Are You Ready to Automate?
A major capital investment may seem like a no-brainer, but it will change your organization in ways you need to consider before signing the purchase order.
Congratulations! Business is great and you’re able to purchase your first automatic press. For many budding entrepreneurs, this is a milestone objective. I’ve been there, and it’s an exciting time. It’s also scary.
Believe me, you will question yourself. Are you ready for this? Can you make the payments? How much should you put down? What is this going to do to your business? Seeing the world through the rose-colored glasses of “what if” can be exciting and exhilarating, but is that vision possible?
The answer is, it depends. It’s yes if you take a step back and fully consider the consequences of bringing on an automatic press.
Sadly, it’s no if you only consider the front-end costs of the press, compressor, chiller, and installation. Many articles have been written about the support and installation costs associated with automation. I’m going to go beyond those and look at changes to your overhead and cash flow that many buyers don’t anticipate – hopefully helping you avoid the disappointment of not realizing the potential of your first major investment.
Before discussing these overlooked costs, it would be helpful to set the stage for how most small printers come to the decision of purchasing their first automatic press.
Startup operations typically begin in a garage, basement, or other home setting. They have a manual press with a flash, heat press, or small dryer. They sell to friends and family, with a few referrals. Or, their printing business may have been a by-product of a craft-making hobby with goods designed to be sold on websites like Etsy. Business grows to the point where it becomes a burden to get the work out with just a manual press. Because it’s easy at this stage to confuse cash flow and profitability, it’s unclear whether the business is making money.
At this point, the entrepreneur has two options. The first is to hire a part-time or full-time employee to help increase production. (The shop may already have one or two employees.) The owner will be doing most of the key tasks like selling, creating artwork, printing, and of course, keeping the books. Something has to give, and it usually means considering the second option: automation. At first glance, it makes so much sense.
Put yourself in that entrepreneur’s shoes. Consider that a manual shop will typically produce about 60 (multicolor) shirts an hour. There are times production may fly up to 300 an hour – say, when an order just involves a neck label or single-color left chest – but that’s the exception, and it’s not sustainable. With an automatic press, the hourly production appears almost unlimited. Even the most basic ones can easily deliver 600 pieces an hour.
It’s at this point that optimism begins to cloud the vision. You have a backlog of orders; you know how much you sold them for. (Hopefully, you also know your costs.) Think of all the extra income! What could go wrong if you can print so many more garments per hour?
Well, you need to step back and look at the big picture. Everything about a business is what I call “related rates.” Think of it as a series of balances. In many cases, when something goes up in a business, another part will go down, and the downward pressure decreases profits.
There are three key parts to a business:
2. Sales and Marketing
3. Finance/Admin/HR (FinMin)
To grow profitably, all three parts must be in balance and working together. You can grow, with marginal profit, if one or more parts are slightly out of balance. This frequently happens with small companies as they move toward annual revenue of about $30,000 per month ($360,000 annually). This is the point where automation becomes increasingly necessary, and the decision is being driven by an imbalance in sales and marketing. You are selling more than you can produce, so you need to increase production.
What may seem like an obvious decision really isn’t. As soon as you increase production, you now have to consider the impact on both sales and marketing and FinMin.
I learned this the hard way. When I decided to purchase my first automatic, way back in the day, I had enough manual work to keep us busy for three months working 16 hours a day. I was drowning. I had two full-time employees and 1250 square feet of space. I just knew the press would be our savior. I could easily make the $732/month payment. I had $10,000 in the bank, a book of work, and availability of another 1250 square feet next door for expansion. It seemed like an absolutely obvious choice, so I pulled the trigger.
Here’s what happened. Our cash balance of $10,000 immediately dropped to $4000 with the deposit of $6000 on the equipment loan. I didn’t have much credit then, so the bank required a 20 percent deposit. That left about $30,000 on the note with the payment of $732 per month.
The equipment came in and was installed. About $700 of electrical work was required, but no compressor, chiller, or gas plumbing. This was an all-electric Precision Oval, for you old-school vets – a heavy iron workhorse.
We got to work, and within three weeks, we had burned through all of the backlog. It was amazing and exciting at the same time, but this is when the reality began to hit home, and I did not even see it coming.
