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This article has been excerpted from The Business Rules, available from EntrepreneurPress.com.
Yeah, I know. Sounds obvious. But before you ignore me, I issue this challenge: Do you personally know anyone in your business or any other business that actually knows exactly what their costs are on a per item basis for every good or service going out the door? If you don't know what your costs are, and the guy next to you doesn't, then who does?
I was fortunate; I learned the importance of this pretty much right away. Mostly because my first business was a startup with literally no money and having a burn rate--or as plumbers refer to it, a drain that works better than the faucet--was simply not an option. Not even for one month.
If you don't know what your costs are on a per item basis in exhaustive detail, then you're hanging out on shaky ground. Businesses don't profit by accident. It happens by design. There's a difference between sale price and costs. And knowing this makes the difference between amateurs and professionals. If you don't know your exact costs, you have no right to be in business. And you probably won't be for very long.
While looking for acquisitions during the past 20 years, I have reviewed the financial records of hundreds of companies, and there were maybe a handful that knew their true costs on a per item basis. At first I assumed it was a local absurdity until I noticed it pretty much everywhere I looked. I then assumed it was a small business absurdity; it's not.
Despite hundreds of thousands of employees, in the 1980s General Motors didn't know which vehicles were profitable and which weren't. GM's William E. Hoglend, an executive vice president, said, "We never brought the numbers in to see how much we were making or losing on the Chevrolet Lumina."
During the 1999 antitrust litigation, a Microsoft economist testified that the company's accounting records were kept "by hand on sheets of paper" and "do not always arise to the level of sophistication one might expect." In response to this testimony, a Microsoft spokesperson noted, "We obviously have our sales receipts but how you assign profit is not something we have."
Anyone else? Robert Goizueta has stated that when he first took over the Coca-Cola Company, "Nobody had taken the time to explain what our cost of capital was. We made a study of the returns we were getting from our fountain business. And we found out that we were making much less than our cost of capital [selling below cost]. So what we thought was a great business was, in fact, a lousy business." And he knew how to fix it. Sell it for more than it cost you.
Let's look at one more large entity, although with a slightly different issue. Phil Carroll, CEO of Shell Oil Company, said, "The finance people kept the books, we believed, primarily to make reports to the outside world. Their information wasn't important inside. Nobody went to finance to find out how the business was working."
Finally, even governments can break this rule. It currently costs the U.S. Treasury more than 1.4 cents to create a penny.
General Motors, Microsoft, Coca-Cola, Shell Oil, the Federal Treasury. You think they're alone?
For more pointers on running a successful business, check out The Business Rules, available from EntrepreneurPress.com.