A business is a living thing, and living things change. Like trees, your business is either growing or it’s dying. It’s dynamic and it’s changing. It may be because the economy forces it to, or because customers need change, or because employees change, or because new products and services enter the market, or because a new competitor enters the market. There could be a dozen reasons. But those changes occur, and you may not be aware of them at first. They are often hidden. If the changes are bad, and you’re not on top of them quickly enough, they can destroy your business.
One of the best ways to identify how things are changing in your business is to be plugged into the numbers. When you plug into the numbers you will have a better understanding of what cash flow is and figure out in advance where it’s going to come from.
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Unfortunately though, too many business leaders focus most of their attention on making sales. This is known as a sales mentality. Why is this a bad thing? Because sales do not equal cash, and cash is what you need to survive. If your gross margins are not enough to cover expenses, then dipping into cash reserves is the only way to make up the difference. Dip too many times and soon you are out of cash.
Understanding critical mass is understanding how your business makes money. For every business it usually depends on some key performance indicators (KPIs) in the business hitting a certain level. The KPIs may be the size of the customer base, or the number of transactions from active accounts. It could be the number of leads generated, or the conversion of leads to sales. It could be the average revenue generated per sale. There are different types of critical mass and many variations depending on the type of business, but they all translate into the same thing for every business. Critical mass is where the cash generated, more or less automatically every month, is enough to sustain the business and allow it to grow without going outside for new investment.
A good place to start is with a tracking system. Identify what the KPIs are for your business and start tracking them. Some numbers may come from a point of sale system or enterprise software, while others may need to be tracked manually. Either way, make sure you create a format you can quickly update and analyze frequently.
Once you have your tracking in place you can establish the correlation between sales, cash flow, and the KPIs you’ve identified. By knowing how much monthly cash flow you have to have, you can translate that number into an average monthly sales requirement, and then calculate the level your key factors need to reach to produce those sales. You now have the data necessary to calculate your critical mass and what it will take to build a self-sustaining business.
It can be real scary for a business leader before a business achieves critical mass, and there are no guarantees that once a business achieves critical mass that it will remain self-sustaining forever. Smart business leaders never let themselves get too relaxed in business. When you develop a good feel for the numbers you learn to anticipate and recognize the changes in your business. This helps you avoid making emotional decisions that put your goals and business at risk, and puts you in a better position to be more objective in how you go about growing your business.