Ten Rules for Great Finance

At Zingerman’s, we first adopted the Open Book approach to finance in the mid-1990s.  We learned about it from reading the now classic book, The Great Game of Business, by Jack Stack and Bo Burlingham, as well as John Case’s Open-Book Management. The concept basically states that everyone in the organization—from hourly staff through to the finance staff, VPs, GMs and CEOs—participates actively in reading, reporting and managing the financials. Everyone is responsible for financial success.

Stack and Burlingham take the approach that business is a game. Like any game, business has rules by which it’s played. And the better everyone in the game understands how to play and win, the better it will be.

The simplistic explanation of open-book finance is that “everyone sees the numbers.” But that’s a passive view of what the system can accomplish. “Seeing the numbers” implies that we’ve let the staff see the scores, but that is incomplete. Done well, business and open-book finance are participative activities, not spectator sports. When it works, it’s because everyone understands the rules of how the game of business is played.

All In It Together
The traditional—and more cynical— business approach would say that the job of the front-line staff is to just do what they are told and then let the people “at the top” focus on finance. A few years ago, it dawned on me to contrast that old-line finance approach with the way we handle service. The fallacy in the big-business financial approach became glaringly clear.

Over the years, we have raised our service standards to high, if ever imperfect, levels. We teach everyone that they are responsible for the quality of every customer’s service experience. Any time we see a guest in need, it’s our job to take care of “business.”

We have a common language about service—everyone here knows what an “extra mile” or a “code red” is. We measure service performance and share the success. Everyone knows that they make a difference in the quality of the service we deliver and everyone knows what he or she can do to make that service even better. As normal as this scenario may sound, it’s probably the opposite of what was happening in a bureaucratic business setting, circa 1979, in which service effectiveness would have been relegated to a “service department.”

Quite simply, the exact same thing applies to finance: Everyone has a major role in delivering positive financial results. And in the specialty food industry—where margins are thin at best—we cannot afford to have the majority of the people in our organization disengaged from the responsibility of attaining positive financial results.

An Overview of Open Book
Using our open-book finance system effectively has significantly improved almost every element of our organizational work.

The financial performance is better; in fact, our bankers just lowered our borrowing rates. But it’s not just financial. Open-book finance has improved the connection that the staff feels to the business. It’s also helped them learn how to handle finance in their own lives so that they live more sustainably outside of work. And better financial results allow us to give to our community more effectively.

We teach Three Steps to Great Finance at Zingerman’s:
1) Know and Teach the Rules
2) Keep Score
3) Share the Success

This column is about the first step—knowing and teaching the rules by which we play the game of business. We’ve adapted them from The Great Game of Business; I’d suggest that anyone who wants to use this system adapt again because what works here will need adjustment to fit with your organization and community. I share them for the content—i.e., what the rules are. They communicate what we’re teaching staff and how employees are involved in the running of the business.

Getting Good with the Rules

Business is basically a game, and like any game, there are rules by which it’s played. The better everyone in the business knows and understands those rules, the more they know how the business is doing (i.e., Step 2, Keep Score), and the more they have the chance to win together (as in Step 3, Share the Success). If you think rules aren’t important, put a team on the basketball court without knowing anything about the three-point line, free throws, time outs or traveling violations and see how it goes.

Here are the rules by which we play the finance game. Some of the rules are universal finance premises; i.e. Begin with a Plan, Profit is Vital, Cash is King, A Dollar Today is Worth More than a Dollar Tomorrow, Building Value is Essential.

Accountants and upper-level execs may say that these rules seem “obvious.” But while the terminology of Rule 2 (Profit is Vital) may seem simple as a stand-alone statement, ask six staff people (not including the accountant or owner) what “profit” means and what it is used for. You will receive some interesting—certainly incomplete and mostly inaccurate—answers. Hence the importance of getting these rules on paper so that everyone can have the same understanding.

The other rules—Success Starts Here, We Speak the Same Language, It’s Gotta Tie Out, and especially the 80/20 Rule and DORs are Number One—are things you will not hear in other companies. These may be easier to adopt because people don’t have any biases for or against them.

