While creating value is the reason you get up in the morning, and the reason your customers come to you, as we’ve said before, capturing value is what makes your business sustainable.
With no value capture, you’ll make no profit, and won’t be able to put money back into the business to run tomorrow, let alone invest to grow into the future.
With proper value capture, you’ll have profit, money put back into the business and growth for the future. It’s where we start to look at our business as a machine.
Before we do that, though, we should begin to monitor the value capture, calculating the amount of profit we’re making, and allocating it to its specific needs.
One micro-finance institution does this with small new businesses in the simplest way imaginable. At the end of the day, sales revenue gets divided into different envelopes.
- The first one is to pay for tomorrow’s inventory.
- The second is to pay for other bills to keep the business going, rent, electricity.
- The third is to pay off any outstanding loans .
- The fourth is for the business owner, to take home.
- The fifth is to invest to grow the business over time.
This simple system emulates a daily income statement and cash flow, without getting anywhere near a spreadsheet, to ensure that enough value is captured, and allocated where it needs to go for the business to keep going.
If you aren’t capturing enough value, to do all of those things, you are going to know very quickly, because some of your envelopes will be empty. If the first or second ones are empty. you’re going to have to do something else tomorrow. If the third or fourth ones are empty, you’ll need to raise your value capture to pay off your stake-holders. If only the fifth one is empty, your business is doing ok, but could do better… maybe you should take some out of the fourth one and put it in the fifth.
Even with such a simple tool, we are also able to do a little useful analysis. The first envelope contains our “variable costs”, the cost items that change depending on how much we sell. The second envelope holds our “fixed costs” that stay the same even if we sell nothing. These two things combined can help us find our “break-even”: we need to sell enough of the items in envelope 1 so that we can pay for the fixed items in envelope 2.
It can also show us our “operating leverage”, which is how much more value we can capture per item once all those fixed costs are covered, and our profitability per unit increases.
Just from five little envelopes, we can really start to control and analyse our business. In the next few short chapters, we’ll show how value capture fits into our formal accounts, and shows us how well our business is doing , or if it could do better.
Envelopes might not suit your business. If it’s too big, there’ll be too much money to fit in envelopes. If it’s online and there’s no actual cash, the envelopes will need to be “virtual”, but the lesson holds good: you need to separate your costs and allocate your cash to monitor and manage your business.
You won’t know if you’re capturing value at all unless you track your sales and costs.
From here, it’s a very short step to your first income statement.