Transcript for Episode #166 ‘Solid Foundations: Right-Size Your Company‘
Host: Scott Weaver
Date Aug 24, 2022
Welcome to Arise2Live Podcast, episode 166.
We are launching a new series called Solid Business Foundations. It’s about building on a solid rock for your business to grow on. Today’s episode is about right-sizing your company so you have the free cash-flow to benefit from your business.
Arise2Live’s purpose is to bring clarity and perspective so you can have freedom in both your business and family life.
This episode launches a new series about building a solid business foundation and is about becoming a better business person by exploring how free cash-flow creates harmony among your company’s key activities, activities in operations, your tax activities, and the important financing activities. When you right size your company, you have a peace-of-mind and confidence that will carry you on. Right-sizing is about free cash-flow that covers all the business expenses, not just the day-to-day operations. The trick to right sizing is adjusting revenues to match expenses, not matching expenses to revenues.
That little trick changes the outlook on solutions and creativity immensely. Unfortunately, on this topic, I do need to say specifically that this episode is not about layoffs and downsizing. Too many non-owner type people have hijacked the word ‘right-size’ to be synonymous with layoffs and confused the subject. We’ll go into clearing this up a bit.
Hello everyone, my name is Scott Weaver, the Arise2Live business coach and this is episode 166. I’m so glad that you’re with me today. Please continue sharing this podcast with other business owners and leaders. I strongly feel that when businesses are successful, when you are successful, a lot of good things happen to families, employees, and even the community. I’m trying to do my part with this podcast and I ask you to do your part by building and running great companies.
Meaning of Right Sizing? 2:23
Where to start? Okay, please bear with me a bit as I make some clarification on words I’m going to use. Words like ‘right-sizing’ and ‘business activities’. If I don’t clarify them, then a lot of meaning is lost and a lot of confusion is gained. Not the elements for a half-way decent podcast episode. I’ll try to get through this as quickly as I can so that we can get on to the topic of better understanding of running a good company.
Regarding business activities, folks figured out a long time ago that there’s more to running a business than just day-to-day operations, there’s stuff that needs to get done to create value that customers want to buy. Operation activities is like the engine of your business—it moves things forward and generates cash-flow. The phrase ‘free-cash-flow’ is about how much money is left over after paying for all the expenses and is “free” to use however the owners want or feel like using it.
If company operations is the engine, the financing is the fuel. Rarely are businesses launched without some sort of investment, whether it’s from loans, money from investors or a rich uncle, or the founder’s savings and sweat equity. There’s equipment that needs to be bought. There are services and software that needs to be bought. Most of this financing activity does not show up in the company operations other than money in the bank account or equipment showing up on the shop floor. Yet experienced business owners know that it takes a lot of effort to get financing and this effort is called financing activities. I should note that owners getting paid through ‘owner withdrawals’ instead of salary is often considered a financing activity.
Other types of activities that business are engaged in, one is paying taxes (usually we hire a tax CPA to help us do that). I call this Tax Activity for obvious reasons.
So, there are 4 main activities to be successful in business: operations, financing, tax, and owners getting paid. If any one of those stumbles, the whole company stumbles.
In very simple terms, your company should be able to pay for everything, as in everything, including equipment purchases and personal taxes and whatever is needed without having the bank account getting lower. That is a challenge to do, but it can be done.
Another way to put this is using a math equation for you analytical types. It would go like this: Free cash flow is revenues minus the total expenses from operations, taxes, financing costs, and owner payouts.
So I hope that you are starting to see the holistic view of your business. If this equation, free cash flow is revenues minus the total expenses; if those are in harmony, the company has a strong foundation and is at the Right-Size.