The numbers are ultimately important because of what they imply for the people the organization impacts. If we can’t pay the staff, people can’t make their rent payments. Conversely, if we can give more to the community and help people in need, if we can reduce our interest costs and improve bonuses, etc., everyone wins. By sharing the stories and the meaning behind the numbers, we bring them alive.

The game of business is no more about these rules than basketball is about how far out the three-point shooting line is. But you do have to know and understand how the rules work, and then use them regularly to bring the whole thing alive, to personalize it and profit—financially and spiritually, as an organization and as individuals—from the work.

Here are Zingerman’s ten rules of open-book finance:

1. Begin with a Plan
Each spring we start work on what we call “ZAP”— Zingerman’s Annual Planning. We spend three months working to get clarity on where we’re going as an organization, what each part of the company is going to do within that, and what action each department and individual will take to make that happen. We start with a vision, a picture of what the successful organization will look like at the end of the planning period.

Good planning is critical to great financial performance. While you can find places that have scored huge financial successes without planning, most of those are going to be a one- or two-time success, not sustainable, learnable, self-regulating and stable organizational models.

Writing a clear plan allows us to go into the year knowing that we have a workable, agreed-upon, inspiring but still strategically sound approach to get where we’re going. The plan also allows for the likely reality that we will regularly drift, fall, and/or trip and find ourselves off course. By having the plan, we can much more easily figure out where and how to adjust throughout the year.

By teaching the value of good planning at an organizational level, we’re helping both the business and the people who are part of it think long term and work with the reality—the rules of business—that resources are limited, time impacted and there to be managed for the greater good.

2. Profit is Vital
The idea of profit being a positive thing is a no-brainer for most. But when I ask staff to define and describe what profit is and where it goes, most have little or no clue. Some chuckle and say, “In your pocket.” I usually come back with, “In my dreams.” Even in super profitable businesses, it’s unlikely that all the profit goes into the owners’ bank accounts. And it certainly never has here.

Staff members are rarely able to give a formal definition for profit, let alone explain what happens to it. Many will say, “It goes back into the business,” which, while true, doesn’t help much. When I ask what “back into the business” means, they cite things like “training,” or “giving to the community.” But, while being profitable can enhance our willingness to do more training or increase donations, any accountant knows that those are expenses, not profit.

With that preface, I talk to the staff about what is obvious to every accountant and to many business people, but is barely and rarely understood by most of the people they employ.

We start with a simple formal definition: Sales – Expenses = Profit

What each organization puts into “expenses” is primarily dictated by the Internal Revenue Service and the rules of GAAP (Generally Accepted Accounting Principles). But to some degree each company defines what goes where in its own financial world. We show staff where food, labor, supplies, social security, rent and all the other expenses on the profit and loss statement appear.

The more interesting issue is understanding where the profit goes.
At Zingerman’s, that means five areas:
a) Capital purchases: Any piece of equipment that isn’t for reselling and that costs more than $1,000.
b) Paying down the principal on loans: Making payments on money that we have borrowed from banks or investors.
c) Paying federal taxes: This is currently running at about 30-plus percent of profits. This one shocks most front-line staff—they simply never think about the reality that $35 of each $100 we make goes to the government.
d) Return to shareholders: This is the payback to those people who’ve invested in the business.
e) We save it: Along with capital purchases, bigger savings will contribute to an increasing book value.

Although not part of profit, we have pay outs that are often tied to it:
• We pay out profit-based bonuses.
• We pay in to our Community Chest, a fund available for those in need in the organization to draw on.
• We give ten percent of the previous year’s profits to the community through non-profit contributions (but if you’re keeping financial track, note that that giving will be an expense, not profit, in the coming year).

What happens when front-line staff understands this? Here’s a great example.
A dishwasher at our restaurant, Zingerman’s Roadhouse, pointed out that two-thirds of the fancy sugar cubes we served with coffee were coming back to the kitchen and getting tossed in the trash. They were going out unwrapped in small cups, so they could not be reused. So we changed to wrapped packets. How much was this worth? Given that we serve probably 150 cups of coffee on a typical day, if it reduced cost by five cents per service, that’s $7.50 a day, or about $2,700 a year. Which goes straight to the bottom line. And that was only one idea by one intelligent individual who happens to wash dishes.

