Should you buy this equipment or not?
Should you expand into a new market?
Should you spend money on this marketing campaign or opt for the cheaper one?
A great number of financial decisions await any business owner. Some of these decisions will make or break the business.
So, how can you know you’re making the right move?
Here are some guidelines for the prudent business owner:
1) Know your numbers.
A leader who knows his numbers like the back of his hand is someone in control of his destiny.
Yet how many business owners dismiss them as something superfluous or unnecessary? I’m talking here, at least, about knowing one’s a balance sheet, income statement, and cash flow.
The balance sheet will indicate your current financial position. The income statement summarizes income and expenses. And finally, cash flow gives you insights into how the business generates and uses capital.
Entrepreneurs often have a bias for action and the future, excited about possibilities. They tend to forget to check on past performance and use it as a guide for future actions. For example, a business owner’s eyes might glisten at the possibility of increased production with a piece of new equipment but forget that sales are having a hard time moving inventory.
Your numbers are a concrete record of your past. Although they don’t necessarily dictate what happens in the future, they indicate possibilities.
Never ignore the numbers.
2) Estimate the financial impact of the investment.
The investment will have a clear and concrete impact on your finances. That will come in the form of the price. It’s one of the biggest deciding factors.
The good news is that at least you have this aspect clearly laid out. It’s a bright shiny number (or a budget range) where you decide if the investment (eg. equipment) is worth it or not.
However, that is not the only number you should be concerned about. Because truth be told, regardless of the price, if you really want to invest in something, you will find ways to finance it.
When we say “estimate financial impact,” we are referring to scenarios that will unfold in the future. These are possibilities, not givens, things that are yet to happen. They are vague and we have limited knowledge of them.
For these things, you can use a number of time-tested frameworks that can help you determine if an investment is worth making.
There are several frameworks you can use:
- Net Present Value (NPV): This is a formula used to determine if a project or investment will be profitable in the years ahead.
- Return On Investment (ROI): It’s a calculation that compares the initial investment with the expected profit.
- Internal Rate of Return (IRR): It gives you the rate at which an investment breaks even.
- Payback Period: A formula that helps determine the amount of time it takes to recover the investment.
- Break-even Analysis: This helps you determine the sales volume required to make a decision worthwhile.
- Sensitivity Analysis: This helps determine the outcome of a decision based on a range of variables.
Using these frameworks will add confidence to the soundness of your decision. The idea here is to use several frameworks and formulas to increase our confidence in the viability of a decision, investment, or project.
3) Consider the “qualitative factors.”
That said, even if the numbers look good, even if the frameworks say that the investment is favourable, you still have to check on the things that are very hard to account for.
One reason is that there are many things we cannot simply put a number on. Second, we cannot predict what will happen in the future. There are forces that are out of our control which ultimately impacts the outcome.
For example, you might be investing in a piece of equipment that makes widgets. Are you sure people will still want widgets 6 months from now?
All the other companies are investing in the widget-maker because of demand. Wouldn’t that flood the future market with widgets and collapse the profitability of everybody?
What if there’s a new product that will make the widgets obsolete? Can the equipment be repurposed to do something else, or you’re going to be stuck paying for equipment that has become obsolete?
Many things are out of your control.
Curve balls often come from these 10 areas:
- Economic headwinds—Recession and inflation can impact your finances.
- Technological disruptions—Rapid changes in the field can make your organization or your service or product obsolete.
- Changing Customer Preferences—A sudden shift in consumer behaviour can impact a product’s market fit.
- Policy and Regulatory Changes—The “problems,” “pain points” or “service gaps” your company solves, the government can decide to take care of itself.
* Competitor Moves—Actions from your competitors could render your strategy useless.
- Natural Disasters and Geopolitical Events—”Black Swans” are just around the corner.
- Employee Issues—A prized employee could leave. Talent shortages could hit the space.
- Financial Markets—Fluctuations could rattle investors or make credit scarce.
- Brand Crises—Unintended mistakes, losses, and scandals could create a sudden reputational collapse.
- Social and Cultural Shifts—Public attitudes, opinions, and perceptions can turn against your company.
It’s difficult to quantify these risks. But they heavily impact investment decisions, nevertheless.
4) Get a 360° view.
It’s looking at the investment from different aspects and angles, directions and dimensions. The goal is to get the most comprehensive and holistic understanding of the situation.
You’re still going to have the final say, but it’s best to get the most robust data to inform that decision. Get inputs and insights you’ve never thought of before and gain a nuanced and enriched understanding of the investment decision.
In order to get to this type of data, you’re going to have to ask from different areas and levels of the organization.
Say you’re planning to buy new factory equipment that’s going to increase your production severalfold. The financials have passed muster, and you think it’s a no-brainer. You’re excited to place your order.
But try to ask different departments and teams, and consider the perspective they might have:
* Operations and Production Team—You might be told that the new equipment will require significant modifications and disrupt the current workflow.
* Maintenance and Facilities Team—They might have concerns about floor space and energy costs, not to mention the durability of the equipment.
* Sales Team—Sales is seriously wondering if they can move more units than what they’re presently doing.
* Human Resources Team—HR is concerned about its potential impact on employee morale and job satisfaction.
* Supply Chain Team—They want the equipment, but they’re wondering how it will impact logistics and ongoing contracts with suppliers.
* Executive Team—Some folks are thinking if the investment is aligned with the company’s overall strategy.
You see, different stakeholders have different takes on the same thing. Each one is as valid as the other. You might ultimately go for the investment and buy the equipment, but at least you do it with your eyes and ears wide open.
So again, investing wisely is paramount, if you want to ensure that you’re making the right financial move for your business, follow these 4 guidelines:
#1: Know your numbers.
#2: Estimate the financial impact of the investment.
#3: Consider the “qualitative factors.”
#4: Get a 360° view.
With these, you’re actually doing careful research, diversification, risk assessment, and long-term planning. They lead to financial decisions that will benefit your business as a whole and in the long run.
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If you would like to explore this opportunity or have any questions, do not hesitate to contact us.
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