Well going on an aside here, this episode may get me in trouble. It seems that the Human Resource industry has taken over the word ‘right-sizing’. To them it has become a nice sounding word that means to strategical maximize profit by eliminating as many employees as possible. So instead of using words like downsizing and layoffs, which, of course, are evil names, it’s much better to use pretty words like ‘Right-sizing’. There are a number of small podcasters and bloggers like me who are pushing back on this word take-over, but I’m afraid our voices are pretty small.
I read on one HR website that gave an example of a company losing 50% of their revenues so they recommended “right-sizing” the company by firing 50% of employees. What world do they live in? Employee expenses and productivity is rarely, like close to never, a 1-to-1 ratio with revenues.
So this gets in a warning, if your HR people are making company-wide strategy decisions, you are or will be in big trouble. You should not have people who don’t run the company or suffer the consequences of bad decisions making the final call. Their input’s great. Their expertise is great but not making the final call. The final call goes to the business owner. It is the owner’s responsibility to make that call to make those big decisions because they see, or at least should see, the total big picture and know where things are going and where the business should be going. I encourage you, business owners, don’t abdicate your role of running your company to somebody else. That is your responsibility and take it seriously because you want to win. Again, this is my rather strong opinion of business leadership and how to run a winning company.
Now where was I? Yes, in this episode, what I mean by right-sizing your company is that you are operating from a strong foundation where the cash-flow operations, the cash from the operations, the business, the engine of the business are in harmony with the financial and tax activities and you have the freedom to pursue your goals and vision. This doesn’t mean that you have reached all your goals yet, but having a right size company means you have a smooth-running engine to get you there.
This is actually a tall-order to reach the ‘right-size’ point and it is a challenge to stay there.
Let me give you three common examples based on my experience, when things don’t go well when the company’s revenues can get out of harmony with the tax and financial activities and for the owner getting paid.
The first example is when the company is young, pretty young. The company has just hit the break-even point and out of the start-up mode. Don’t get me wrong, hitting this milestone is a major accomplishment and worth celebrating over. I mean that point when the revenue from customers covers the operational expenses, that is a good thing. It means your engine, your business engine, is actually working. However, there is a trap that many new business owners fall in: they think they are profitable, but they are not. Yes, at the end of the day there’s cash left over from paying the operations expenses, but the bank account is getting lower and lower. That’s a huge red flag.
In the Arise2Live view of the business life-cycle, a business begins as a start-up and is losing money until it reaches operational break-even, then the business enters the ‘break-out’ phase where they are operational profitable, but the business is not profitable because they’re paying back the startup loans. They are paying back the investors, and the owners actually start getting paid full salary. In other words, the expenses from the financing activities start to be a burden on the cash-flow.
So in young companies, the general problem is that the company is not sized to generate enough revenue to cover both operations and the tax activities and the financing activities and actually pay the owners what they’re worth. The solution is to make more money. Upsize.
The second case where a company gets out of harmony with its revenues is when there’s a drastic change in the economy, things such as global pandemics and everything is shut down, or high inflation. Or maybe the technology in your industry changes. But the point is, is that revenue significantly drops and new sales efforts is not likely to be successful with existing products. Businesses in this situation either need to be launching new products and services or looking for new opportunities to engage in or, if needed, downsize in operations to match expenses with the new level of revenues. Either way, there’s going to be some sleepiness nights for the business owners when they’re making that these type of big decisions.
The third case is from the business owner directly. Sometimes a company in the stable mature stage, the owner just gets burned out. They get tired of working the 80+ hours a week and rather than hire managers, the owner reduces the size of the company to a size and time effort that the owner can managed by themselves. In this case, it is almost always results in a smaller company, that is, downsizing.
Of these three cases, a new company just out of the break-even stage, the mature company that’s hit with an economic storm, or a burned-out owner working too long and wants to cut back, only one of these three cases is a guarantee to be downsizing.
In fact, if you start thinking a little deep, looking under the surface you can see that this is one of the big reasons why you can’t assume that right-sizing is the same as job elimination as so many in the HR industry claim. Given these three cases, it’s a 50-50 chance on increasing number of jobs, that is hiring or decreasing. It all depends on the situation and the uniqueness of the company that is undergoing change.