We teach the staff the truth of the business world—the story behind profit. When we’re profitable, we have the financial stability to make more effective decisions. Being profitable enhances our ability to borrow from banks by showing a positive balance sheet, which assures them that we have the margin to cover the inevitable risky decisions made to operate our businesses. And, very importantly, because our commitment is to donate a large share of the previous year’s profit, it’s important that we actually be profitable so that we can continue—or better still, expand—the funds we give to the community. This latter piece is a big motivator to increase profitability for many staff members.

3. Cash is King
We ask the staff to explain the difference between being profitable and having cash. Few understand that the two, while related, are often different. A business can be profitable but have no cash on hand. Or you might have plenty of cash but the business is not operating profitably.

We share that the most common cause of failure in rapidly growing businesses is shortages of cash. We talk about the implications of shortages—as in, “What happens to paychecks when there’s no money in the bank?” We then talk about one short-term solution to cash shortages—borrowing. And then we use that example of borrowing to back up to Rule 2 and show how borrowing $10,000 today will negatively impact profitability going forward because it increases interest costs. In this context, we teach about accounts payable, accounts receivable, paying down debt service, and cost of paying interest on loans.

Why would a front-line staff member need to know about this? Because they make decisions that majorly impact our financial results. If they don’t understand what profit means and why you need cash, they will make poor decisions.

One of our best, most loyal and intelligent staff members had what we call a “belated glimpse of the obvious” when she realized what Cash is King means in the day to day. While her unit was doing well from a sales and profit standpoint, cash was tight because accounts receivable were high. At the department’s weekly huddle, the forecast on cash was grim. The accountant politely mentioned that any purchases the business might put off would help make it possible to pay the bills. All of a sudden, it clicked for her; she had a stack of credit card receipts waiting to be processed, set aside because she was so focused on giving good service to customers. All she needed to do was to run them through immediately, rather than wait until there was a free moment, to reduce the stress around the cash shortage.

She was not letting them pile up indiscriminately. We had trained her, first and foremost, to give great service and she was committed to doing so. And there were a lot of customer needs she was attending to instead of getting to the credit card processing. But once she understood what to most accountants would be obvious, she quickly carved out the 30 minutes that it took to finish processing and put thousands of dollars of needed cash into the operating account.

Another time, having cash allowed us to take advantage of a big buying opportunity. We had a one-time chance to buy something at an amazing price that has a multi-year shelf-life. There was nothing wrong with the product—the supplier just wanted to move it. We were able to buy 3,000 units, at a savings of more than $5 per piece. Front-line staff members were able to quickly calculate that even if it takes a few years to sell them all, that’s $15,000 added to the bottom line. Even when they add on the cost of holding the inventory, that’s still a financial win. Without the cash, we could not have done it.

4. Building Value is Essential
This is probably the least utilized rule in the day-to-day operation of the business. “Building value” in the financial sense is something that staff members rarely think about. In essence, it refers to what shows up on a balance sheet as “retained earnings,” which in turn is a mathematical calculation that combines the value of capital purchases we’ve made along with long-term savings resulting from profits.

Without getting into depreciation, this balance sheet entry is basically the value that owners have accumulated over the years. While the spiritual value of what we’ve built is great too, it’s important to people who invest to be able to show financial wins. Few front-line people—even in an open-book setting—think much about why they’d want to build book value in a business. But there are reasons:
a) Healthier balance sheets make it easier to borrow because banks rarely lend to anyone who needs money.
b) Retaining earnings is a way that we show the staff, the community and the bank that we’re building a sustainable business that has the wherewithal to be here for the long haul.
c) If owners aren’t seeing any return on their investment, they will take their money out of the business. If they take it out, the business will not be viable, which means no jobs.

5. DORs are Number One
DOR at Zingerman’s stands for Department Operating Report. Don’t get hung up on the name—you can call it your “scoreboard,” your “dashboard” or whatever you feel like (our Mail Order staff calls theirs “Murray”). We elevate the DOR to the highest level of organizational importance because the DOR is the place where everyone playing the “game” can and does look to see how we’re doing.

