On one hand, marketing is an expense that needs to be controlled, just like all of your other expenses.  On the other hand, marketing is an investment, and the more you spend, the more you make.  Should your marketing costs be firmly budgeted, or should they be maximized for the greatest amount of sales in the shortest period of time?

Maximizing Marketing ROI

There’s no room for guessing here.  If you measure all the key aspects of your marketing, and you know, with certainty, exactly what your marketing return on investment (ROI) is, and you know your marketing generates a real profit, then your marketing costs should be approached very differently from the rest of your expenses.

In this case, you KNOW that every time you spend a marketing dollar, for example, you get $2.00 back.  Why would you want to limit yourself to $1000 when you could spend $100,000, or $1,000,000, or $10,000,000 and make that much more money?  When you’ve got a strong ROI, you’ve still got limitations.  In this case, you would limit your marketing budget based on your ability to cash flow the costs, your production capacity, and your ability to handle both known and unknown risks.  For example, in 2005 investors were making fortunes flipping properties – until the market changed.

Trial and Error

Many small businesses, however, do not have their marketing machine this finely tuned.  I was speaking with one of my clients last week, and when I asked her about her marketing efforts, she described the various ads she was running.  When I asked her which ad was most effective, she told me she didn’t know, because “that sort of thing is very difficult to track in this industry.”

If that sounds familiar, let me make 2 things very clear:

1. If you pay for advertising, you cannot afford ignorance about your marketing results, and
2. Without a system for measuring results, tracking things like this is very difficult in every industry.

We’ll look at some simple ways for tracking advertising results in a later post.  For the purposes of this budgeting discussion, I just want you to understand that spending money on advertising when you don’t know your ROI is one of the most common reasons businesses make so little profit.

If your business is in this position, here’s what you need to do:

1. Freeze your marketing budget right were it is. Don’t cancel your current advertising, and don’t spend even one more penny on additional advertising, no matter how much of a great deal it is that expires by the close of business tomorrow.
2. Put a plan in place, with a short deadline, to test and track your results. If you don’t know how, then bring in someone who does know how for some temporary help.  If you do know how, then why haven’t you done this already?  Most likely, it’s because you’re working so hard that you don’t have the time.  If that’s the case, you need to bring in someone who does know how for some temporary help.
3. Set a maximum marketing expense as part of a comprehensive budgeting process, and stick to it. This amount should be no more than you are currently spending, and in most cases should be less.  It should be low enough that, unless you are a recent start-up, should allow you to show at least a small net profit.  When it’s time to to test another advertising medium, pay for it by eliminating something already in your budget.
4. Once you know your average ROI, use it. This becomes your benchmark.  Change or eliminate the peices that provide the worst ROI, and replace them with something better.  Over time, your average ROI will improve, making you more and more profitable.

It was no surprise that over-valuations ran rampant, but what I was really glad to see was the care that the sharks took in determining the percent of ownership they would accept.  It was really quite simple.  If the shark thought the concept was profitable enough and the entrepreneur had a good grasp of the critical variables that need to be controlled for the business to succeed, then the shark would accept a 50% ownership share.  If the entrepreneur did not understand their critical variables, the sharks required at least 51% ownership before they would invest.  Obviously, they wanted the controlling interest to protect their investment from the entrepreneur they were partnering with.

In the worst cases, the entrepreneur was not only lacking insight into how their own business would function, but they vigorously defended their ignorance.  In these cases, there was no middle ground for the sharks.  They either wanted nothing to do with the business, or, if the concept had enough value, they would offer to buy 100%, take it or leave it.

So, if you went in front of the shark tank today, with your current business, how would you fare?  Would the sharks be comfortable investing in your business with you calling all the shots?

Maybe they would, maybe not.  If not, it’s because you’re missing some key components that are critical to your level of profitability.  If it’s not good enough for the sharks, don’t let it be good enough for you.

Use these simple steps to gain control of the profits in your business:

1. Identify the critical variables in your business
2. Implement a system to measure those variables
3. Track those measurements
4. Use that information in your decision making

4) I Know Everything I Need by Looking at my Bank Account Balance

It’s amazing how many times I’ve heard this!  Sure, your bank account balance is important, but you can’t manage your business effectively without additional information.  If your balance is getting higher, does that mean you’re more profitable?  Maybe it just means more of your bills are going unpaid, or you’re collecting on more of your past due receivables.  Maybe it’s just a reflection of better payment terms extended from some of your bigger suppliers, or maybe a vendor misplaced a large check you wrote, and you’ll be in deep trouble when they find it and cash it.  A declining bank balance could mean declining sales, but could happen just as easily during strong growth, when you’re spending more on materials to meet increasing demand.  The bottom line is that the bank balance by itself means very little.  To make effective decisions, it must be considered in conjunction with the changes shown in your other assets, liabilities, sales, and projected cash flows at a minimum.  Spend some time getting to know your balance sheet – it’s got your bank balance on it, as well as information on all of your other assets and liabilities.  Once you get comfortable with it, you’ll find it’s twenty times more helpful than your bank balance alone.

