One of the things that never ceases to amaze me is how little many entrepreneurs know about the finances of their own businesses. Worse still, how late they find out that their company is in crisis. Just like in personal life, sometimes we ignore the signs of an illness because we naively think that if we ignore them, it will not happen.
I have spent almost 25,000 hours working and advising owners of the most diverse types of businesses; some have been medium-sized companies, others have sales of more than five hundred thousand dollars a month and employ two hundred or more workers.
Because I have specialized in financial reengineering, I am frequently called to provide advice to companies in crisis.
Generally, I start by analyzing the financial statements and some special reports to get an idea of the problem.
Then, as if I did not have that information, I meet with the businessman and ask him some questions like these:
What have been the sales in the last six months and how has your behavior been compared to the same six months last year? What is the sales trend of your business?
What is the average contribution margin of your business in the last six months and what was last year in the same period? What is the trend in sales prices and costs for the next six months?
What is the contribution margin for each of the products that represent 80% of your monthly sales? What is the contribution margin generated on average by customers whose sales represent 80% of their monthly volume?
What is the financial and operational balance point of your company?
Do you know exactly how much was earned in the last accounting period? Do you know where those profits were invested, if any? If you had losses, do you know how they were financed?
What is the working capital of your business? Do you have the capacity to meet your commitments to suppliers and banks in the next twelve months?
To the first question, everyone answers easily, vehemently and convincingly. In general, almost every entrepreneur I've dealt with is very vigilant about their sales behavior. I have a client who requires the managers of his 12 stores to report the amount of sales, every day at closing, by Skype or email.
The businessman pays a lot of attention to sales volume because he considers it to be the engine of profit. This is usually the case. When sales grow, it is because the business is growing and it is an example of the effort we make to attract more customers to the company. If sales grow, it is because the customer is satisfied with our products or our services.
Knowing the composition of these sales also favors the analysis. Sales increase for some products, while others decrease. The entrepreneur who looks only at the total volume could be missing that vital information to make decisions and control the results.
But not always more sales mean more profit.
I use a phrase frequently when a company sees its sales grow, but has cash flow problems. I say, "You are facing the irony of growth."
This "growth irony" is not always a symptom of companies in crisis.
As an entrepreneur, you know that in order to increase sales, you must invest, you must increase your production capacity and, perhaps, also your sales force.
Although you do not have to invest in additional square meters in your facilities, you do not have to invest in additional machinery and you can increase your sales with the same sales force and the same current administrative structure, you will have to invest in working capital to support growth On sales.
Suppliers may finance part of that growth, but not all.
In addition, you will have to pay your bills in 60 or 90 days. Growth can take place in a few months, but investment recovery is slower.
You have to finance working capital with your own funds and bank financing, you must have the ability to give credit to your new clients. You must also finance the necessary increase in inventories. At first, new inventories will start rotating more slowly.
That's where the “growth irony” is experienced: You feel the business is growing, but you have cash flow problems.
How do you know if your company is really in crisis?
There are 5 ways to find out, there are 5 symptoms that should catch your attention and lead you to take action immediately:
1. The company has difficulties to pay invoices to its suppliers on time. And perhaps it has also fallen behind in the payment of taxes, social security contributions and other obligations with the Government.
2. Right now it is requesting its banks to make adjustments in their loan operations to lower the monthly installments or, perhaps, proposing new financing to organize the payment of their commitments and level the cash flow.
3. All your real estate and perhaps also some valuable machinery is fully pledged as collateral for bank or commercial loans.
4. Sales are not growing, markets have contracted and prices cannot be increased.
5. Product profit margins are lower than last year and marginal profit is not covering fixed costs and expenses. In other words, the company is operating below the break-even point.
Only one of those questions, answered in the affirmative, should immediately turn on a red light and alert him. You must act right now. You must make changes to prevent the situation from worsening.
You should know right now what level of progress the situation that has caused that problem may be having. You must locate exactly where the real problem is.
Some statistics indicate that 25% of businesses facing financial problems do not recover and never operate again. Other sources say that the percentage is higher, they speak from 43% to 46%.
The first step in solving a problem is: define the real problem. A poor definition of the problem can lead to the loss of valuable time.
However, in order to define it properly, it is necessary to know the reality and have accurate information about the true situation of the company and the results of its business.
That is the point with which I started this article: many entrepreneurs know very little about the true financial situation of their businesses and do not have precise information about the profits that their operations are leaving.
These entrepreneurs are too busy on the "battlefield." This is good, but many times they start paying attention to their finances when the crisis is very advanced.
Do you know what the financial situation of your business is today?
Do you know what your marginal earnings are?
Do you know if your company can meet its commitments in the coming months?
Do you know what steps you need to take right now to prepare for or avoid a crisis?
Leave your comments and questions in this article.
If after reading this article and looking at some figures in your companies you think that yours may be in crisis and you want to find solutions right now, write to me at [email protected]. I will answer you to arrange a first telephone interview.
Together we will look at the steps you can take to get started immediately.