So how do we approach our situation to deal with this 50-50 chance of increasing or decreasing the company?
Here’s a key point in right-sizing a company: it’s about revenues, not expenses. Again, the trick to right sizing is adjusting revenues to match expenses, not matching expenses to revenues. It is a mindset shift. Focusing on revenues keeps you focused on providing value to customers that give you money. You are more creative on finding solutions. You are working towards real long term solutions while focusing on expenses often leads to what I call spreadsheet management methods – working towards a numbers, an answer that looks good on the computer screen, but in reality has a lot of negative side effects.
Digging down a little bit more on revenue: revenue has the very basic equation of widgets sold times the price that a customer bought. Customers buy X things for Y dollars.
There is not a lot of levers to move when it comes to revenue. To increase revenue, you can increase price, but often there are times where the competitors prices limit on how much you can charge. The other option is to sell more, which means to build more widgets for the customer to buy.
If you need to grow, if you need to up-size, to get your business the right-size, I suggest starting with the question: What does it take to build more? That question leads to other questions to build more. Is it more employees? Is it more equipment? IS it more salespeople? Is it more marketing? If so, will the increase in productivity on the company’s output lead to new revenues that cover the new expenses, and does it add to the free cash-flow to help out on the financing activities? If so, how much and when will the new cash come in? There’s usually a delay factor and in this situation, it’s homework time to work out the details.
Sometimes downsizing is needed. In this case revenues are decreasing and the best solution is to decrease output and sales. So I suggest starting with the question: What does it take to build less? That question leads to other questions. Should I reduce my product line, cut a few products out? Is part of the solution reducing the number of employees or removing equipment? If so, which one? Or both? Can I keep customers if I produce less? Will the lower expenses allow me to continue to generate proper revenue generation? Will the lower productivity reach a decent cash-flow from operations to cover all activities in the business? Rarely is it as simple as cutting costs, the impact on the value creation process when you downsize is important because your value creation is what feeds your customer. It provides the customer needs that they keep on buying and in this situation it’s homework time to work out the details.
If you do let people go, seek out some HR expertise in your local area. Yes, I’m down on them for taking over the word rightsizing, but they still have an important role. They know the law to make sure that you’re legit and stay legit. A lot of times the good ones, just might be aware of other companies that are looking for workers, allowing you to take care of your employees as they leave. And that is a good feeling to have. Don’t let HR people run your company.
The main point of this episode is that a business truly operates at its right size when the free cash flow from operations covers the owner’s wages, the taxes paid, any financing activities or cost, like paying back loans, investors, equipment, etc.
So I need to ask you, “As a business owner, are you at this point? Are you at the right size where your free cash-flow covers all the activities of your company?” If so, great! Go celebrate tonight for all your hard work. You are well on your way of reaching your vision for the business.
If not, well, you have some work ahead of you. Remember that Free Cash-flow is revenues minus the total expenses from all business activities including you getting paid. From this, by calculating all the expenses of all your activities, you can determine the financial revenue targets, the number of widgets to get out the door, and the number of customers you need so that you can right-size your company and so that you know where to focus your activities to right size your company.
Whether your particular business situation is to upsize or downsize or you’re just right size, I ask you business owners, to take full responsibility of your role and to be intentional about your actions.
I know that in either upsizing or downsizing, that can be a stressful time of change, but the end benefits of having the right-size company are good. When you know that you are operating your company from a solid foundation, you are just much more confident, you have less stress, and the free cash flow allows more flexibility, more options to reach your vision in the future, that destination that you’re going to. I’m not sure if this is the right words or not, but that process of going through the real world of right sizing your company and figuring out things, it just gives a certain level of confidence that cannot be faked. So as you move forward in your company, you can do this.
You can right size your company, you can arise to live.
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