Budgeting: Concentrate Resources
Overview
Aesop’s neighbor buries his wealth, but his servant steals it. Aesop says, “Unused possessions create no good.” In one interpretation of the parable of the talents, Jesus praises businesspeople who trade to increase their owner’s wealth. A successful business provides benefits to its customers, income to its employees, and profits to its investors.
Evaluate the profitability of various opportunities and select the one that promises the best profits. Let us learn how to allocate the budget of a business to maximize its return on investment.
Vignettes
What Use Is a Miser’s Gold?
An Aesop Fable
Aesop’s neighbor converts all of his riches into gold, melts it into an ingot, and buries it in a secret place. Every day he gloats over his treasure for hours. Aesop said, “He left his heart and spirit in the hole.”
His servant snoops on him, sneaks back to the place, and snitches his gold. When the miser returns, he discovers that the hole is empty. In despair, the man pulls his hair and cries, “My treasure is gone!”
Aesop sympathizes with his neighbor’s loss. “Don’t despair like that, my friend. You won’t miss it. Just put a brick in the hole and imagine it’s your gold. You won’t be any worse off than before. Before you lost it, your gold was of no earthly use to you.”
Aesop chides misers. “Unused possessions create no good.”
Trade the Talents of the Business
Jesus lived several centuries after Aesop. Where his parables influenced by Aesop’s fables? This is one way to interpret his parable of the talents.
A man entrusts his wealth to three servants while he travels. Two servants trade his talents to increase the man’s wealth. The third servant digs a hole in the ground and hides the wealth. When the man returns, he praises the two successful businessmen, but condemns the unprofitable miser.1
How Should Wealth Be Used?
Both Aesop and Jesus encourage you to use your resources for good, instead of hoarding them. The resources of a business are its money, time, and efforts. A successful business provides benefits to its customers, income to its employees, and profits to its investors.
What Is the Cost of Losing an Opportunity?
Opportunity cost is the amount a business could have profited from an opportunity. If a business exploits an opportunity, it produces profits, but if not, the loss in profits is ignored by accountants. A wise entrepreneur evaluates the profitability of various opportunities and selects the one that promises the best profits.
Key #11: Concentrate Resources
Lexus-Riley prototype2
If money follows results, we will get more results for our money.
Bob Riley, race car designer and cofounder of Riley Technologies.
Constance Concentrates Resources
Constance, the owner of a business, wants to roll over the budget to the next year, but Dwight, her marketing consultant, disagrees.
Your business should invest its money where it will earn the best profits. If your business focuses on serving its key customers, its profits will magnify. The top 20 percent of your customers will produce 16 times more profits than your other customers.
Confused, Constance asks, “Where will my business find the money?”
Mission
Dwight says,
Let’s start with the mission of the business. Its most profitable customers seek high-quality products and services so focus on quality. Less profitable customers prefer cheaper versions. Your business should quit spending money to dilute its reputation.
Target Market
“What benefits does your business provide and who really benefits from them?”
Constance describes her key customers and explains how the business benefits them.
Strength and Weaknesses
“How can my business improve its reputation?”
Your business has a stellar reputation in its strength so compete on this strength. If the business delegates its weaknesses to suppliers, the business can specialize in its strength. Your business should contract with professionals, specialists, and service companies.
Products and Services
“Your business offers treasures for its most profitable customers, but why does it offer product and services for other customers?”
“Maybe my business should discontinue the less profitable items and add value to products and services that are treasured by its key customers.”
Distribution
“Which distributors and retailers consistently delight your key customers?”
Constance lists them and says, “Some others tarnish our reputation and cause more problems than they’re worth. My business should discontinue them and replace them with new distribution channels that will delight our key customers.”
Promotion
Your promotions seem to focus on all customers, not the top 20 percent of your customers. Your key customers have different motivations, timing, media usage, and influences than your other customers. Your promotions must trumpet empathy with its key customers.
Pricing
“How much profit would you lose if your business charges more than its direct competitors?”
“The bottom 80 percent of its customers may switch to them, but my business would only lose 20 percent of its profits. Increasing the price would greatly increase our profit per item and increase our total profits.”
Prospecting
“Let’s evaluate your direct marketing campaign. Does it currently target your key prospects?”
“Oops, we should focus on results, not reach.”
Customer Service Policies
“Why does the business reward complainers?”
“I was taught in school to treat everyone equally.”
“Does everyone treat your business equally? Reward the best, not the rest.”
Budgeting
“We have brought up many ways your business can allocate money to its key customers and away from its other customers. Focus where your business will get the best profits. Don’t feel overwhelmed. Just make one budgeting decision at a time.”
Taking Action
“Decisions are useless until your business acts on them. Consider the 80/20 rule as an engine that can empower your business. Your budget will ignite the engine when you jump into action.”
That night Constance dreams about the bedtime story, The Little Engine That Could. In her dream, she chants, “I know I can, I know I can, I know I can.” She visualizes the Pareto law as the engine of her business, building momentum and chugging upward at an ever-accelerating pace.
Does this story inspire you to concentrate its resources on serving your key customers?
