Street Smarts

1. Numbers are the bedrock of business success.

Numbers run a business. If you don’t know how to read them, you’re flying blind.

Financial literacy is key. Understanding the financial health of your business is not optional; it's essential for survival. Without a firm grasp of key metrics, you're essentially making decisions in the dark, increasing the risk of failure. This means going beyond just knowing sales figures and delving into the relationships between various financial indicators.

Living entity. A business is a living entity with needs of its own, and unless the leaders pay attention to those needs, the business will fail. The numbers will tell you how good your sales are; whether or not you can afford to hire a new salesperson or office manager; how much cash you’ll need to deal with new business coming in; how your market is changing, and what impact the changes will have; and on and on.

Accounting is not optional. You don’t have to become an accountant yourself. You do have to know enough accounting, however, to figure out which numbers are most important in your particular business, and then you should develop the habit of watching them like a hawk. This includes understanding the income statement, balance sheet, and cash flow statement, and how they interrelate.

2. Cash management is paramount; earn before you spend.

Cash is hard to get and easy to spend. Make it before you spend it.

Value of cash. Most people don’t understand the value of cash when they go into business. It's a finite resource, especially in the early stages, and must be managed with extreme care. Frivolous spending on non-essential items can quickly deplete your startup capital and jeopardize your long-term viability.

Viability is key. The point at which the company can sustain itself on its own internally generated cash flow. But it’s not just start-up entrepreneurs who waste cash. The corporate landscape is littered with the corpses of companies whose leaders thought the good times would last forever and spent money they hadn’t yet made on luxuries they didn’t need.

Make money first. If you’re smart, you’ll put some of it aside for a rainy day. Whatever is left over you can spend as you please. You can pay big bonuses to your employees. You can make big donations to charity. You can buy a corporate jet. You can run for president. Whatever. But first you must earn it.

3. Gross margin, not just sales, dictates survival and growth.

Don’t focus on the top line. Gross margin is the most important number on the income statement.

Sales are not everything. In the early days of a business, everybody obsesses about sales. We want to see them increase constantly—the faster, the better. But focusing exclusively on sales is dangerous, especially when you’re working with limited capital.

Gross margin is key. Instead, you should be tracking your gross margin—that is, the percentage of your money left over after accounting for the direct cost of whatever it is that you’re selling. (Gross profit is sales minus cost of goods sold. Gross margin is the percentage of sales that represents.)

Maximize gross profit. It takes the same amount of time and energy to build a low-margin business as it does to build a high-margin one, but you’ll have more to show for your efforts if you stay focused on maximizing the gross profit you earn. In the start-up phase, it determines whether or not you’ll survive long enough to reach viability. Thereafter it continues to have a major impact on your ability to grow the company.

4. A sale is only real when the money is in hand.

A sale isn’t a sale until you collect.

Cash flow is king. Starting out, most of us tend to believe that when somebody buys something from us it’s like money in the bank. Sooner or later, we’re going to get paid. That’s not always true, of course, and just how much sooner or later the payment arrives can make a big difference, but most people don’t think about that in the beginning.

Bad debt is a killer. The term “bad debt” doesn’t enter their vocabulary until they suddenly find themselves with a receivable they can’t collect. By the same token, the concept of collection time doesn’t become meaningful until they discover they don’t have enough cash to pay their bills despite having made a lot of sales.

Treat customers like loans. Remember: When you deliver a product or a service before getting paid, you’re making a loan to the customer, and you should treat it accordingly. That means determining whether customers are creditworthy and finding out in advance how long they take to pay their bills. It also means getting into the habit of regularly checking the state of your receivables, and making sure your average collection time is what it should be.

5. Sound finances prevent bankruptcy.

When your short-term liabilities exceed your short-term assets, you’re bankrupt.

Balance sheet awareness. The vast majority of people in small business, I suspect, have no idea what a balance sheet is, or how it differs from an income statement, otherwise known as a P&L (for profit and loss). The balance sheet certainly doesn’t figure into their decision making.

Bankruptcy defined. There I learned that a company is bankrupt—at least technically—when its current liabilities (that is, the ones that have to be paid within the next twelve months) are greater than its current assets (the ones that will turn into cash within the next twelve months). That information comes straight off the balance sheet.

Current ratio is key. I could have saved myself a lot of grief and pain if I’d gotten into the habit of looking at it on a regular basis and keeping track of the most important ratio derived from it, namely, the current ratio, which measures a company’s ability to meet its short-term debt obligations. You calculate it by dividing your current assets by your current liabilities. If the ratio is 1.25 or higher, you’re in fairly good shape. If it’s less than 1.00, you could be headed for trouble.

6. Long-term vision beats short-term gains.

Forget about shortcuts. Run a business as if it’s forever.

