How do you define “sustainability?” The oft-quoted UN Bruntland commission states that: “sustainable development is
Sustainable development is a development that meets the needs of the present without compromising the ability of future generations to meet their own needs.
That’s pretty broad. Ask most people and they have a vague notion of sustainability along the same lines. We are not destroying the environment by using up resources or creating overwhelming pollution. We shift to using replaceable resources like plant materials and look to solar and wind for power.
However, having consulted with many small and medium sized businesses, I have a different take on sustainability. Namely, the only two components that matter are:
- Profitability
- Shareholder equity
If you have ever watched the shows Shark Tank or The Profit on CNBC, you have seen many examples of small business people and entrepreneurs that do not know even the most basic metrics concerning their business:
- What is the variable cost of their product or service?
- What are the fixed operating costs?
- How much revenue are different products or customers bringing in?
- What sort of investment will be needed for inventory or equipment to grow the business?
Too often, small business people simply have a checking account and credit cards. The income and cash flow statements are one and the same. Worse yet, the business checking account is also their personal account, so differentiating business and personal expenses is difficult at best. If there is more money in the account at the end of the month than at the start, after all the bills are paid, it must have been a good month.
Company A: Successful Operation
Consider two businesses, Company A and Company B. Company A is an established business operating successfully, with a process that looks like this:
- Revenue is generated
- Variable and fixed costs are paid (inventory, salaries, loan payments, tax payments, etc.)
- The remaining cash is profit that is added to the assets in the balance sheet
- Assets increase, liabilities decrease, shareholder equity grows
This is sustainability, especially if the revenue and costs are predictable. The value of the firm grows and management and investors are happy.
Company B: No Visibility
Company B, however, has no visibility to its costs or specifically where its revenue is coming from:
- Revenue is low or uncertain
- There is not enough money to pay costs
- Costs are cut (product quality suffers, employees are let go)
- Money is taken from the cash account or assets are sold to make up the shortfall
- Assets decrease
- Shareholder equity shrinks
If this continues for months or quarters, the assets will be exhausted. The company will cease to operate or at least be bankrupt. Customers will no longer be served or supported. The management and investors are in trouble.
From a different perspective, take Tom’s Shoes, which has a policy that someone in the world is helped every time a customer buys one of their products. So they have to make enough money to cover the products they sell, the products they donate, and all their other expenses as well. If they don’t, the company eventually ceases to exist and they no longer help people in need.
The point is that when operations and financials are out of control, the company fails and it can no longer carry out its mission. Make sure you understand who is buying from you and how to take care of those customers. Make sure that you have visibility to every detail of the costs of your operation.
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