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Financial Waste: Prepaid Expenses

"Who do you trust more with your money? Your vendor or yourself?"

During the last five years, I have become infatuated with LEAN Manufacturing and making my life more efficient. It started during my Operations class at UMass-Amherst, under the guidance of Professor Alan Robinson, who consults for companies that need to reduce waste (check out his latest book, "Idea-Driven Organization"). In one class, he showed us a video that changed my life. It was the factory tour of FastCap, a manufacturer in the northwest corner of Washington state. These guys have an A++ understanding of LEAN, and their founder, Paul Akers, is not shy about sharing resources. In his book, "2 Second Lean" (which is freely available), he talks about the Eight Wastes and how they can cripple an organization. They are (I will use my own experience in creating a financial model that had excessive sophistication):

  1. Overproduction: Since I want to impress my audience and satisfy every possible need, I create a model with unnecessary features.

  2. Transportation: Because of my model's sophistication, I send it to a colleague for a thorough review.

  3. Inventory: My model takes up significant storage space and requires excessive CPU resources to run.

  4. Defects: Because of the file size and complexity, bugs are inevitable. My colleague will immediately notice these.

  5. OverProcessing: I have to review my work, find those bugs, and redo my work to reduce features and volume size.

  6. Motion: I need to constantly switch between worksheets and programs to detect bugs and conduct a deep review.

  7. Waiting: My client is waiting for the model that I promised to produce within a reasonable time period.

  8. Wasted Potential: I lose my client's trust and future business because I could not deliver a clean model within his expected timeframe.

So how does this quick story tie into the above quote? A client was regularly paying a vendor a set amount each month instead of paying the amount due, which led to a big credit during the first half of the year. It was understandable why he did this; he was proactively budgeting for an expense and wanted to reduce cash flow volatility. However, when you incur a large credit balance with a vendor, you are losing the opportunity to spend that money elsewhere where it could deliver greater value (Wasted Potential). You are also creating an accounting nightmare because you have to post those payments against the actual bills you receive. You have to reconcile your full balance against a vendor statement, which involves contacting the vendor every month to receive it (OverProcessing & Motion).

Again, my client had a sensible thought process; he wanted fewer surprises with his expenses. When I told him the above quote, he changed his thought process. That freed up cash for him to make impactful assets purchases and hired a full-time team member. Both of those solutions have paid off, as my client just doubled his assets thanks to a large real estate acquisition.

How does this story apply to others? Unless you receive a significant discount (~25%) and you know you will be using that service for the next year, never prepay for the year. The other exception is if you are required to prepay for the service (i.e., insurance, permits, commercial rent, etc.) Last week, I made this mistake, as my email box was cluttered past my tolerance level, prompting a one-year subscription for SaneBox, which has done its job well. However, three hours ago, I watched a video on keeping your Outlook inbox within your tolerance level for the low cost of $0.00 (by the way, if you ever touch any Microsoft product, you must subscribe to Lelia's channel). If I just paid for the month-by-month option, I could cancel my SaneBox subscription and save my business $40.

Lastly, I currently use Gmail and GSuite for my business; however, I am seriously considering switching to Microsoft 365. I will have future blog posts about the potential transition.

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