5) Watch All My Expenses, I Don’t Need a Budget

When it comes to budgeting, there are only two types of business executives.  One type uses self-adjusting budgets and regular budget variance reports to manage profits at a peak level, and the other type doesn’t understand exactly what this type of budgeting is or what it can do for your bottom line.  Which type are you?

6)      I Can Fix Anything By Increasing My Sales

This is the BIG ONE.  It incorrectly assumes that all sales are profitable, and that all financial problems are related to income.  Think about this for a minute: In the US, most people that win a lottery are broke before they win, and they’re even more broke after they win!  If being broke was an income problem, then the additional income provided by winning the lottery would fix the problem, but it never does.

Don’t get me wrong, increasing sales is usually a great thing.  But if your sales are driving revenue to increase by 20% per year, and your costs are increasing by 40% per year, you’re on the fast track to financial disaster.  Increasing sales will not help production issues, quality control problems, logistical errors, customer satisfaction issues, or a host of other problems, and in most cases, increasing your sales will make these problems worse.

Don’t put the cart before the horse.  As long as you have a reasonable level of sales (maybe not enough to reach your current break-even point, but enough to reach a reasonable break-even point) you need to work on your profitability first.   It’s a lot easier, and less expensive, to do this now and increase sales later than the other way around.

Link to part 1 of this post

If you’re in business for yourself, whether you’re planning your grand opening or a 25 year veteran, I wanted to take a few moments to discuss your expectations.  Science has shown that our expectations can have a significant effect on the outcome of an experiment, which is why scientists prefer double blind testing.  That’s every bit as true for the entrepreneur as well.

Many people are just looking for an income, and the concept of business seems so simple – buy low, sell high.  The purpose of a business is to generate a profit, and most people, especially business owners, think they understand that.  But there are a few assumptions, or traps, that get in the way of far too many business owners.  They really seem like common sense, which makes it so easy to fall prey to them.  Don’t let them destroy your profits.

1) I’m the owner, I don’t need a salary.

This cuts right to the core of what it really means to own a profitable business.  The successful business owner deserves to get paid for investing in the business, taking the business risks and being the creative force behind the business, whether she or he actually works in the business or not.  In addition, all employees of a business deserve to get paid a fair wage for the work they produce.  You would not expect an employee to continue working for your business if you stopped paying them, would you?  If you’re a business owner and you work for your business, you should get paid just like all of your other employees.  Conversely, if you do get paid a fair salary, and there are no profits at the end of the year, you don’t own a profitable business.   You might own a good job, but that’s not the same thing as a profitable business.  It is far easier to sell a business than a job when the time comes, and often selling “the job you own” is downright impossible.

2) Gross Profit is still profit.

I prefer the term “Gross Margin” over “Gross Profit” because I’ve seen too many business owners confuse gross profits and net profits.  “Gross Margin” is your revenue minus your direct expenses.  “Net Profit”, or simply “Profit”, is your revenue minus all of your expenses.  If you’ve paid your direct expenses, but you have not paid your overhead, it’s not profit!  I understand that it’s a whole lot easier to tell a business analyst that you’re making a 30% profit instead of showing a 2% loss, but you’re not fooling anyone but yourself.  If you haven’t factored in ALL of your expenses, it might be gross profit, but it is not profit.  You cannot fix a problem until you acknowledge there is a problem.

3) Cash Flow just means Profit, right?

Wrong.  Profit means your total expenses were less than your total income, but remember that profit is not always in cash.  Profit is sometimes visible as an increase in your bank account balance, but it can also be seen in other areas, such as an increase in your accounts receivable, an increase in your long term assets, or a decrease in your debts.  Cash Flow is all about when the money comes in, and when it goes out.  They are two separate things.  A profitable business that does not have the cash it needs to pay its bills can go just as bankrupt as a company with steady losses.  That’s why it is so important to manage both your profits and your cash flows.

Click to go to part 2 of this post