Sounds good, right? Who wouldn’t want more profit from less work?
This week, I was reminded of a few principles that I believe are vital in business, but I had lost my way with them.
Practice what you preach - For the most part, I follow the advice I give regarding finances quite well. The team treats me like every other client, and I have the same structure around my finance function as we provide to others.
However, I was lacking some external accountability and insights from trusted sources. No matter who we are or what our skill sets entail, as business owners, we can all find ourselves stuck in the weeds at times. We can be too close to our own business to see the glaringly obvious—even when it sticks out like a sore thumb! Sometimes, we need a little nudge from the plane, even when we’re excited about the jump!
That brings me to my second guiding principle, which had slipped my conscience - the Pareto Principle or the 80/20 rule.
The Pareto Principle specifies that 80% of consequences come from 20% of the causes. ie there is an unequal relationship between inputs and outputs
As in all aspects of life, this phenomenon occurs in every aspect of our businesses. For those experienced in project management, you will be well versed in the fact that 80% of the results will come from 20% of the time/effort.
The same is often true in your business’s bottom line. 20% of your efforts/services/products will generate 80% of your profit. Now think about how powerful it would be to be able to identify that 20% and go all in on that. It would transform your profit margins!
Let me share with you a real example (simplified and numbers changed for confidentiality) we came across when onboarding a new client last year.
This business was generating £100k profit, which the owner was fairly happy with, given how young the business was and its growth stage.
They had never looked at any real management accounts. Just the Annual Statutory accounts their accountant prepared and a cursory glance at the P+L report in Xero. This report was not customised for them and was based on the standard Xero chart of accounts. The chart of accounts is how you break down your sales, expenses and balance sheet items. So, as a standard, all sales go to one account.
When they came on board with us, we got to know the business and the owners. Where they were, how their business worked and what their goals were.
Then, we customised their chart of accounts to suit their business. This business had two main divisions, each providing different services to different clients. The new look chart of accounts in Xero brokedown sales by division and then product and some of the direct costs in the same way too.
Why was this important? It meant that when we produced their first ever proper set of management accounts at the end of the month, we could break down their sales and gross profit by these divisions.
What did we find? One division was actually generating £150k of profit, and the other was making a £50k loss…
Great Financial insights empower the business owner to make better business decisions!
And that is what they did. They decided to stop the loss-making division instantly, cut the amount of work they needed to deliver, and boost their profit by £50k.
Going back to my own business for a minute. This is what I have been awakened to this week. A change of strategy to refocus on the work that brings us most of our profit! One of my mentors asked me, “What would you do if you were being courageous? Clearly, there was a mix of fear and arrogance clinging to the current strategy. Arrogance because I thought I could buck the 80/20 rule and deliver on all aspects of my strategy at the same time - pure craziness. Then, the universe delivered exactly what I needed at this exact time in two ways - a frank talk from some very close friends to point this out and reading the book that reinforced this.
A strong recommendation for 10x is easier than 2x by San Sullivan and Ben Hardy.
Strong Management Accounts and understanding what they tell you are a genuine competitive advantage for small businesses.
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.