M.E. Program Coursework

Posts in this section of my blog are relative to my Masters of Entrepreneurship coursework.

This section curates the program work to make it easier for classmates to find and review posts about the current course.
The work appears in reverse chronological order of all classes.

Click on the link below to read work from a specific class.

ENT600 - Entrepreneurial Planning

ENT601 - Entrepreneurial Innovation

ENT610 - Entrepreneurial Creation

ENT640 - Entrepreneurial Feasibility Analysis

ENT645 - Entrepreneurial Marketing

ENT650 - Advanced Entrepreneurial Finance

ENT670 - Advanced Entrepreneurial Strategy

Hiring People Like You

September 15, 2018 ENT600 - Entrepreneurial Planning, Entrepreneurship, Graduate Program Coursework, Insights and growth Comments (0) 17

You will have the desire to hire people like you when you're an entrepreneur.

Leveraging social capital to build your founding team makes it easy to hire people like you. People with your values, your background, and a substantially similar knowledge base can be advantageous for you, the founder. You’ll have a common language, communication may be more comfortable, it will take less time to get those new hires up to speed, and you will have greater confidence in their ability to achieve your goals and objectives (Wasserman, 2012). Hiring people like you might seem to be a smart business choice.

When you hire, people like you are probably hiring them because you have had a good working relationship in the past. You hire people you like and people with whom you enjoy working. You hire them because your experience tells you they are good at what they do. You hire them because although they have different areas of expertise—sales, marketing, or finance—they are likely to have similar backgrounds, networks, and possibly industry knowledge. Arguably, this may give you an advantage at first. Surrounding yourself with people like you when you’re risking everything else to get your business off the ground will provide some comfort. On the surface this seems rational; homogeneous teams may make things a little easier in the beginning but are likely to be the cause of stress as your business grows.

Hiring people like you means you may be hiring people who have not just similar strengths, but also similar weaknesses. Hiring people like you may also mean few will challenge your view of market opportunities, customer targets, or product features and benefits. People like you will tend to see the world in much the same way as you. And this might mean you miss business opportunities because hiring people like you limit your ability to see much of anything different than you may see it. Hiring people too much like you may well restrict your long-term success in business.

Hire people who have different backgrounds, education, and experiences. Hire those with a different world view, a different attitude, and from a different place in the community and the world. Cultivate this diversity within your company because it is this diversity that will help you identify and exploit opportunities for business growth. Hire people whose strengths bolster your weaknesses. Hire people who do things differently than you, who challenge your thinking, who push your buttons, who make you question your decisions. And listen to them. Surprising as it may seem at times, you do not have all the answers. The input of others—people who are not like you—can make you a better in business, a stronger leader, and often, a better person.

When you surround yourself with people like you, you will get a company built in your image. And as enticing as this might sound, it will likely limit your ability to achieve those business goals to which you aspire. Don't give in to the desire to hire people like you.

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Reference

Wasserman, N. (2012). The Founder's Dilemma. Princeton: Princeton University Press.

 

Photo by Andrew Wulf on Unsplash

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Are you building the right kind of capital for your startup?

September 8, 2018 ENT600 - Entrepreneurial Planning, Graduate Program Coursework Comments (2) 38

In its original use the word, “capital,” referred to the number of cattle a person might own. The headcount of cattle and total assets of the owner were often synonymous in ancient Greece and Rome, so capital took on the broader meaning of “wealth” until sometime in the thirteenth century when it evolved to mean money advanced to an entrepreneur to start a business (Hodgson, 2014). Wealth created through goods and stock—assets that could be turned into cash for investment—became the primary definition of the word capital for more than 500 years.

In the eighteenth century, industrialization changed the economic structure. Labor, as well as money, became a critical factor in the ability to create wealth. Economist Adam Smith recognized the importance of labor in the creation of new products and introduced the idea that “capital” applies to people as well as things (Smith, 1776). Karl Marx expanded on the Smith’s idea, arguing that “capital is not just things or people, but a social relationship between people, established by the instrumentality of things” (Hodgson).  And the concept of capital grew again—financial, human, and social.

