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# Archive for August, 2013

## Why are ratios important?

For business analysis, ratios are far more useful than just looking at the absolute numbers.

A ratio is where you express something, either as a percentage or as one number against another, like horse racing odds.  A horse with odds of 2-1 is likely to be a better bet than a 100-1 outsider.

We use ratios to assess a business’s performance. For, example if business “A” makes £50,000 profit a year and business “B” only makes £10,000, which is the best business?

You would probably think business “A” but it depends.

We can’t truly know the business performance unless we know what capital or assets are used. It could be that business “A” has £2m of assets and business “B” only has £200,000 of assets. This would make business “B” twice as good and business “A”, even though it makes less profit.

The Return On Investment for business “A” is £50,000 divided by £2 million x 100 = 2.5%. The return on business “B” is £10,000 divided by £200,000 x 100 = 5%.

Where would you prefer to have your money, in a bank paying 2.5% interest or 5%?

Ratios are so important because we can compare, not just against our own businesses year-to-year, but we can compare against other businesses.  For example, if you ran a small mini supermarket, then just with the absolute numbers you would not get any reasonable comparisons if you compared your results with those of Sainsbury’s.

Sainsbury’s is going to generate much more profit in real terms and it’s going to have more cash in the bank, because they’re bigger.  But, if you look at the ratios, and you look at the gross profit, sales per square foot or the Return on Investment, it doesn’t matter how big or small a business is, you can make some meaningful comparisons.

We can then see how well we are performing against the competition and see if we can learn anything.

There are basically three ways to scale your business and make more profit:

• Enterprise
• Licence
• Products

An enterprise is where you grow and employ people. This is the most common way of developing a business and (depending on your situation) it can require you to look for business funding/investment.

You can run your enterprise as a lifestyle or management style business. Lifestyle is where you work alongside employees doing some of the operational work. Or, you can have a management style enterprise where you take yourself out of operations and become a business manager. It is common for the founder to become the Managing Director, even though this may not be the best option for them.

An alternative to building an enterprise is to licence what you have developed. An example is a franchise, but it doesn’t have to be a brand. It can be know-how.

The products option includes writing a book, training or CD/video resources. A good example is Paul McKenna who doesn’t charge £25 an hour as a hypnotist…he has a business empire of training and products.

When thinking about these options keep in mind that they are not mutually exclusive. You can have your own business, grant a licence and sell products.

When choosing what to do, think carefully about what you want. Perhaps you love what you do, in which case an enterprise may not be the best option for you personally.

Whatever one or combination you choose, you can create a financial model. When you do this you will know:

• The different types of customer
• The number of customers
• How much each type of customer will spend
• Different revenue streams
• Net profit

You can do all this in the planning stage so you know what your exit plan is.

## Pay yourself first

I’d like to share with you a concept called “Pay Yourself First”.

The truth is that because we are living in a capitalist society, everyone is trying to get their hands on your money. Big businesses use clever marketing to take advantage of powerful psychological drivers that are hard wired into all of us.

Now, with so much temptation on a day-to-day basis, why not pay yourself first by saving some money for when you won’t be able (or don’t want) to work?

Yes, this may reduce your cash for other things now but the chances are you can reduce your monthly expenditure without affecting the quality of your life. In fact, you may find the less you spend the happier you are!

Is this all boring?

Perhaps, but I reckon it is much less boring than sitting around without any money to spend for years and years. That would be like living like a prisoner in your own home, you deserve more than that, don’t you?

Working out how much you need for the rest of your life takes a little time and energy but it’s well worth doing.

If you find there is a shortfall don’t panic. There are probably lots of things you can do in your business to improve what you take out. And, there are lots of thigs you can do with personal expenditure to reduce what goes out of your pocket.

Here are some ideas to get you going:

• Paying off expensive debt like Credit Cards
• Driving a different car
• Drive slower so you use less petrol
• Swap the second car for a bike
• Do not buy anything on the spur of the moment
• Taking less expensive holidays
• Drinking less (or no) alcohol
• Stop smoking
• Rent out loft space for storage
• Rent out your driveway as parking
• Cancel the gym and walk more
• Shop smarter
• Drop a brand with food
• Cancel paid for TV

Have fun by being prudent in the knowledge that you are paying yourself first.

## Are you balanced?

Make no mistake about it, you are much more important than anything in or around your business.

You are so much more important than a few extra sales, a bit more profit or some cash in the bank.  You are also far more important than any demanding customer, ungrateful employee or a needy supplier.

Money can’t buy you health and happiness so everything you do about planning and growing your business needs to make sure you are happy at every level. There is no point having loads of money without having anyone to share it with. As the saying goes, no business success makes up for a failure at home.

So, the first numbers we need to consider are what I call you your personal numbers. These are a combination of financial and non-financial numbers.

To help us I’d like to introduce you to the Your Life Circle.

Draw a circle with four lines through the middle. At the centre write zero and where the line touches the circle write ten. Each line from the centre to the outside represents something that is important to you. These could be health, money, family and friends.

The idea is that you score each category from 1 to 10 and join the dots up. In the ideal world you would have a perfect circle but the chances are your circle will have some dents. Use this to help you focus on what is important.

You could create lots of circles, one for each category. So, you could create a circle for your children with:

• Fun this week
• Reading a book with them
• Listening to them
• Time on the floor playing

For money you could have these categories:

• House
• Car
• Holidays
• Entertaining

You can also use circles in your business. For example, you could have a overall business score which could have these categories:

• Sales
• profit
• Cashflow
• Enjoyment

And, just like your personal circle you can break them down into more specific circles.

I’ll leave you to decide what is on your Life Circle. But, what I would say is that perhaps the scores should come from other people, as well as yourself.

Your spouse can tell you how well you are doing as a husband or wife, your kids can tell you how well you are doing as a parent. Your own parents can tell you if you are a supportive son or daughter and your doctor can assess your health.