Building a business takes time. Building a business is a lot of hard work. Everything that a great company needs takes a long time to develop—a diversified base of loyal customers, experienced managers, a vibrant culture, efficient systems throughout the business, a sales force that works as a team, a great reputation in the industry ... everything.

Shortcuts are dangerous. To be sure, we all look for shortcuts. That’s only natural, especially when you’re on your first venture. You constantly search for easier ways to make your company grow faster, and sometimes you find them. Unfortunately, they almost always come back to haunt you.

Think long-term. A great company is one that can last forever, and I needed to make decisions in that frame of mind—even though I fully expected to sell the business someday. It would be worth more if I took my time and did what was best for the company in the long term.

7. Respect your true competitors.

Identify your true competitors, and treat them with respect.

Not everyone is a competitor. Here’s something else I didn’t know starting out: Everyone who does what you do is not your competitor. Instead you compete against only those suppliers who offer the same services, are more or less equally reliable, and charge prices similar to yours.

True competitors are important. As for our real competitors, I came to see that they were extremely important to our long-term success. They played a critical role in shaping our reputation in the industry—which was, and is, our most valuable asset—if only because their opinion carried more weight than that of any other group.

Treat them with respect. When they spoke well of us, everybody listened. So I made a habit of treating them with the respect I hoped they would show us as well, and I insisted that our salespeople do the same.

8. Business relationships differ from friendships.

You have no friends in business, only associates.

Avoid doing business with friends. Some habits are more difficult to maintain than others, and I constantly struggle with a really important one: Don’t do business with friends. I’ve broken that rule several times and always regretted it.

Friends make assumptions. But friends, I learned, inevitably make assumptions that hinder your ability to do what’s best for the business. Even though I would tell them up front that they would be treated like any other vendor, they still expected me to make exceptions for them. When I wouldn’t, the relationship went sour, and I lost a friend as well as a supplier.

Employees are not friends. It’s even more important to understand that you can’t be friends with your employees. I’m not saying you shouldn’t treat them with respect and affection, but neither you nor they should ever forget that it’s a business relationship.

9. Company culture starts at the top.

Culture drives a company. In the long run, the boss’s most important job is to define and enforce it.

Culture is critical. When I started my first business, it never crossed my mind that I was creating a culture as well as a company. I didn’t even realize that companies had cultures, let alone that the culture might actually affect the business’s performance.

Culture is the CEO's responsibility. Along the way, it dawned on me that setting the culture was ultimately the CEO’s responsibility. Although Elaine was doing the heavy lifting, she couldn’t have succeeded without my support.

Enforce the culture. Not only did I have to give her the resources she needed, but I also had to modify my own behavior to fit in with the new regime and make sure that everyone else went along as well. Among other things, I had to learn how to hold my tongue and respect the chain of command.

10. Plan your life before your business.

The life plan has to come before the business plan.

Business is a means to an end. Building a successful business is not an end in itself. It is a means to an end. It is a way to create a better life for you and those whom you love, however you—and they—may define it.

Life plan first. You need to do the life plan first and then keep revisiting it, to make sure it’s up to date and your business plan is helping you achieve it. That habit, I can assure you, will prove to be the most important of them all.

Avoid common mistakes. I’m sure you’ve heard it said that four out of five new businesses fail. I don’t know whether that statistic is accurate, but I firmly believe that four out of five new businesses would succeed if the entrepreneurs in question didn’t make the most common mistakes people fall victim to when they’re starting out.

11. Resilience and learning from mistakes are essential.

We all have mentors in business, although we’re not always aware of the role they’re playing.

Resilience is key. The most important quality is resilience. I’m talking about the ability to bounce back from failure, to turn around a bad situation, to profit from your mistakes.

Mistakes are inevitable. That’s because everybody makes mistakes, plenty of them. What’s more, we keep on making them as long as we’re in business. Sure, we like to think we’ll eventually get so smart we won’t make mistakes anymore. Forget about it. You will never stop making mistakes.

Learn from failure. As upset as you get, however, it’s important to bear in mind that failure is still the best teacher around. You’ll do fine as long as you’re open to the lessons it’s trying to teach you.

12. Focus relentlessly on building a customer base.

There is only one opportunity you should be thinking about during the start-up of any business.

Customer base is key. I’m talking about the opportunity to build a customer base that will make the business viable—that is, able to sustain itself on its own internally generated cash flow. First, you have to figure out what kind of customers will give you such a base and how you can draw them in. Thereafter, you need to focus relentlessly on building the base.

Discipline is essential. That’s not easy. It takes a lot of discipline, which doesn’t come naturally to most people. Look at the experience of Bobby Stone, which I recounted in chapter 1. And he is typical. Most first-time entrepreneurs I know have trouble maintaining focus.

Be flexible. Although you need to be focused, you can’t be rigid. After all, your approach may not be working. You have to figure out how to make it work. You have to watch, listen, ask questions, experiment, make changes, refine your concept, and constantly develop your customer base.