In modern economics, capital is typically defined as an asset that you can use to produce something that is economically useful to a business or an individual.  The word, then, has different meaning depending upon its context (Goodwin, 2003). The most common types of capital are:

  • Financial – referring to an investment that produces something of value;
  • Natural – involving the supply of natural resources in any form that plays a productive process in economic gain;
  • Human – referring to individual education, skills, abilities, and labor used in some combination to produce assets for economic benefit;
  • Produced (Physical) – relating to those physical assets (products or objects) created for sale by applying Human Capital to Natural Capital for economic gain;
  • Social – referring to the goodwill, trust, shared values and social knowledge that, in combination, facilitates a financial benefit.

Even with these different meanings, you still might think capital is synonymous with money. And it would make sense since if you’re a founder, you are spending a lot of time raising and worrying about financial capital.

Indeed, financial capital is essential to get your business off the ground and keep it going. However, human capital is required to strengthen your weaknesses and often to produce a physical product, and your social capital is necessary to attract employees, customers, advisors, and investors (Wasserman, 2012). For those of you that manufacture a product, access to natural capital supports your ability to create produced capital which is the output that generates the revenue necessary for you and your company to thrive.

If you consider the different context in which the word capital can be used, you might begin to reconsider which type of capital should become your priority. Should you still concentrate on building financial capital first? Maybe.

Of all the capital types, it might be more critical for you to first invest in building your social capital. Some argue that social capital—the trust and goodwill you have created with others—might make it easier to raise financial capital, develop supply networks, entice customers, and find employees willing to help you accomplish your goals (Wasserman, 2012). Most successful entrepreneurs will tell you a robust network of support is critical to building sustainable ventures. Your social capital and your personal network is an essential part of your success.

Maybe the ancient Greeks and Romans were on to something when they considered capital to be synonymous with wealth. Perhaps they understood that wealth was rooted as much in the social connection as it was in financial assets. Wealth is measured in many ways, but social capital may well be a good predictor of financial wealth.

What do you think? Is social capital the key to building wealth and financial success?

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References

Goodwin, N. R. (2003, September). Five Kinds of Capital: Useful Concepts for Sustainable Development (Working Paper No. 03-07). Retrieved September 9, 2018, from Global Development and Environment Institute: http://www.ase.tufts.edu/gdae/publications/working_papers/03-07sustainabledevelopment.PDF

Hodgson, G. M. (2014, 4 April). What is capital? Economists and socialists have changed its meaning: Should it be changed back? Cambridge Journal of Economics, 1063-1086. doi:10.1093/cje/beu013

Smith, A. (1776). Wealth of Nations (Annotated edition, 2003 ed.). Bantam Classics.

Wasserman, N. (2012). The Founders Dilemma. Princeton: Princeton University Press.

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Choosing between wealth and control

August 30, 2018 ENT600 - Entrepreneurial Planning Comments (8) 84

You’re an entrepreneur. You identify a problem, come up with a solution, and then launch a business to deliver that solution to the marketplace. And as the company grows, you continue to exercise control over every aspect of it, because after all, it is your idea and your solution, so there is no one better to ensure the vision of the company than you, it’s creator.

Until you’re not.

Many startup founders desire to maintain control as the primary means to achieving their goals with their business. One of those goals, of course, is solving that problem on which the company is built. However, many of the other goals are much more personal. Things like personal pride and wealth, for example, come to mind. Thanks to men like Jobs, Gates, and Zuckerberg, almost every first-time entrepreneur has aspirations of building something big by controlling everything and then gaining fame and a fortune when the company goes public.

It rarely happens.

Pride and personal recognition have fanned the flames of more crashing businesses, than the successful companies those same goals have fueled. Control is the problem for founders who, like Yertle in Dr. Seuss’s Yertle the Turtle, desire “to be king of all they can see” (Geisel, 1958). A king might see the wealth in the distance, but eventually, somebody sneezes, the king loses control, and everything comes tumbling down.