The operation of a 48-inch electric dryer was about $250 a month more than what I had been spending, and my rent had doubled to $1200 a month. (Yes, this was a long time ago.) So just those two changes added $850 to my monthly overhead. I didn’t add any new people right away, so we were good there.
But three weeks after the machine was installed, we were out of work. The scheduling board was empty. I had relied on family, friends, and referrals, but those channels were now tapped out. The good news was that I had no serious competitors then, but I was still out of work. That meant I now had a sales problem.
Since I was the only one selling, it meant I was either on the phone setting appointments or out of the office making calls and taking orders. During this time, my two employees had nothing to do but reclaim screens, clean the shop, and do some minor prep and maintenance. It was certainly not enough to keep them busy. My labor costs stayed the same, but we weren’t billing to offset them.
I began to see I had a problem, but it was nothing like the bigger storm on the horizon, a critical mistake that almost put us out of business. I was out of cash. My accounts receivable (AR) had ballooned to over $30,000. Previously, it had been running around $4000.
My policy had been 50 percent down with the order, with the balance paid on delivery. It had been a manageable plan. As soon as I got paid, I’d order the stock for the next few jobs.
Automation changed all that. We were printing orders so fast that things began to slip through the cracks. Customers would pick up jobs and not pay. My guy at the end of the dryer would slip up and let the goods go out the door. Jobs would get printed and sit for two days to a week or more. In the meantime, we kept printing, because we could. Making it worse, we started to make printing mistakes that became very expensive.
It didn’t take long before all the available cash had been converted to AR, and I was at a standstill. We were out of cash and out of work. I couldn’t make payroll. I couldn’t pay my bills. I couldn’t pay myself. It was a classic example of insolvency. We had been busy up to the moment we ran out of cash.
Fortunately, I had a couple of mentors who helped me through, but at a heavy price. One of them co-signed a new working capital loan equal to what I had borrowed for the press. My loan payments were now roughly $1500 per month plus the premium I had to pay for him to co-sign. I won’t go into the details on that, but it ended up costing another $900 per month until I could get him off the note.
All of the added costs and inefficiencies had reduced my forecast profits to single digits. Mistakes cut them even further. As our reputation spread, so did our growth, and the pressures on cash flow continued. It was a very expensive lesson and ultimately took almost five years to recover.
Let’s back up to the concept about a business being in balance and the related rates between production, sales/marketing, and FinMin. Arguably, the most important consideration is the one that results from your success – the impact on cash flow. Without adequate cash flow, you are done. You can’t grow, and ultimately, you may be out of business.
The decisions you make are tied to how much available cash you have. Young operations today have the luxury of selling online and collecting 100 percent of the order before it is even produced. That definitely lessens the pressure, but it does not solve the problem. More money only accelerates the problems you have. It’s like rocket fuel: Properly channeled, it will accelerate your growth and profitability. Handle it improperly and you’ll blow yourself up.
Lesson #1: Understand Your Cash Flow Statement
The cash flow statement is the third, and least common, of the major accounting statements. The others are the income statement (also referred to as the profit and loss statement), which details income, expenses, and profits; and the balance sheet, which tells you how your assets and liabilities are divided, as well as how much equity the business has.
The cash flow statement is sometimes called a sources and uses statement. (You may also hear it called a funds statement or a statement of changes in financial position.) Sources are increases in profit, cash from accounts receivable, collections deposits, prepayments, AR advances (receivable financing), and new working capital loans. Uses are principle reduction on loans, accounts payable payments, purchases (inventory, supplies, and equipment), operational expenses, and increases in AR.
Whatever the name, don’t be scared of this document. It simply tells you where your cash is coming from and how you are using it. The statement is the key to your success and survival. Cash is the life blood of the business and if it bleeds out, the business will die. It’s as simple as that.
Lesson #2: Know Your Financial Gap
This concept is very closely tied to your cash flow statement. Simply put, the financial gap is the amount of cash you will need to cover increased costs as you grow. (After all, growth is the point of automation.) Every business has a financial gap – you just need to know what yours is, and in order to do that, you must have a cash flow statement.
