Financial Principles
“Write your principles in pen and your business model in pencil”
Finance can be an intimidating topic.
It feels personal because money is always tied to emotions, be they greed, fear, excitement, envy or our sense of self-worth.
Before we dive into unit economics and breakeven calculations, it’s important that we’re on the same page when it comes to our fundamental principles.
These principles remove paralysis and guilt, and give you the freedom to build a business that you’re proud of.
Money is not evil
Money is not good or bad, money is fuel.
You can use that fuel for whatever you like, but fuel doesn’t shape your personality.
If you see someone using money to be a jerk, chances are they were a jerk beforehand, money just magnifies their desires.
We can use money to magnify our positive desires too, be it through creating jobs, promoting a good cause, influencing beneficial behaviours, or redistributing wealth.
The love of money, as the bible verse says, is the root of all evil, especially when people feel justified in entering win/lose relationships to gain more of it.
Rather than shying away from wealth, it’s more effective to generate wealth and use it for good.
You can’t pour from an empty cup
Creating positive change in your community requires a great deal of energy.
It takes time, attention, money, enthusiasm, a loyal audience and a talented team.
At first, you can begin building these without spending much money.
Eventually though, you run out of pro-bono energy and need to compensate people for the effort they’re expending.
This is great – you generate meaningful employment for people you care about – but it requires a sustained pool of money.
The tight-assed approach doesn’t scale, instead creating a culture of scarcity than undermines your good intentions.
If there’s money in the bank, you can use it to advance your business or your cause.
Your legal status does not make you a saint (or sinner)
I know a lot of awful not-for-profits, who waste their resources and spin their wheels.
I know a lot of wonderful for-profit companies, who make a real difference to their community.
The absence of profit does not make you a saint, and the presence of profit does not make you a sinner.
What matters is your measurable social outcomes and your integrity.
If you’ve prioritised both of those, pick whatever legal structure makes the most sense for your business and your cause, then let your results do the talking.
Numbers are everyone’s business
Every member of a team should have an understanding over how their role contributes to the business.
They don’t need to be a CFO, but they should understand how their work spends money and generates value, and have a sense of whether they’re a net contributor or a net detractor.
This is doubly true for founding teams – everyone needs to have a basic understanding over the financial health of the business.
If they don’t, how are they expected to make helpful choices?
Price is not a reflection of your worth as a person
Setting prices is a tricky art, requiring a good knowledge of what things cost to produce and what the market is willing to pay.
It is not a psychological self-evaluation, where you let your self-worth shape your prices.
Just because you made something doesn’t mean it should be cheap.
Just because you knew how to solve a problem doesn’t mean it wasn’t immensely valuable to the customer.
Just because you feel like an imposter doesn’t mean you are an imposter.
You are not going to be everyone’s cup of tea
Very, very few businesses are genuinely for “everyone”.
Some people won’t like your business – some will see you as too extravagant, others will see you as too cheap, too bland or even too niche.
Your job is not to adjust your menu to please every single person, it’s not possible.
Someone is going to miss out.
Attempts to include every conceivable customer raise extra headaches, making your business either too complex or too vanilla.
By accepting this from the outset, even celebrating it, we can ask a better question:
How might we become some people’s favourite cup of tea?
It’s more lucrative to delight part of the market than to try and appease literally everyone.
Costs are like fingernails – you have to trim them constantly
Most parts of running a business become more expensive over time – more meetings, more maintenance, inflation, pay raises, larger premises, replacing equipment, etc.
Very rarely will a cost shrink on its own – you’re going to have to seek out opportunities to trim them.
The task is never-ending, there will always be a need to make systems more efficient, cut the underperforming product offerings, and re-allocate your time towards the most valuable tasks in your business.
It’s easier to do this on an ongoing basis, rather than leaving it too late and then attempting a big overcorrection that hurts your culture and reputation.
Cash Cows, Small Margins and Loss Leaders are all excellent – in the right proportion
There’s nothing wrong with a Cash Cow, a product or service that delights a customer and makes a hefty margin.
There’s nothing wrong with Small Margin products and services, which cover their own costs and a bit more.
There’s nothing wrong with a Loss Leader, which doesn’t generate income immediately but leads to a Cash Cow or Small Margin sale in the future.
However, these three must be in balance.
Too much of the loss making sales can give you cash flow problems, so we want to grow them in proportion with the surplus-generating sales.
What gets measured gets managed
It’s very hard to improve something you’re not measuring.
Our natural tendency is to take proactive steps to fix whatever we monitor, like how wearing an activity tracker causes you to take more steps each day.
If you believe something is important, you’ll want a way of measuring it and tracking how it is performing.
Tradeoffs are the essence of strategy
People think that strategy is about saying no to the bad things and saying yes to the good.
Not true – that’s called common sense.
Strategy is about saying no to good things, in order to say yes to the best.
That means tradeoffs – these decisions sting at first but pay off later.
You might have seen examples of this in quotes like “Good, Fast, Cheap: pick any two”.
Customers and team members are more understanding than you think, so long as you deliver on the strengths you’ve promised.
It might be reduced choices in exchange for exceptional quality.
It might be higher salaries in exchange for long hours.
It might be higher prices in exchange for indulging challenging customers.
It might be lower margins in exchange for increased certainty.
The important thing is that you don’t pretend that you can have it all, certainly not from the beginning.
Embrace the tradeoffs and pick what matters to you the most.