Being a king and building wealth are not mutually inclusive. Some research suggests that if you focus on maintaining control of your business you may become king, but it is unlikely you will ever create significant wealth. And if you focus on building wealth, it is inevitable that you will give up control (Wasserman, 2012). It is rare for an entrepreneur to maintain control and achieve wealth.

Here’s why: Like it or not, your business will inevitably outpace your skills, abilities, and expertise. If you believe controlling all aspects of the company will ensure your success, it is unlikely you’ll recognize when your company has outgrown you. You might be the king, but you’re likely to have little else. Plus, investors don’t like kings all that much. Particularly once you’re out of the startup phase.

Whereas if you give up control, delegating to those individuals with expertise in their designated areas of your business, while you focus on building the financial value of the company, you will be more likely to create wealth. Investors like delegation. It allows you, and everyone else in the company, to focus on those individual strengths that build wealth. Even Jobs, Gates, and Zuckerberg eventually learned the only way to create real wealth was to give up control.

Which is more important to you, wealth or control? Now, that you know, how will you structure your business to achieve your goals?

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References

Geisel, T. (. (1958). Yertle The Turtle. New York: Random House.

Wasserman, N. (2012). The Founder’s Dilemma. Princeton: Princeton University Press.

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Interview: ClassB CEO Eric Hilferding on Entrepreneurship

March 8, 2018 ENT670 – Adv. Entrepreneurial Strategy, Graduate Program Coursework, Interviews Comments (0) 495

The following is an interview with Eric Hilferding, CEO of ClassB, a custom t-shirt manufacturer, and printer for my graduate coursework in entrepreneurship. Eric and I first met in 2005 when I was with the Boy Scouts of America. His company was one of the BSA's first licensees in the revamped licensing program. We became fast friends and I have long admired his attention to detail, his creativity, and his commitment to service.  

 

Eric Hilferding of ClassBQ. Tell me a little about ClassB and your role with the company.

A. ClassB is a provider of custom decorated goods including t-shirts, embroidery and promotional products to primarily nonprofit organizations. The company started in 1982. We currently have 38 full-time employees. We focus on having a great customer experience. The internal motto is we sell service not t-shirts. I am the CEO of ClassB and one of the two company founders back in 1982. I have been formally running the company since the mid 1990’s.

Q. Did you have any entrepreneurial experience or education before launching the company?

A. I have zero business or entrepreneurial education - I have a BA in History. Luckily, learning about running a business was always a part of my life. I started working at around age 8 at my grandfather's lumber yard. My parents often discussed business at the dinner table.

When my mother and I started ClassB, all immediate family members eventually were employed. I read profusely to fill gaps in my knowledge. I was very lucky to have my father with his extensive business knowledge available at all times. Without his experience, I would have failed many times over. Now I realize how right he was on everything.

Another key area is my Boy Scout experience. I learned so much by making lots of leadership mistakes in my Troop and working at Summer Camp. Having that sandbox to learn is one of the most valuable things I can imagine. If not for my parents and the Boy Scouts, my only business reference point would be work based sitcoms.

Q. What are you most passionate about and how does it tie to your work each day?

A. My main passion is that we treat customers right. It's probably some of the Boy Scout indoctrination. However, most of it is driven by a sense of perfection and trying to avoid the guilt of an unhappy customer. I obsess over a bad customer experience and have to process thru it to be able to move on. I get lots of satisfaction by improving things. I lose interest if things stagnate or a task becomes repetitive and no longer optimizable. The idea of constant iterative change and the occasional disruption suits me. I also enjoy the new things I have to figure out. On some days I’m a scientist, engineer, investigator, lawyer, judge or a plumber, etc. It’s never the same every day.

Q. Business owners have many responsibilities during the day. Some of those responsibilities are more challenging than others. What are a few of the things you find to be the hardest to do? What are some of the easiest? Moreover, why are these things easy or hard for you?