Think of it as driving a bigger, gas-guzzling car. You’re going to need to fill up more often. Your growth creates a “cash-guzzler” and the financial gap is the calculation that tells you how much more fuel you need and how often you will need to fill up. The financial gap determines how fast you can safely grow your business without running out of cash. If you grow blindly, you will exceed your resources. It’s a type of financial mismanagement and it’s one of the most common reasons young businesses fail.
Your bookkeeper is not going to be able to help you on this. Calculating the financial gap is best done by a competent certified public accountant (CPA). It’s not a commonly performed calculation, yet it’s one of the most valuable key performance indicators (KPIs) to your success.
Lesson #3: Know Your Customer Acquisition Cost (CAC)
The third lesson relates to the cost of bringing on new customers. When you blow past all of your family, friends, and referrals, it becomes expensive to get new clients. This is almost never considered until it is too late. These costs can be substantial and can literally strip away any profit a new customer brings.
Fortunately, in today’s digital economy, we have the ability to determine these costs fairly easily. If you are using any kind of online advertising like Facebook, Google Adwords, Display Network, and so forth, you can easily track the costs. If you spend $1000 a month and bring on five new customers, your CAC will be $200 per customer.
The important thing about this number is how it relates to your gross margin (the amount of money above the cost of material and inbound freight for the customer order).
If your gross margin is typically 33 percent, each new customer will need to be worth more than $600 for you to have any additional available cash.
If you have ever watched “Shark Tank,” you’ve heard the investors asking the contestants about their CAC all the time. The lower you can keep it, the faster you can grow. This is why startups need extra working capital – to cover their CAC. Without understanding your CAC, you can find yourself being incredibly busy with no additional cash to show for it.
Lesson #4: Grow Your Existing Customers First
The best way to help feed your growth is to know where it comes from. The least expensive and most profitable growth comes from your existing customers. They can grow in two different ways.
The first is to sell them more products at higher margins. Repeat work is so much more profitable than new work because the customer knows what to expect and you know how to deliver it – you already have. The key to maximum profit here is being able to repeat the experience exactly as you did in the past, faster. Repeat customers are also less price sensitive, so you avoid the race to the bottom of the RFP bidding process. Success is based on trust, so make sure you never let them down. This is why print spec sheets and approved samples are so important.
The second path to growth with current customers is to sell to them more frequently. If the customer orders once a year and you can find a way to sell them a second order, you will double their growth rate. There are many ways to do this, and they are very easy once you have the client’s trust.
When you know your CAC, you have a number that you can use to factor in additional discounts, samples, and so on to stimulate more business. The point of all this is simple: There is a cost to growth, and automation brings those costs forward.
Lesson #5: Find a Good CPA
The faster your business grows, the more important it is to work with a competent CPA. Most small businesses only use their CPAs to prepare and file their taxes, missing a huge opportunity.
You can grow your company to $1 million of revenue a year easily, but it will not be in a healthy state. I have analyzed over 150 companies and know this for a fact. Their problems come simply from not knowing the right questions to ask to get the answers they need.
Typically, larger companies have either a comptroller or a chief financial officer who is responsible for the healthy management of the company’s finances. Often, small companies don’t have a person like that, which is why it’s so important to have a good CPA. You can expect to pay $175 to $400 for their professional advice, just as you would for a good lawyer.
The CPA will help you plan to grow safely and provide you with the key ratios and KPIs to help guide your development. Their goal is no surprises. To get the
maximum benefit from a CPA, make sure you get your closing numbers to them quickly. Shoot for no more than 10 days after the close of month. The longer you wait, the less accurate the analysis. Remember, the CPA is making decisions based on what has already happened. These are trailing results, which means that if changes are necessary, they need to be applied and measured sometime into the future for them to be effective. The longer you wait, the more time it will take to see your results.
It’s All Related
I hope this hasn’t been too overwhelming. The takeaway? Your business runs on related rates that need to be in balance for you to grow profitably. If you do not know or understand them, your future profits will suffer and you will not realize the full potential from your decision to automate. Determine what your related costs will be before you invest in your first automatic machine. If you do automate, absolutely know how fast you can grow and do not exceed that rate or you’ll risk running out of cash.
Finally, cash is king. Understanding where your cash is coming from and how you use it will determine how fast you can grow. You are in business to be profitable. The more you understand about cash, the better your chances of achieving and maintaining profitability.