Startups can to do things that don’t scale
We celebrate “scalability” as a measure of business success, because it can be replicated by another team in another market.
While you might reach this point eventually, startups are allowed do things that don’t scale, at least while they are figuring out their model.
That means you can use your own car for deliveries, borrow the expertise of your friends and family, go over the top to win a customer, borrow equipment you can’t afford to buy, or work a lot of unpaid hours.
That’s part of the journey – you can afford to be cheeky while you’re validating your model, and take advantage of your perks and free kicks without guilt.
Established businesses should be able to pay proper rates
The flip side of the above principle is that an established company should not need to constantly cut corners.
No underpayments, no unfair expectations of staff, no burning the candle at both ends.
A business should be able to pay its bills, without resorting to illegal and immoral tactics.
Yes, you’ll find plenty of examples of big businesses cutting corners, but these approaches usually signal the end of the glory days.
“Cash flow is more important than your mother”
Without cash in the bank, you are not a business.
Trading while insolvent is illegal, no matter how “promising” your ideas might be.
Cash is like the petrol in your car, and as every driver knows, it is essential that you know how much you have in the tank, and how far away you are from the nearest service station.
It’s not enough to have done the work either, you need a system for ensuring that you get paid what you’re owed, periodically, without delay or headaches.
This might mean you pause long term projects to focus on short term revenue in difficult times – it might be ugly, but it keeps your business alive.
Tax is not the enemy, but it pays to be smart
Paying tax might not be so bad; it means you’re earning income and have the ability to support important social services.
The aim is to pay lots of tax, but no more than necessary.
We want an accurate understanding of what is our fair contribution, by taking advantage of all the relevant deductions, without resorting to evasion.
We can save thousands of dollars a year by learning the intricacies of our tax laws, but want to stop short of anything that might land us on the front of the newspaper.
Budgets let us tell our money where to go, rather than wondering where it went
Budgeting is a fancy word for planning – planning where we want our money to go.
A budget doesn’t magically change our situation, but it forces us to choose where we want to be spending our dollars, and where we want to be saving them.
There is zero reason to operate without a budget, it puts you at the mercy of momentum rather than controlling your momentum.
Turnover is vanity, profit is sanity
Turnover sounds impressive, but it’s not meaningful on its own.
If you grow your turnover from $2m to $4m, but your costs go from $1.8m to $4.6m, you have a problem.
In that scenario, it would be better to grow slower while controlling your costs, so that you’re likely to make money each year.
Profits are what keep you alive.
Unsustainable growth might work for a season, but not indefinitely.
Better to be a smaller, profitable business than a turnover machine that goes broke.
Financial metrics are great in combination with other metrics
The above is a great example of why one single metric distorts our view.
My guess is that your financial goals only matter to you if they are matched with other goals.
For example, people who want to be famous also want to be respected – there’s not much glory in being famous and disliked.
People who want to earn more money also want an increase in their quality of life, no point earning millions if they make you miserable.
In our businesses, we want to see higher turnover alongside higher profits.
We want to see increased customer numbers alongside increased customer satisfaction scores.
We want to see an increase in headcount alongside an increased profit per headcount.
Whenever you go to pick a metric, ask yourself what other metrics will you need to improve in tandem.
We can’t afford to have bottlenecks and dependencies
It’s easy to become focused on the current financial performance of your company, and ignore the long term growth prospects.
For example, if you double your number of customers but every transaction needs a face-to-face conversation with you/the founder, tripling your sales will mean tripling your work.
A bottleneck is the narrowest part of your customer journey, such as your sales channels, your retail space, your checkout, your delivery team or your back-of-house fulfilment system.
A dependency is when a task must be done by a scarce resource, such as a key person or a specific piece of equipment.
If they were to leave or that equipment needed repair, do you still have a functioning business?
We want to remove these bottlenecks and dependencies; redesigning how we serve our customers so that we have interchangeable people and processes.
This gives you the ability to take a holiday, removes the stress of an expensive breakdown, and ensures you can’t be held over a barrel.
Assets are what make your business valuable
The way to avoid bottlenecks and dependencies is to create assets.
Assets are what help your business generate revenue, with or without you in the room.
There are physical assets like machinery, land, signage, and your fitout.
There are digital assets like your website, video content, customer data or training manuals.
There are intangible assets like your brand, reputation, trade secrets and methodologies.
These assets let you bring in new team members, expand into new markets, serve more people at once and potentially sell the business for an impressive amount in the future.
If the whole show depends on you showing up every day to make money, it’s a job and not a business.
Your first (or next) priority is to get financial clarity
If nothing else, I hope you see the need to create some clarity around your finances.
There is no possible upside to keeping yourself in the dark.
By establishing clarity on the numbers today, we can identify our strengths, weaknesses and interesting questions to explore next.
That lets us draft better business models for the future, designing a business that achieves our overall goals, while also removing the threats and anxieties that could otherwise ruin the whole company.
The best part about getting clarity is that it’s genuinely interesting.
You’ll be interested in where your revenue comes from.
You’ll be interested in how much it costs to create each product/service.
You’ll be interested in identifying exactly when you break even.
What you build next and how much money you make is up to you – these principles give you clarity, choices and freedom.
My suggestion is to assess each of them again and decide if you truly agree.
Don’t just take my word for it, they should be self-evident.
Finally, I recommend working with your team to create any additional financial principles that you believe are important.
Principles help your team understand the non-negotiables of your business, and spare you from fights and nasty surprises in the future.
