Business can be one big balancing act. Knowing when to increase or decrease weight and on which side of the fulcrum to do so is understanding where to find the inflection point. This means learning when to plow more money, people or other assets into a project in order to reach scale. Conversely, it can also help management identify when enough is enough and it’s time to pull the plug on an undertaking. Most big companies have legions of finance types who prepare pro formas, or what if projections, before spending the first dime on a new product, concept or capital expenditure.
Smaller, midsize and even quasi wannabe big companies too frequently launch significant efforts without thoroughly grasping what it will take to gain operating leverage where revenues can climb without adding additional permanent expenses. Failing to perform this exercise runs the risk of a company finding itself operating in a black hole without the foggiest idea how far down is down.
The answer can be found by comprehending the basic concept of “fixed cost, volume relationship.” I call this teeter-totter management, or knowing what it takes to tip the scale to generate free cash flow leading to profitability.
Everybody in business knows that in order to make money they have to take in more than they spend. Some costs are fixed, such as certain payroll or the people needed just to keep the lights on, combined with rent, and depreciation on equipment, just to name a few. Then there are the variable costs, including commissions paid to sales people and raw materials that are directly related to how much a company sells, also referred to as “cost of goods sold.”
When business gets difficult and organizations understand their variables costs like the back of their hand, good companies move quickly to reduce expenses to mitigate the cash burn rate without saving themselves out of business or doing too little too late.
Alternatively, when the good times seem to be on the horizon, knowing the inflection point of a business’s cost structure will enable a company to rapidly ramp up proactive spending to have more product, or staff for a service business, on hand to maximize the opportunity. This can enable a company to gain market share many times before the competition even has a clue that times are a changing.
When constructing a meaningful business plan, the balancing act is knowing how much you will have to spend before you can utter those coveted words: cha-ching
From a one-person company to corporate giants, the bottom line is having the discipline to create a series of what if scenarios before they occur.
Michael Feuer co-founded OfficeMax in 1988, with $20,000. During a 16-year span as CEO, he grew the company to 1,000 stores worldwide with sales of $5 billion.
