
If you think that this sounds like a laundry list of items to worry about, and to consider while also trying to grow the business, you are right! Securing the appropriate source of financing is a complicated task that will be different depending on the business in question, the projects under consideration, and competitive forces within the industry. This also provides an opportunity for financially oriented individuals, whether they are CPAs, CMAs, or other types of financial professionals. Sharing insights, developing capital plans, and building alternatives applicable to the business in question all represent areas through which entrepreneurs and managers can better leverage existing accounting relationships. The dollars and cents of business strategy, however, only represent one component of the overall business-financial-strategy landscape.
Finance provides the lifeblood of business, and provides the information necessary for entrepreneurs to make better business decisions, and here is where millennials provide an interesting case for discussion. Compared to other generations, and when considering the issues of student debt and lackluster job, millennials are widely considered to be more entrepreneurial than other demographic groups. Having a fundamental understanding of how to best finance different business goals provides an important leg up when competing against other businesses. Think of it like this—if you have a better play caller and offensive line than the other team then you will most likely perform better than your competition. While better knowledge and personnel does not guarantee victory on the field, simply knowing more about finance will not definitely lead you to succeed in business, but it will help without a doubt.
Economics, defined briefly on the previous pages, is not merely an academic exercise reserved for the academic schedule of first year business majors. Finance is not the only way to understand how businesses operate, and economics provides a much needed compliment to the financial terms influencing the business. Supply and demand, while the most high profile examples of economics in most business classes, are merely the end result of a variety of forces that drive a business forward. As we will drill into below, pricing, traffic patterns, technology, and the competitive actions undertaken by other organizations in your business will influence how well the business does operationally and financially. Economics, and the forces that dominate the economic conversation, can and do have real-world impacts on businesses in a wide variety of industries.
Freakonomics and Business
Freakonomics was a bestselling book that nearly redefined how economics and economic strategy was perceived by both business people and even non-business minded people. In essence what this book, and the following conversation briefly did, was make economic theory and economic concepts mainstream conversation items. Far from remaining relegated to classrooms, research papers, and financial models, economics was a dinner table topic. While the somewhat halo-like effect from this book, and the follow-up book has clearly faded with both time, and market shocks, there are several topics and themes from this book and mindset that are still readily applicable. Supply and demand, linked to price, obviously form the building blocks and foundation of economics and economic theory. That said, there are many factors and underlying currents that ultimately drive economic and financial results that any business, regardless of size, should be aware of and take into account when making decisions.
The management team of any business clearly wants to increase both top line revenue and bottom line profits, but what are some of the non-obvious factors that might drive this performance? Pricing is a function of several factors—not just the supply and demand of your particular product or service to the marketplace. Several other ideas and concepts to keep in mind when considering the relation of economics to your business include what your competition is doing. It is not simply enough to understand the pricing and products that your competition is sending, but also taking a step back to broader areas allows you to evaluate different types of forces driving business performance.
For example, no business operates in a vacuum and so it is always important to be aware of external economics that can, and do, impact your business. Redevelopment initiatives, tax policies and proposals, small business development initiatives and objectives, zoning regulations and codes will all influence how your business performs. Arguably more importantly than how the current situations are situated and constructed it is important to remember that these forces can change and evolve over time. It is always important to keep up to date on these types of factors and information, especially how these forces can cause you to change business thinking.
Some other factors that influence the quantity sold and purchased in the market (equilibrium) include, but are not limited to, the following:
1. Competitor prices—who is your competition, and what are they charging for an equivalent product/service?
2. Substitute goods or services—what are the substitutes to your business (think of taxi drivers and Uber drivers)?
3. Are there macroeconomic (big picture) forces that are changing your business? Think the Affordable Care Act and Dodd-Frank for headline examples.
4. Does your business have barriers to entry? These barriers can be geographic, or based on a piece of paper (like a CPA license, for an example, close to home for the author).
5. How is technology changing your business? Notice I did not ask whether technology is changing your business, but how technology is changing your business.
