I have around twenty years of small business case studies I have observed firsthand. Most of the stories start similarly. The CEO is stuck or frustrated because their financial performance is not moving fast enough or in the right direction. Sales are possibly strong, but there is a disconnect between revenue growth and available cash balances. These CEOs do not understand why they continually struggle with meeting payroll several times throughout the year.
And then there are a few instances where a business owner has experienced success. They merely want to implement a robust financial management system to upgrade the practices they currently have in place.
Nearly 100% of the time, their success does not continue. Easy times led to questionable hiring for positions probably not needed, discretionary high-risk investments, and pulling excess amounts of cash out of the business. In summary, their strong financial performance led to overconfidence in future short-term decisions. My perspective in these situations is that they thought success would continue.
In this brief article, I’m going to focus on the second CEO, the one who is overconfident because their financial performance is going well, maybe too well. Good times are great, but so is the financially resilient small business that’s read in both times of feast and famine.
The Good Life
The last chapter of Paul Bloom’s book PSYCHE is entitled The Good Life. He writes, “We haven’t been interested enough when things go well.” This last chapter focuses on positive psychology and the causes of a happy life, and this line stood out the most.
“One of the main findings in happiness research is stability.”
Paul Bloom, PSYCHE
While the author is addressing happiness, I believe his views and opinions apply to strong financial performance. Below are some of his insights regarding happiness:
- We are often poor at predicting happiness
- People tend to think future life events matter more than they actually will
- People fail to appreciate we are fairly resilient to bad experiences
Bloom summarizes that we are poor at predicting future happiness. I think this also applies to small business financial performance when revenue and operating cash flow are strong and trending in the right direction. Accordingly, Bloom says we don’t appreciate how good we are at telling stories and reinterpreting information that preserves our good feelings and the views we cherish the most. When I read this, I thought he was describing some of the most successful CEOs I have served.
A Case of Overestimating the Future
Now that I’ve learned some psychology basics on predicting the future, I thought of one of my favorite stories about a business founder overestimating the future. His name is Harvey Firestone, and the company he created was one of the most successful enterprises during the first quarter of the 20th century. By the year 1919, his company generated $9 million in profit on sales of 4 million tires. Firestone could not keep up with demand.
A few months later, Firestone was on the brink of disaster. Sales ground to a halt and the company owned $43 million and banks would lend no more. They worked their way out of the financial crisis by slashing tire prices. By 1921, they were once again profitable, but only at a fraction of where they had been. By 1924, they owed no money to banks. Was this period easy for Firestone?
“It was not an easy road we traveled, but we safely got to the end.” This statement came after the way he described his thinking at the start of a time of profound growth in 1919. Firestone thought nothing could harm his company because they were sailing smoothly with the wind. That mindset was before rubber prices dropped from fifty-five to sixteen cents a pound.
You could be thinking that Firestone pulled out of this financial disaster, and in some ways, they came back a more financially resilient company. True, but what is the lesson to be learned?
Let’s Answer the Original Question When Financial Performance is Going Well
Financial success is fleeting. Some businesses plateau. Others face economic troughs in predictable sales cycles such as the automotive industry. Competition can erode past successful performance too.
Because of everything that can go wrong with great financial performance, I only have one piece of advice. Be paranoid. As I stated, financial success is fleeting. Predicting future success is fraught with overestimation based on the positive stories we tell ourselves.
However, I will leave you with a few practical tips in the form of questions:
- If your financial analyst is modeling your business model going out at least three years, what cash reserves have you built up?
- Does adequate capital exist to withstand the loss of a major customer or two or a significant decrease in a product or service?
- Do you need that new COO or CMO when a different solution could be as effective?
- If you are pulling money out of the business to invest in another, are you applying the G3CFO Rule of 25™ (this is a concept taught in G3CFO coaching that applies to IRR thinking)?
- Will you still be relevant in five years? Take a look at this article to describe what I mean.
Because financial success is fleeting, I think we need to start better understanding what financial resilience means and how we can apply that concept in our small businesses.
There is a physics concept called elasticity which explains how a material can return to its original form. Like the Firestone story where success nearly led to bankruptcy, they came out of that situation better than before. That’s financial resiliency.
But before a financial resiliency mindset, I’d start with a healthy form of financial paranoia while remaining positive about the future.