Predictable Predicaments

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My 8-year-old son is into using the word “predict” right now. As in, “you can’t predict that, mom.” This term is usually used when I tell him something terrible will happen if he doesn’t (insert chore here). He’s right; I can’t predict many things, but there are things I can anticipate and prepare for.

Most of our 60 Minute CFO students and customers come to us with business situations they are either currently in or trying to prepare for. And the good news is that most of these predicaments are pretty predictable. Because it’s fun to say, I’ll call these “predictable predicaments.”

Here are a couple of examples and how you can prepare for them.

Predictable Predicament #1: You see inflation and your costs rapidly increasing.

 When your costs increase, your margins decrease. Your margins are where you make money, i.e., your levels of profitability, and there are three on which to focus:

1.    Gross Profit Margin               = (Revenue - Direct expenses) / Revenue

2.    Operating Profit Margin         = (Gross Profit - Indirect expenses) / Revenue

3.    Net Profit Margin                   = (Operating Profit - Other expenses) / Revenue

 The first thing to do is to identify which expenses are increasing. Are they direct, indirect, other, or some combination? This analysis will tell you which areas to adjust. For example, if they are direct expenses, you optimize your Gross Profit Margin by adjusting your pricing.

 If your Gross Profit Margin is satisfactory, but your Operating Profit Margin declined, you must carefully examine indirect expenses. While tedious, even a 0.1% increase over several line items can significantly affect your operating profit.

 If your losses are at the Net Profit level, it’s likely due to increased interest expense. If so, consider paying down debt faster or shopping for lower interest rates.

 Use the “% of revenue” column on your Income Statement to analyze expenses and profit margins. If you don’t have that column, ask your financial manager or bookkeeper to provide it. If one or more profit margins have declined, look at each expense to determine which ones have increased as a percentage of revenue. A report prepared for each month side by side will facilitate this analysis.

Another best practice for rising costs is to take a zero-based budget approach. Instead of accepting an annual increase, question all expenses reason for existing to maximize profitability in any situation. Premium Brazillian coffee in the breakroom? Deluxe skin cream in the bathroom? Do you need these?

Predictable Predicament #2: Sales are declining, and you are worried about liquidity and paying bills on time.

This situation can and should be addressed on a sales and marketing level, but there are steps to take on a financial management level.

First, resist the temptation to put your head in the sand and hope it all blows over. Good leaders take swift and decisive action.

Second, identify how bad the damage will likely be and how long it will last.

Use Business Mastery (.xls) to forecast your sales, expenses, and cash flow (estimating your cash, inventory, asset, and debt levels).

Business Break-Even (.xls) calculates your break-even revenue.

What revenue do you need to break even? If revenue is expected to be below this number, it’s time to cut indirect expenses.

Debt-to-Equity: This ratio indicates your safety or “ability to withstand adversity.” How much debt and equity do you currently have? Can you stand to take on additional debt to get through this rough patch, or are loans and lines of credit already maxed out?

Revenue per admin employee. Your historical amount for this is your benchmark. Has it gone down? Do we need to cut staff? This number will tell you. If revenue per admin employee significantly declines, you cannot support the existing administrative staff members. Laying off valued employees is never easy, but if the business’s survival is at stake, do it anyway.

Predictable Predicament #3: Your business profitability is growing rapidly, but cash flow is negative. What do we do now?

Cha-ching is the sweet sound of success until it’s all you can hear and deafening. Then, the pain of a high-growth phase can be genuine. “Growing broke” is the common problem in this predicament because growing businesses require more of everything: inventory, employees, space…and the big one, cash.

 Cash flow management is the most important thing to do in this predicament, and I have good and bad news.

 The bad news: Very few accounting software programs will give you an accurate statement of cash flows.

The good news: You can project your cash flow with a few steps in Business Mastery (.xls). This is the most direct way to figure out how much cash you will need to support your epic growth.

Conclusion

No matter your predicament, it doesn’t have to be a solo job to figure out how to make it through a challenging business situation. Involve your leadership team, reach out to others in your industry and ask for help and ideas.

Do you have a predictable predicament on your mind? Let us know how we can help!