The DOR is the single most important financial document to use—more important than profit and loss statements, balance sheets or cash flow reports.

What makes the DOR so important? It will likely contain the most critical elements of each of the other three financial statements. DORs are much shorter than typical financial statements. Somewhere between five and, at most, 25 different line items are typical. They should be able to fit onto a single white dry erase board and a single sheet of paper (two at the most). Consequently, they’re easier to read quickly and effectively than those longer and more complicated financial documents. With a modicum of training, any interested individual can learn to read the DOR and figure out how things are going in their own area.

The DORs report critical, non-financial, as well as financial, measures; we track food and service quality and other key issues, such as sanitation, staff satisfaction, etc. They also show financial numbers that are essential to know for operations but don’t show up on a financial statement. A classic example is the check average in a restaurant. Everyone needs to know it—it’s important to managers and servers—but it never shows up on a standard statement.

DORs also include forecasts. By scanning its five to 25 lines, I can tell much better how a business or department is doing and what the trends are than I can by reading only financial statements. Plus, the DORs take the power out of the office and put it in front of everyone. We can all read it, learn from it and make a difference.

6. It’s Gotta Tie Out
A basic problem in many organizations is that individuals operate under the mistaken assumption that they’re working on their own. That mindset—often referred to as a “silo mentality”—implies that each person works without impacting anything else. That’s completely inaccurate—everything each of us does has impact on the organization and everyone else in it.

Watching people understand the idea of tie out is an amazing thing. Most resist the idea at first—it’s a lot of responsibility to realize that if I over-order on one item by $2,000, other buyers will have $2,000 less to spend unless we borrow money or delay payments. It’s scary to realize that if I increase my sales forecast significantly, the purchaser will order more product to fill the demand. It’s overwhelming the first time you realize that adding staff and increasing labor costs also raises benefit costs, which could lower profit. And downright intimidating to understand that if you lower sales forecasts and labor cost is managed as a percentage of sales, you will have less money to spend giving staff the hours they thought they would have.

This rule is one where leaders and accountants must aggressively teach the concept and show everyone how to apply it evenly. We have to make sure that important questions of tie out are always being asked. For instance:
• When sales are forecast to increase, will we have enough product? Do we need to schedule more staff?
• Have we adjusted for what may happen if we run out?
• If there’s a frost in Florida and citrus costs skyrocket, have we forecasted a higher food cost? Raised prices to compensate? If we raise prices, will sales fall?

The ultimate truth of this rule is that it’s at work whether we like it or not. Although few people pay much attention to it, this rule is one of the most important ones we have.

7. A Dollar Today is Worth More than a Dollar Tomorrow
Although this concept comes as second nature to nearly all entrepreneurs and accountants, it’s rarely a conscious thought for those working in their businesses. You can remedy that by trying the following exercise: Ask if anyone in the room will give you $10 on the promise that you’ll give it back to them before they leave the room. Unless you have a habit of not doing what you say, most will make you the “loan” without worrying much about it.

Then try the question again: “How about you give me the $10 and I’ll give you back the same bill a year from now?” Everyone but the independently wealthy or the exceptionally generous will balk. And for good reason. If they have to wait a year to get back that $10, they should be getting back more than they sent your way. Ten dollars a year from now is worth less than ten dollars today.

To explain this rule in more detail, we teach about accounts receivable, about the cost of increasing inventory; we talk about how interest works and what happens when we borrow money from the bank; we work through the math to determine whether it’s better to take a discount on early payment of an invoice or to take longer to send a check and give up the discount.

Can front-line staff understand what this means? Of course. At a new employee orientation class a few years ago, a staffer talked about the experience of attending his first weekly huddle where we review the DOR and all the key numbers. He told the story of hearing one of the managing partners ask the crew about a large purchase of product she wanted to make. Doing so would pull a significant amount of cash out of savings because she’d be buying about a six-month supply. But the lower cost for the product would allow for a good reduction in cost of goods. Our staffer was shocked that a) she was even asking the group for input and b) the group members were calculating the cost of the interest the business would be giving up to compare it to the savings on cost of goods from the lower purchase price. When this concept gets through, it’s a beautiful thing to behold.

