Thanks for joining us as we continue our discussion on No Man’s Land. Last week, we focused on the struggles of outgrowing your management and how to get your management back to tip top shape (look here for a refresher.)
Along with any growth will come change and challenges, and your business venture is no different. The model adopted by your business is likely to face the consequences of these changes, and your business may outgrow this model altogether.
“Most entrepreneurs attract their first customers by running their businesses according to a ‘high performance, cheap labor’ economic model,” says Doug Tatum, author of No Man’s Land. As the company grows, this economic model crumbles as the company must begin to adjust to a normal cost structure and venture away from cheap labor costs. To make it through No Man’s Land, companies need to develop a new business model that allows them to continue to provide their value proposition (what brought customers in the first place), but modified in order to maintain success and continue growth.
Before entrepreneurs are able to secure their companies’ financial stability, they need to understand what lies within the business model, what changing the model would include and what effect this rapid growth and change can have on the company’s financial performance.
Maybe you’re wondering what exactly we mean by “business model.” To be specific, the business model is a financial analysis of how a business makes its money. Analyzing a business model includes considering revenue produced from selling your company’s product offerings, as well as changes in this element of revenue. It also includes cost and capital under different scenarios, as well as capital employment.
In order to perform this business model analysis, there are two helpful accounting tools to guide you through. The first tool is the balance sheet, which acts as a still photo of the business’ assets and liabilities at the end of each month. Accounting is also able to provide a view of how the balance sheet changes over time. This tool is known as the income statement, which provides a glimpse of the new assets gained by the business (revenue), and the assets that have left the business (expenses).
However, neither of these tools give rise to a company’s economic model. This is because both of these tools are actually backward-looking, meaning the information they provide focuses on how the company performed in the past. An economic model is the opposite, forward-looking. It projects to the future, speculating on what a company’s economic picture will look like based on a possible scenario. However, both tools are extremely helpful in predicting future scenarios by measuring where the company has grown, struggled and succeeded in the past.
There are two reasons why it is important to forecast a company’s business model:
- It helps entrepreneurs decide if they actually want to commit to the strategy under consideration.
- It gives the company a basis for evaluating how the business is actually performing against the projected model once the journey is underway.
It goes without saying that companies stuck in No Man’s Land struggle when their previous business models break down, thus leaving an unclear understanding of the company’s financial health. To get out of this phase of No Man’s Land, companies have two options:
- Return to a size where their model works well
- Attempt to grown their way out of No Man’s Land
To proceed down the second path, companies must develop an understanding of how their current business model will change as it moves forward. It is important to keep in mind that the business’ value proposition must be scalable to navigate through No Man’s Land.
You’ve laid out an economic model for growth, and you’ve figured out how large you need to grow in order to stay profitable. So what’s the next step on this path through No Man’s land?
- Monitor your company’s financials to be sure your company is performing according to the model. The balance sheet and income statement are helpful here – these allow you to see where your business is relative to the model.
- Create and assess weekly operational reports that let you know where you are on your path to growth. These reports let you guess with accuracy what the financial state of the business will be at the end of the month. Ask your financial staff this question: What kind of operational report can you create that will allow you to predict, with accuracy of within +/- 10 percent, the company’s net income, prior to creation of the end of the month financial statements?
- Create future scenarios based on your company’s business model. Although you can’t run your company looking backwards, you can look to the past to help predict the future.
Creating a business model that is able to grow along with your company is not only important, but also necessary for the success of your business. Following these guidelines for growing your business model will help you smoothly transition out of No Man’s Land.