Financial Review
Balance Sheet
A sophisticated marketing plan uses financial documents to review the financial condition and the growth potential of a business. In a balance sheet, assets minus liabilities equal net worth. In other words, the net worth of a business is its total assets minus its total liabilities.
Total assets include current assets, fixed assets, plus goodwill. Accountants consider cash, accounts receivable, and inventory as current assets, but real estate, fixtures, equipment, vehicles, and licenses are considered fixed assets. They calculate goodwill when a business is sold.
Total liabilities include current liabilities and long-term liabilities. Current liabilities include accounts payable, short-term notes payable, accrued expenses, and taxes owed, whereas other liabilities are long-term liabilities.
Income Statement
An income statement summarizes the profits or projected profits of a business. Gross revenue is total sales and revenue minus returns and allowances. Gross profit is gross revenue minus the cost of goods sold (variable costs). Total operating income is gross profit minus total operating expenses (fixed costs). Other revenue and expenses affect pretax income while any extraordinary gain or loss affects net income after taxes.
Profit-and-Loss Statement
In a profit and loss statement, gross profit is total net sales minus the cost of sales whereas net profit before taxes is gross profit minus controllable and fixed expenses. Controllable expenses include salaries, payroll taxes, security, advertising, automobile, dues and subscriptions, legal and accounting, office supplies, telephone, plus utilities. Fixed expenses include depreciation, insurance, rent, taxes and licenses, plus loan payments.
Cash Flow Projection
Cash flow is the beginning cash plus cash income minus cash expenses. Total beginning cash includes cash on hand, in a bank, and in investments. Total cash income is cash sales, payments, investment income, and loans during the month. Total cash expenses include new inventory, taxes, overhead, loan repayment, and other cash expenses.
A startup must project their monthly cash flow for three years to qualify for a loan from the Small Business Administration. An ongoing business needs to know its cash flow for buying materials, scheduling production, hiring personnel, and promoting its products and services.
Donald Rumsfeld3
Prune—prune businesses, products, activities, people. Do it annually.
Donald Rumsfeld, Secretary of Defense under George W. Bush and Gerald Ford.
Summary
A successful business provides benefits to its customers, income to its employees, and profits to its investors. Evaluate the profitability of various opportunities and select the one that promises the best profits. Pareto’s law predicts that the top 20 percent of inputs will produce 80 percent of the results.
A financial review describes current and possible outcomes from business decisions. The 11th key to enhanced profits is to concentrate resources.
Concentrate Business Resources on Top Inputs
Decide how the business will concentrate resources:
- How will the business alter its budget to improve the quality of its products and services?
□ Buy higher quality components and materials
□ Sell off inferior parts of the business
□ Reward and nurture high-quality employees
- How will the business alter its budget to avoid or overcome threats?
Redefine its target market
□ Focus on a different region
□ Redefine the problem it solves
□ Form a strategic alliance with a competitor
- How will the business alter its budget to specialize in its strengths?
Expand buildings and equipment for producing the specialty of the business
□ Hire and train employees in this specialty
□ Sell assets that produce other products and services
□ Outplace employees whose skills are not compatible with its specialty
- How will the business alter its budget to delegate its weaknesses?
□ Outsource weaknesses in tasks, projects, functions, and other responsibilities to suppliers
□ Contract with relevant professionals, specialists, and service companies
□ Build strategic alliances with suppliers who compensate for weaknesses of the business
- How will the business alter its budget to focus on its key customers?
□ List the top 20 percent of its customers and profile their typical traits
□ Conduct marketing research so the company better understands its key customers
□ Encourage other customers to switch to competitive businesses that can better serve them
- How will the business alter its budget to offer treasures to key customers?
□ Discover what benefits and values that key customers seek from its offerings
□ Add value to products and services that are treasured by key customers
□ Discontinue products and services they do not treasure
- How will the business improve its revenue from key customers?
□ Identify the price at which its key customers would switch to a competitor
□ Gradually raise the price near this price point
□ Compensate for lost customers by increasing the profit margin
- How will the business alter its budget to delight its key customers?
□ Reward distributors and retailers who delight key customers of the business
□ Discontinue contracts and agreements with other distribution channels
□ Find new distributors and retailers who can consistently delight its key customers
- How will the business alter its promotional budget to empathize with key customers?
□ Research the process that key customers use in deciding to buy the products and services of the business
□ Target key customers and prospects with promotions, spokespeople, and publicity
□ Quit targeting other customers with its promotional budget
- How will the business alter its budget to target top prospects with direct marketing?
□ Research how to best influence top prospects with a direct marketing campaign
□ Use a list of key prospects from a direct marketing business like InfoUSA
□ Discontinue direct marketing campaigns that target other prospects and customers
- How will the business alter its budget to reward key customers, rather than complainers?
□ Stratify the customer service policy to reward key customers
□ Discontinue benefits to less profitable customers and complainers
□ Encourage top complainers to switch to a competitor
- How will the business alter its budget to implement its decisions?
□ Assign responsibilities and tasks within the business
□ Hire experts, contract with suppliers, or trade skills with others businesses
□ Buy software, equipment, facilities, or a business to implement these decisions