8. The 80/20 Rule
Most every manager in the business world has probably experienced—painfully—
what the 80/20 rule isn’t. You know, those old-style financial meetings? Someone reads from the financial statement, all too often in a sleep-provoking monotone, informing the group of last month’s financial results. Usually the numbers are followed by an explanation of why they are what they are. The group listens; people argue theories of why the numbers were what they were, but nothing much happens, and the meeting ends.

Instead of spending time reviewing what’s already over with, our rule says that we spend 80 percent of our time looking forward and doing forecasting and only 20 percent of our time talking about past performance. The 80/20 rule makes finance fun, meaningful and downright exciting.

Thinking ahead means we can think positively. We have a chance to change what we do now to get where we want to go. It gives time to coordinate amongst ourselves and with our suppliers to do what needs to be done to get there. By using this 80/20 rule during our weekly staff huddles, we’re helping everyone to see where we’re headed. Sometimes it looks like we’re going where we want to go; at other times not. Looking forward instead of just reporting on where we’ve been allows us to steer in the same direction, to put our energies into productive, positive adjustments.

9. We Speak the Same Language
This is not a fancy rule; mostly it seems self-evident. When we first started to use open-book finance, we discovered that we had key people—me included—each of whom had their own definitions of important terms. For instance, people were commonly confusing a “sale” (where product is put in the hands of the client) with both a “booking” (a commitment by the client that a sale is going to take place at some future date) and a “receipt” (where we actually get the money). All are important but they are not the same and you can see where using them interchangeably could get any organization into a lot of trouble.

By committing to honoring this rule, we’ve set up glossaries, documenting what we mean by each key term to ensure that each of us understands the same thing. For example, when we use the term “Net Operating Profit,” everyone knows what’s included and what’s not. When we talk about “labor cost,” we do not include benefits. Freight for products coming in is included in cost of goods. When it comes to finance, we all have to speak the same language.

10. Success Starts Here
This rule underlies the whole open-book finance approach. If we didn’t firmly plant Rule 10 in people’s hearts and minds, our recipe for great finance would never work well. Every player on the team has to know that they’re responsible for winning, not just waiting for the star players to pick up the pace. In practice this means that we’re all responsible for making our mission a reality every day. And that—whether we’re full time or part time, old or young, high or low on the organizational chart, new to the organization or an old hand—we’re all responsible for getting great financial results.

Is it working? The results piece is easy to see because it shows up in black and white on the DORs and the financial statements. The cultural change is something you pick up watching and listening to what people say. Three quick examples:

1) Standing behind the counter at the Deli, I heard one staffer turn to his peers and, unsolicited, tell them the up-to-the-minute sales totals for the day. That was nice but what caught my attention was the immediate question that came back: “Is that before or after discounts?”

2) Not two hours later, I was at the Bakehouse about 30 minutes before closing. I walked by while the two front-line staff on the counter were talking. “We’ve got $121 to go,” one said. I asked what they were talking about. “To get to the sales total for the day,” the other answered. I went in and the phone rang. Sixty seconds later I heard the first staff member say, “That gets it down to $61. Just sold two coffee cakes!”

3) While teaching the new staff orientation not long ago, an employee at the Deli who can’t be over 18 started telling the rest of the class how valuable the finance training had been. I asked her why and she replied, “When all my friends start complaining about how high the prices are, I can explain that we don’t have a very big margin and that it costs a lot to put out such good food.”

These stories are even more important because of the tone in the voices of the people who said these things and the look in their eyes when they said them. This is not a group of University of Michigan MBAs trying to impress me. These are hard-working, caring staff who have no formal business training, but who totally get it. They don’t just “know the rules;” they understand them and understand why they’re important.

This first step to Great Finance—knowing and teaching our Ten Rules for Great Finance—has been just as important as knowing and teaching how to make a cappuccino, cook corned beef or bake a loaf of country bread. The more everyone understands, the more they know how to impact the results, the more they know how the results impact them, their peers, the organization and the community, the more we all win.