A. The hardest thing for me is finding uninterrupted time. Every day being different is great - having so much to do is a problem. I have lost weeks just trying to finish something in 30 min increments. Kind of related: the most challenging thing for me is finding good people - they make all the difference. I have learned to hire people that fill my weaknesses not people who are like me.

I can’t tell if someone is a good fit in an interview. I have to hire them and then decide in 2 weeks at most so I can circle back to my 2nd option. The destruction to customers, profitability, and other employees that a single person who is “not a good fit for the job” can bring is incredible. As long as I remember that, firing people is easy. If I forget, firing is a drawn out, expensive, painful to all parties process - especially me. The easy stuff is fixing systems and things - why because I’m a systems guy, not a people person.

Q. As an entrepreneur, there are all kinds of things that can affect the business. We could spend all day, every day, worrying about those things. What are some of the things that “keep you up at night?” And what do you do each day to mitigate those worries?

A. I worry a lot - to the point of being unhealthy. I have a terrible fear of not doing things correctly - still a Boy Scout in some ways. I always strive to go above and beyond. I always play things straight - I assume that everything will always be discovered at some point - so it should be done in a way that would be correct from the get-go.

My biggest fears are someone taking advantage of us. This comes in two forms - frivolous lawsuits and unfairly instituted/ enforced regulations. I have seen a few ridiculous claims - I have a good family lawyer to pass them off. I also worry that someday an employee here makes a small mistake that destroys the company, puts all my employees out of work, and puts me in bankruptcy.

Many regulations often require academic-like responses, seem punitive, or meant for an unspecified situation—they are a time and soul killer. My fear comes in because they often seem to be unfairly applied. Unfortunately, you never know for sure how to comply or if the rule is real. You have to wait time to have an idea. It’s the uncertainty that gets me. The personal interpretation of a regulation by a single inspector has been devastating in time and money.

I mitigate these two things by trying not to think of them. I do all I can to do the right thing anyway and just hope.

Q. How do you motivate yourself each day? What do you do to let off steam?

A. Motivating is easy for me - I’ve worked all my life, so has everyone in my family. I’m a workaholic for sure. When things become overwhelming as they often do, I just have to remember to ignore the 100 things going on and move one thing forward at a time. Eventually, I can work out of the mess. I wish I could say being a business owner is glamorous - clearly, I’m doing it wrong, but my 'letting off steam' is maybe two days a year where I get to go hiking in the desert with not a soul in sight for miles.

Q. What’s your favorite customer story from your business?

A. For owners and managers, you really only hear the problems. It’s great you ask this question because it's important not to lose sight of the daily things that go right. Ninety-eight percent of the time, things go good or perfect. The customer service people at ClassB get to hear all the good stories. I encourage them to share with everyone. We have the entire wall of the customer service area with photos and experiences that customers have shared with us.

I think my favorite situations are when we go out of our way big time to get the customer their shirts in time for an event that has special meaning for them. We have turned out shirts in a day and overnighted them because the customer made a mistake and we wanted to make it right for them. The best customer experiences come from looking for the customers best interests and ignoring the effect on any single transaction. Bake in some money to your price to be able to treat them the way you wish things worked.

Q. In your experience, what have you found works best to motivate employees?

A. Wow, have I worked the gamut on that! The one thing I have learned the hard way is don’t listen to what they say will motivate them. Money, benefits, and perks only work in certain market conditions or individual situations and are secondary or even a counter to the true motivator. The number one motivator is good managers. Those managers have to have people skills. They have to make the work environment-friendly, positive, professional, productive, fun and fair. They have to respect all the
employees by having their fellow employees have a purpose and contribute to the team.

All managers have to pull their weight and show appreciation for everyone's efforts. They also have to hold a high standard. If all that is in place - employees will be close to self-motivated and not look to leave. They are more productive, and guess what: Now those managers worth more, and they get more money. Try to work it backward, and it does not work at all. I personally am a horrible motivator - I am lucky that I have managers that are really good at that.

Q. Entrepreneurs are risk-takers. We know there’s a probably a more significant chance for failure than for success. Still, we move forward. As you think about your entrepreneurial plans, what is your worst-case scenario? What makes that the “worst” for you?

