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Understanding how business variables interact will bear fruit

“Make everything as simple as possible, but not simpler.” —Albert Einstein

If you’ve ever exercised by lifting weights, you know that the amount of weight on the bar is only one variable that needs to be considered for a particular exercise.

If you’re doing a bench press, you can add more weight because your chest and shoulder muscles help your arms to lift the weight. But if you put 50 percent of that total weight on each of two dumbbells, you can’t lift either one. You probably also learned that you can’t use the same weight for curls as you do for bench presses.

Likewise, if you’re going to do only one repetition, you can handle more weight than if you’re going to lift it 10 times. If you are lying flat, you can do more than if you’re lying on an angled bench. And if you’re going to do more than one set, you’ll probably have to reduce the weight further so you’ll still be able lift it when you’re in the third set. Are you trying to build strength or develop endurance? Are you trying to lose weight or improve your golf game? All of these variables make a difference.

Now, consider this list of variables. Dilution. Ownership. Growth rate. Borrowing capacity. Valuation. ROI. Interest rate. Profitability. Leverage.

You’ve probably encountered some of these variables at one time or another. You may have discovered that they are closely linked, so that as some of them change, others change even more dramatically. You may have concluded, however, that you don’t have the time or expertise to develop a framework to evaluate them in an integrated or balanced manner. Yet, these critical variables demand your attention, and you know it’s important to understand how they work together.

Wouldn’t you know it, these issues are the ones that usually come up in the most important decisions that a company must make. Should we borrow more money to fuel the dramatic growth opportunities in front of us? Is it worth giving up some equity to outside investors to achieve that accelerated growth plan?  How do I measure and evaluate all of that? Conversely, how fast can I grow my business without outside capital?  For family businesses, there’s this classic equation: How do I fund the transition of retiring family members when the business needs that capital to grow?

There are a lot of perspectives from which to consider this conundrum. Your company’s “Strategery” is part of that process as you seek to prioritize the company’s opportunities to make the most powerful strategic choices to drive future performance.

Being clear about your goals and objectives is the critical foundation upon which the evaluation of these issues must rest. Of course, these variables are also influential as you make your “capital allocation” decisions, a fancy euphemism for “we don’t have enough money to go around” so how do we decide how to allocate our limited resources?

These issues become problematic when they’re not managed and always surface when a company does not prepare a longer-term financial forecast that allows it to anticipate trends and future results. Many companies ignore this process, usually with a statement that rhymes with “I don’t know what’s going to happen tomorrow, much less next year, so why should I bother trying to forecast the future?”

It’s certain that forecasting future results is an art more than a science, but it’s also true that we can do a lot to “get in the ballpark” of future expectations. Even if you’re going to venture an estimate of future sales, you can evaluate the sales cycle, inventory turns, collection periods and other metrics to better understand the range of likely outcomes. If you’re off by even 10 percent to 20 percent, you can still get a pretty good idea of the general direction of the discretionary cash flows available to meet some of your goals.

What these issues have in common with weight lifting is as simple as it is complex. While the nature of the weight lifting routines is pretty obvious – there are a lot of variables that affect each other, and when one is changed, it changes the other – the failure to embrace those differences can lead to serious and permanent injury. Likewise, when companies fail to consider the interaction of growth rates, leverage, dilution and valuation, for example, unseen currents of conflict and trouble gain strength. The longer these issues linger, the more expensive and difficult they are to resolve.

In a series of upcoming columns, we’re going to explore these concepts, their relationship to each other and the impact they have on your business.

 These are some of the most important concepts that companies need to understand, so stay tuned as we develop a comprehensive framework that can help you think about them – and literally save your business.

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Lary Kirchenbauer is the president of Exkalibur Advisors Inc., providing practical business strategies for family and other privately owned businesses in the middle market. He can be reached at 415-602-7870 or lary@exkalibur.com. His Web site may be found at www.exkalibur.com.