Making Business Decisions
Everyone who starts in business wants it to be a success. That could mean we gain a particular quality of life or we make the difference in the world that we intended. But for all businesses it also has to mean that we make money so that we have the resources to continue to be in business. To do that we need to put our resources in the right place. In this blog we share the Co- approach to making those decisions.
We know that there is a tendency in small businesses to make decisions based on gut instinct or preference. That is understandable. We are often the worker, manager and leader. Time is pressured and there’s a lot to be done. Where are you going to find the time or headspace to do anything other than go with your gut? If you could find the time, where would you start? The first idea we are going to introduce is Return on Investment.
return on investment
Return on Investment is an important business concept that gives us a way forward to think about where we should put resources. What does it mean to make a return on investment? Simply put it means we have:
More money than we started with - a profit
That money is in our bank account - the return is in cash
That return is in a timescale that works for us
How do we make a return on investment? This is really important to understand, because it is the opposite of how we make money in the world of employment. In that world, money comes from our salary and hours worked. In business, we make money by taking risks. We talk more about this in our Five Foundations Business Guide. The key message is that although we are putting an amount of time or money at stake, we are not gambling. We are assessing the risks before making our investment and we are staying involved throughout the process to make sure that the plan goes to plan. As Robert Kiyosaki, the American businessman and author, says “investing is not risky; not being in control is risky”.
decision making methodology
How do we take this concept of Return on Investment and turn it into something practical we can use to make business decisions? We set out below a four step process.
Estimate the Return - by calculating the net benefit (or net cost) to the business. We can do this by comparing the contingent costs to the contingent income associated with making the decision, and seeing which is higher and by how much. Contingent income and costs are amounts of money you will receive or spend in the future, in cash, and which you haven’t yet committed to.
Look at the Cash Flow - this step lays out the contingent income and costs over time so that we can see whether the return is in a reasonable timescale, and if we will run out of cash before we get the return?
Consider the Wider Gains and Losses - this is particularly helpful if the first two steps don’t give you a clear cut decision. Maybe the return is not as high as we expected, and we may need some short term borrowing, but there are some strategic or longer term benefits to going ahead. As much as possible we want to quantify these other consequences.
Assess the Risks - this is arguably the most important part. As you would imagine, it involves identifying risks and putting in place a plan to manage them. Doing this step maximises the likelihood that you get the return that you are hoping for.
What kind of business decisions can this help you make? This approach does take some time and effort. But it is worth it for key business decisions. Should we invest in a new product line? Should we take on that new contract? Should we recruit one or two team members? The answers to these questions can often involve many different considerations - more than most people can analyse in their head - and that is where this methodology helps.
The reality is also that our business success, and whether we make money in business, also depends on many smaller decisions that we make each and every day. It wouldn’t be feasible to stop every time you had a choice to make and work through these four steps. For that reason we are going to introduce two more ideas - Return on Capital Employed, and Always Investing.
return on capital employed
All businesses have some capital invested - money that has been put in by the business owner or lenders, and there may be retained profits from previous years. It’s the business owners’ job to decide how that capital is going to be put to use in the business. The concept of Return on Capital Employed ROCE then lets us evaluate and compare over time the return from those choices at the whole business level.
To calculate ROCE you divide the net profit of the business by the capital employed (being the shareholders capital, retained profit and any loans) and multiply by 100 to get a percentage. The UK average of ROCE is around 5% with the most successful companies and sectors achieving 10-20%.
always investing
As a business owner, everywhere you put your time and money is an investment of a kind. In fact, for most business owners, the largest single investment they make in their business each year is their time - and where you invest your time in your business makes a huge difference to the bottom line. In a way this becomes more important the longer we are in business. What often happens is at the start of a business journey, the business owner is conscious of the risk they are taking and the return they need to get. Over time they can forget that they are in the business of investing and instead it can start to feel like a job. The ‘Always Investing’ mindset acknowledges this and considers how your time is invested in the business and whether it is delivering you what you want or can be improved.
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