A. I always view the current situation as transitory. What is working today will not at some point. All I can do is keep moving and try my best to adjust.

I think my worst case scenario is that I get so caught up in the day to day issues of running my business that I lose the big view of where the market is going, and we fall behind. Know this always happening to an extent. I don’t want to fail my family or employees because of something I missed. I don’t want to look back after the failure and realize I spent too much time on ABC instead of XYZ.

There is a burden in having so many people and their families relying on you for their lively hood. I have maybe 60-100 people indirectly or directly relying on me. I do not want to fail them. If it was just me, failure is easy and guilt-free - plus the Boy Scouts taught me how to survive in the woods if need be.

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Stop focusing on your product and start focusing on your customer

February 19, 2018 ENT670 – Adv. Entrepreneurial Strategy, Entrepreneurship Comments (0) 502

The most common definition of business suggests it is the “organized effort of individuals to produce and sell, for a profit, the goods and services that satisfy society’s needs” (Pride, Hughes, & Kapoor, 2013). In a manufacturing-driven society, this definition might be valid, yet it arguably emphasizes an outward-in approach to product and service development and in doing so has potentially set a generation or more entrepreneurs off on the wrong foot. So many entrepreneurs believe that the “thing”—the product or service—they have created will “satisfy society’s needs” without giving enough thought to understanding what society needs, values, and expects. The focus on the thing poses one of the most significant long-term barriers to success for entrepreneurs.

Entrepreneurs devote too much time and energy to the perfect execution of the product or service at the outset. In fact, many entrepreneurs invest—maybe even over-invest—in the thing before they understand if there’s an actual market for the thing. Not long ago, I spoke with an entrepreneur who had an idea for a new technology product and a pool of funds to develop the product. He was searching for a developer to help get this product off the ground but had not thoroughly researched the market opportunity for what he was about to create. Moreover, he had done little more than cursory research on his target customer. His focus was on product execution, rather than customer understanding. Unfortunately, this approach is all too common with startup entrepreneurs. A good product or service—one that meets a customer's desires—will be far better than a great product or service that misses that mark.

Steve Jobs once said, “Customer’s don’t know what they want until we have shown them” (Isaacson, 2011). To Jobs’ point, when new ideas for products and services are solicited from customers, those ideas tend to mirror competitive products in the marketplace or be derivations of products or services already available (Furnham, 2000). However, this should not suggest that knowledge of the target customer and customer input is without value. In fact, one might argue that Jobs and his team developed their products based on a clear understanding of the needs, values, and expectations of their target customer. Apple’s customers, for example, have come to expect the most innovative products, of the highest quality, that enable a short learning curve, efficient use, and support the simultaneous engagement with other products (Hyungu, 2013). Apple’s focus on delivering products to that target customer, and then taking care of that customer with committed customer service, elicits profound loyalty to the company and its products.

Customers are the only thing that matter to a business. Regardless of the product or service offered, if there are no customers, there is no business. It is surprising how many entrepreneurs start their business with an idea of a product or service and a detailed plan for execution of that offering, without a clear understanding of the customer. The customer’s needs, values, and expectations are never thoroughly researched, and the thing, as developed, misses the mark with the intended audience.

All of this is not to say that the thing—the product or service—is not essential. It is. However, a product or service is only relevant in the context of the customer’s needs, values, and expectations. A product and service placed at the center of the business, particularly in today’s business environment, may work in the near term but is not sustainable. The customer must be at the center of the enterprise for a business to have long-term success.

Perhaps a more appropriate definition of a business for our current environment might be “the organized effort of individuals to satisfy society’s needs, by producing and selling goods and services, for a profit.” Changing this definition might encourage entrepreneurs to focus first on the customer, and make product execution and delivery the second step in the business development process. Putting the prospective customer first might well make all the difference between success and failure of the next entrepreneurial venture.

What do you think? Should the customer needs, values, and expectations trump sheltered product development?