Economics, from the perspective of an entrepreneur or small to medium size business owner, involves several factors and pieces of information that drive business performance. Drilling in specifically the forces that can affect local businesses, technology is an essential aspect of implementing economics and understanding the ramifications of economic changes at a small to medium business. Taking a step back from the details of day-to-day operations of your business, let’s take a look at how technology and economics are intertwined. A local business, for example, can market to, attract, and retain customers on a global basis simply by leveraging technology to gather better information and developed superior products and services. Gathering the best information available, from whatever source is available to your business, forms the foundation for developing an economic plan and strategy.
Enough to think about? I thought so, but let’s keep diving even deeper with an example of how a somewhat mundane sounding topic, interest rates, can dramatically impact the performance of your business over the short and long term. While this might seem like time and effort that is not related to core business requirements this is an investment that will certainly pay dividends moving forward. This conversation, while vitally important to understanding how to best manage your business affairs, is linked to an even broader business question. If you are trying to run your business effectively, from both an operational and financial perspective, there is a question that you must answer—what business are you actually in?
What Business Are You In?
An old adage from case studies in business school is that the railroads that once dominated the American transportation and industrial business landscape failed and faltered due to one important question—not understanding what business they were in. This is a double-sided question, however, and involves incorporating customer and stakeholder expectations into the value equation. Identifying the business that your organization operates within is a critical question that you must understand in order to effectively manage the finances, economics, and competitive forces on top of the day-to-day requirements of the business. Let’s suppose that your business is a local restaurant (capitalizing on the growth of gastro pubs and other “foody” type businesses) located in the downtown area of a medium size town that is centrally located to both local businesses and schools. What business are you in?
Notice the question is not specific to the type of food, portion size, or pricing of your food products—these are not relevant to the above question. Your business, while specializing in food products for this discussion, really focuses in fulfilling the following job or requirement—a convenient place to eat during a busy business day. Whether they are running for a quick bite to eat during their business day (local business owners), catching a quick meal either while going to work or coming home from work, or getting their children something to eat, the underlying job is the same. The customers that you are attracting, hopefully retaining, and who are ideally spreading positive word of mouth about your business are busy individuals who are looking for affordable and convenient food products. In other words, the food must be tasty, easy to carry, and appealing to a relatively large audience.
So, taking a step back for a minute, let’s see what types of food new products would not work under this definition:
1. Anything with heavy sauces, either cream colored or red sauces
2. Messy food that do not hold temperature well such as yogurts or other dairy-based products
3. Items that contain food byproducts that large segments of the population are allergic to—peanut butter and shellfish are two high profile examples
After establishing which job that the business solves for local businesses, commuters, and individuals, entrepreneurs and management professionals have a better idea of what questions to ask to better outline and establish a business strategy. In this example, for instance, some of the local stakeholders and partners that should be consulted for information include local transportation schedules, schools, and other small to medium size businesses. For example, our food restaurant should work with the school board to work with offering complementary food offerings to appeal to the student market.
The Job To Be Done
Additionally, and logically extending from the job that was previously identified—convenient food that is easy to carry and eat while on the go—the management now has a starting point from which they can develop plan. Put simply, now our food restaurant can start testing and developing new offerings, demo these products with customers, and see how they play in the real world. In essence, now we have the information that we need to execute effective strategy in a cost-efficient manner. Yes, that is right, it is possible to execute strategy and develop new products and markets without always breaking the bank on a technology upgrade. Let’s leave the food example, and take a look at how any organization can, if managed properly, develop a strategic plan in a timely and cost-effective manner.
Regardless of what business you actually operate within, the underlying themes of economic theory and identifying the job fulfilled by the enterprise represent an essential part of building a business plan and strategy. At the heart of any business strategic plan, and strategy in general, is the information that the management team can gather, and so it is important to keep in mind the benefits of technology with economic and strategic planning. Information, however, must be interpreted and analyzed in a cost-effect manner, and this brings us to our next topic of conversation. The importance of literacy, even for business owners, managers, and entrepreneurs, cannot be overstated. That said, let’s take a look at why exactly it is important for business managers to be business literate.