Albert Einstein once said, “No problem can be solved from the same level of consciousness that created it.” For instance: You have problems with your fellow employees and you think that changing jobs is the best way to solve the problem but then you find yourself with the same problem in a different place.
Changing location does not solve a problem if the mindset that created the problem has not changed. An unchanged mind will undeniably create the same problem no matter the location.
So how do we keep from producing the same adverse effects? The answer lies in the expansion of our mind. We expand our minds when we engage in new activities, read books from different fields or consult with others. When we expand our minds, it becomes easier to identify the root cause of our problems. Identifying our problems is the first step to solving them: Without proper problem identification we will be solving the symptoms of our problem and not the problem itself. When we do not know what is wrong, we might even implement permanent solutions to temporary problems further complicating our lives.
Application to Business
A common example in the business field is using sales discount to increase revenue. Business owners that practice discount promotions usually use cash flow as an indication that things are going bad. When cash is low, the first thing they try to do is to increase sales by offering discounts. However, if the problem to their cash flow problems was not sales, using the discount strategy only makes the problem worse. This is because increasing sales is not always the best way to increase profits. It is much better to increase cash by reducing cost because each increase in sales also means an increase in cost. So if your problem is a run-away expense, increasing sales only increases the associated expense. This could mean your business will run at a bigger loss when compared to the period before you ran the promotional discount. Also promotional discount can sometimes act as a permanent solution to a temporary problem if it hurts your brand image: Once you start offering discounts customers will begin to expect it and it will be hard to change strategies without losing customers.
A business that uses cash as its litmus test is likely to find itself in all sorts of trouble. There are other factors that affect cash flow besides revenue and knowing how to measure your profitability is an important skill to have as a business owner.
Increasing your level of consciousness
One important concept any successful business should know is how cost behaves. By this I mean, which costs are consistent over time and which ones change as revenue changes. This is important to know if you are going to determine at what level you are truly profitable. The point you start becoming profitable is called your breakeven point. To know your breakeven point, you will need to know the expenses that are consistent over time (your fixed costs) and the expenses that vary as revenue varies (your variable costs).
I will illustrate by using the same problem above where the cash flow problem was solved by running a promotional discount. What if majority of the expenses were variable in nature i.e. expenses increased as sales increased and the discount rate was lower than the variable expense? This will be bad as each increase in sales will cause an increase in the losses suffered by the business. So even though they might be a short term surge in cash, the long term consequence of the promotional discount is an increase in the losses suffered.
Rather than randomly increasing sales by running promotional discounts, a better way would be to first understand the number of units that should be sold to earn a targeted net profit. This information can better direct you as a business owner how to better spend your marketing dollars. Imagine if you knew you only had to sell a hundred units to get the amount of cash you needed in your business, you can focus your energies to create the awareness you need to sell those hundred units. It is much easier to focus your mind on producing results when you have a concrete number to work with. It’s funny how the mind works!
Previously, I gave an example where expenses vary as sales vary. What if the business that ran the promotional discount above had most of its expenses fixed. This will mean that the source off its low cash flow problem is not generating enough revenue to cover fixed costs i.e. the business in question is not taking advantage of its operating leverage. Operating leverage is when an increase in sales causes an increase in net income. A business with high fixed cost is highly leveraged: Cash flow will suffer if the right strategies are not implemented to take advantage of being highly leveraged
A cost volume analysis can be used to find the best price, sales mix or target volume. This exercise should be performed at least once in a highly leveraged business as it provides information that is useful for business growth. One of the beauties of being on the web is that once you turn profitable, you can quickly turn your business into a money making machine. Thanks to operating leverage: Most of your costs are incurred at startup and very little costs are incurred with each additional unit of sales. This makes it easier for the percentage increases of profits to exceed percentage increase in revenue.
As a business, it is important to have tools that direct you to the source of your problems so you are treating the right problem and not the symptoms.
Remember, we cannot solve our problems with the same level of awareness that create them. At Lifestyle CPA, I can show you how to properly identify your problems and create the level of awareness you need to solve the right problems.
Please leave a comment below of how you increase your level of awareness as a business owner.