 

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References

Furnham, A. (2000). The Brainstorming Myth. Business Strategy Review, 11(4), 21-28.

Hyungu, K. (2013, September). To Be A True Industry Leader: Apple Inc. and Microsoft Corporation in Consumer. Leadership & Organizational Management Journal, 2013(3), 114-130.

Isaacson, W. (2011). Steve Jobs. New York, NY, USA: Simon & Schuster.

Pride, W., Hughes, R., & Kapoor, J. (2013). Business (12th ed.). Cengage Learning.

 

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The Delicate Balance of Inventory Management

October 9, 2017 ENT650 – Adv. Entrepreneurial Finance, Graduate Program Coursework Comments (2) 724

ENT650 - Week 8

Any business that holds and manages inventory does so with the goal of selling that inventory to produce revenue for the company. The key is to maintain just enough to meet demand, but not so much as to have money tied up in inventory for a period longer than necessary. No business holding inventory desires to have more, or less, inventory than is needed to meet customer demand at any given time because failure to meet customer demand will negatively influence sales and profitability. These factors make inventory management one of the most significant challenges any business, but particularly a small business, can encounter.

Depending on the kind of business, there can be many different types of inventory. For example, manufacturers will likely have an inventory of raw materials, work-in-progress inventory, and finished goods inventory at a minimum. A retailer might have merchandise inventory, a service business might have an inventory of hours available to resell, and a magazine or online publication might have an inventory of space that could be filled with advertisements. How each business type manages its inventory may be a little different, but each has the same purpose in mind: To maximize cash flow.

Demand forecasts are an integral part of inventory management. If the business demand forecasts are incorrect, it can be a significant blow to cash flow. For example, if the business assumes the demand will be high, and the assumption is erroneous, it may have too much cash tied up in inventory assets, which in turn would restrict cash flow because the product on hand is not selling as predicted. Conversely, if the business predicts the demand will be low, and the assumption is incorrect, it may not have enough inventory to meet customer expectations, resulting in lost sales and therefore tighter cash flow.

One of the simplest ways to manage physical inventory is to measure productivity and turnover (Traster, 2007). The idea here is to determine how often during the year the business can convert its inventory assets into cash (learn more about inventory turnover and other financial ratios here). Assessing the most appropriate turnover rates is a factor of a company’s sales volume. The goal is to either turn the inventory more times over the course of the year or reduce the amount of inventory held at any given time to maximize cash availability. If money gets tight, it is smart to evaluate the slower moving inventory and determine how price adjustments might help improve sales and increase cash flow, even if the margin on the sale is lower than desired.

Another way to manage inventory levels to maximize cash is to improve supply chain processes using a just-in-time model. For example, gaining agreement from a supplier of raw goods to hold those items necessary to produce a finished product in the warehouse, but not take them into inventory until manufacturing demand requires it, means raw materials are not in stock before necessary. This is one way to hold on to cash a little longer. Another approach might be to make a process change and to delay final assembly and packaging of the product until just before a customer may need the product, thereby reducing labor costs and inventory levels until the very minute (Anderson, 2010). These are only a couple of ways that small modifications in the supply chain process might reduce inventory levels and improve cash flow.

Service businesses and publishers have a slightly different problem. In these companies, fixed inventory is available, and when it is not used in the defined period, it is revenue lost. A consulting firm or advertising agency might have calculated its available inventory of hours by assuming that every revenue-producing person should bill (to clients) an average of 95% of his or her hours per each week for the firm to be successful. Assuming a 40-hour work week and 30-minutes for lunch each day, each should bill 35.625 hours per week. If less than 35.625 hours are billed, that inventory of hours and the revenue it would have produced is lost. The firm must somehow make up that lost revenue elsewhere. Sometimes, hourly rates are increased over time to help make up the difference. But often the solution means firing those who consistently under-perform.

Publishers allocate and maintain an inventory of advertising space within a publication for a specific time. If the advertising does not sell before the publishing deadlines, the revenue is lost. To offset lost revenue, the publisher might offer deep discounts on the unsold space at the last minute to improve cash flow. The publisher might also increase the inventory availability in subsequent issues in an attempt to recoup revenue lost to unsold advertising space.

Inventory management is an art and science. It requires diligence, a reliable inventory system, and designated staff to maximize cash efficiencies. While different business types have different requirements for inventory levels, all businesses must have a keen understanding of their customer needs and market demands to forecast need. Moreover, companies must have a detailed knowledge and control of cost and production schedule to ramp up, or down, depending on the demand forecast. Striking the proper balance with inventory is vital to maximizing cash flow.

 

References

Anderson, L. (2010). Accelerating Cash Flow Through Supply-Chain Innovation. MWorld, 9(1), pp. 36-38.

Traster, T. (2007, May 14). 5 steps to get a grip on inventory. Crain’s New York Business, 23(20).

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How to use Financial Ratios

October 5, 2017 ENT650 – Adv. Entrepreneurial Finance, Graduate Program Coursework Comments (4) 783

ENT650 - WEEK 7

In an earlier post, Financial Ratio Analysis and the Entrepreneur, I shared some insights on Financial Ratio Analysis and how investors and lenders may consider and use financial ratios to determine whether to invest or lend to an entrepreneur. Entrepreneurs should also understand how to use financial ratios in the regular course of business operations.  Each financial ratio has a purpose, and when compared to industry benchmarks, a ratio can provide insights as to a venture’s performance as well as help set stretch goals for business improvements and growth.

The most common financial ratios used by investors and lenders include:

Leverage Ratios

These ratios indicate the long-term solvency and highlight the extent long-term debt is used to support the venture. Leverage Ratios include:

  • Debt-to-Equity Ratio which measures how much debt is used to run the business.
  • Debt-to-Asset Ratio which measures the percentage of the company’s assets that are financed by creditors.

Learn more about Leverage Ratios and how to calculate them here.

Liquidity Ratios

These ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health. Liquidity Ratios include:

  • Current Ratio which estimates the company’s ability to generate cash to meet its short-term commitments.
  • Quick Ratio which measures the ability to access cash quickly for immediate demands.

Learn more about Liquidity Ratios and how to calculate them here.

Efficiency Ratios

These ratios offer insights into operations and help to spot problem areas related to inventory management, cash flow, and collections. Efficiency Ratios include:

  • Inventory Turn-over which examines how long it takes inventory to be sold and replaced within a year.
  • Average Collection Period which looks at the average number of days it takes customers to pay for goods or services.

Learn more about Efficiency Ratios and how to calculate them here.

Profitability Ratios

These ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry. Profitability Ratios include:

  • Net Profit Margin which measures how much a company earns after taxes relative to sales.
  • Operating Profit Margin which measures earnings before interest and taxes (EBIT).
  • Return on Assets which provides insights on how well management is using the company’s resources.
  • Return on Equity which measures how much the company is earning for each invested dollar.

Learn more about Profitability Ratios and how to calculate them here.

As I mentioned in the previous post, these are just a few of the ratios used in determining the health and viability of a given business. Together with other factors such as customer acquisition costs, these ratios provide a great set of tools for managing an entrepreneurial venture. Fully understanding these ratios and the implications on the venture will be beneficial for an entrepreneur before he or she seeks additional investment or debt financing.

 

Resources

Here are a few resources that might be beneficial for identifying industry comparisons for your industry:

  • RMA Annual Statement Studies. Data on business for comparisons

http://www.rmahq.org/annual-statement-studies/

  • Almanac of Business and Financial Ratios ($)

https://www.amazon.com/Almanac-Business-Industrial-Financial-Ratios

  • Financial Studies of Small Business ($ or library)

http://www.worldcat.org/title/financial-studies-of-the-small-business/oclc/45625113

  • Bank Rate Small Business Ratio Calculators

http://www.bankrate.com/nsccan/news/biz/bizcalcs/ratiocalcs.asp

 

Reference

Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.

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Financial Ratio Analysis and the Entrepreneur

October 5, 2017 ENT650 – Adv. Entrepreneurial Finance, Graduate Program Coursework Comments (4) 1118

ENT650 - WEEK 6

Lenders, and often investors, will calculate one or more financial ratios when reviewing an entrepreneur’s financial statements to gain a quick understanding of the health of the business before determining whether to lend or invest. Within an industry, there will be “good” and “bad” benchmarks against which the venture will be measured (Rogers, 2014). Investors and lenders will consider the particulars of a business and likely weight the importance of the ratios differently when comparing to the industry benchmarks.

Many financial ratios could be applied, but the following appears to be most common types (BDC Staff, n.d.):

Leverage Ratios. Leverage Ratios provide an indication of the long-term solvency and highlight the extent long-term debt is used to support the venture.

Liquidity Ratios. Liquidity Ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health.

Efficiency Ratios. Efficiency Ratios provide insights into operations and help to spot problem areas related to inventory management, cash flow, and collections.

Profitability Ratios. Profitability Ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry.

There are other ratios, of course, and as mentioned before investors particularly have ratios they rely on more based on their experience and industry knowledge. For example, a recent interview with an investor uncovered a preference for knowing the Customer Acquisition Costs. Customer Acquisition Costs are not often viewed as part of a Financial Ratio Analysis, but such factors are often important measures for both investors and entrepreneurs alike.

The entrepreneur, investor, and lender can gain useful information and financial trends on a business venture when using Financial Ratio Analysis. However, it is important to note that financial ratios have little meaning without comparison (Peavler, 2017). For example, a company can compare its ratios to those average ratios of their industries, but the best and most accurate comparisons come from using benchmark companies—high performing companies within their industry. Comparisons against these companies can create and encourage stretch goals for a business.

While Financial Ratio Analysis does provide numbers for performance comparison, it does not provide causation factors (Peavler, 2017). Moreover, identifying why certain ratios that are out of line with the benchmark comparisons is critical because it provides a starting point for correcting problems and improving financial performance.  Ratio analysis can have value for entrepreneurs but depending on where the venture when it is seeking funds, these ratios may or may not be helpful in securing financing.

Entrepreneurs seeking early-stage financing are more likely to encounter investors who value continual improvements in customer acquisition costs, improvements in customer engagement at the various points of contact, and repeat purchase or purchase frequency. These measures help the investor gauge the interest in the offered products and services and are often a good predictor of long-term revenue.

Conversely, established entrepreneurial ventures—those that have several years financial history—looking for ongoing financing are likely to find as much emphasis placed on financial ratios as is placed on the customer measures noted above. This particularly true with bank financing because bankers are more risk adverse and financial ratios when properly utilized, provide a more objective measure of a venture’s performance compared to its industry thereby giving bankers a greater level of comfort when lending money.

Entrepreneurs are often motivated to launch a business in part because of their interest and expertise in a specific domain area. However, many entrepreneurs may be less skilled when it comes to the business finances beyond the basics of revenue and expenses. As an entrepreneur’s business grows, understanding key aspects of finance becomes increasingly more important, particularly should he or she seek outside investment or financing. It is important to understand the basics of Financial Ratio Analysis and how it can be used to determine the health of a business before seeking investment or financing. Yet it is equally important to understand that Financial Ratio Analysis is only one tool in an investor or lender’s tool-box. And while it is an important tool, it is not the only tool that might be used, particularly by investors, when determining the probability of long-term success of an entrepreneurial venture.

 

References

BDC Staff. (n.d.). 4 Ways to Assess Your Business Performance Using Financial Ratios. (Business Development Bank Canada) Retrieved September 29, 2017, from bdc.ca: https://www.bdc.ca/en/articles-tools/money-finance/manage-finances/pages/financial-ratios-4-ways-assess-business.aspx

Peavler, R. (2017, February 28). Limitations of Ratio Analysis. Retrieved September 30, 2017, from thebalance.com: https://www.thebalance.com/limitations-of-financial-ratio-analysis-393236

Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.

 

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