When you run a manufacturing business, whether it’s in an early stage of growth, has been around for years, or has transitioned to a second or even third-generation of ownership, you can probably answer almost any question someone could ask about your market and the products and/or services you sell. But there’s a good chance you would struggle to answer the following five key questions that can make or break a company’s financial condition – and that can create all kinds of problems for any business:
- What are your margins, by product?
- Do you have the right staff on hand?
- For manufacturing businesses, how long do raw materials sit around before they are used, and how long does it take to turnover your inventory?
- What does it cost to acquire a new customer?
- Do you know the profitability of each customer?
Assuming the products you manufacture and services you provide are things your customers need/want, the answers to these questions are key to understanding why your business’s cash flow and profits may not be all they should be. Even a business that offers a great product or service, and has satisfied customers, can get into financial trouble by neglecting the financial analysis these questions require. Since ultimately, you’re in business to generate a profit, answering these questions is worth your time. Still, many, perhaps even most entrepreneurs and small- to mid-sized business owners and CEOs cannot. Why?
Business Owners Often Don’t Focus on Numbers
When a company is fairly new, everyone is laser-focused on growth. Things are moving quickly, and owners and managers spend their time and attention designing and building quality products and making sales. If the business has momentum, taking the time to construct and review financial metrics seems like a low priority (and, quite honestly, it’s probably not as exciting as the other things competing for your time and attention). So, understanding the firm’s financial condition is often neglected until some type of trouble starts brewing.
Similarly, in mature companies the owner or CEO is usually absorbed with staying competitive, ensuring quality manufacturing and service, dealing with suppliers, and delivering to customers as promised. Sales are tracked, and Accounting takes care of receivables, payables, payroll and taxes, but often not much is done in the way of financial analysis.
Business owners often don’t realize they need better, ongoing financial analyses until something starts to pinch. That could mean not having the information needed to respond to questions from an investor, a lender, or the CEO. Or, a problem with cash flow indicates something is wrong – even though you’re generating sales, there isn’t sufficient cash to pay the bills. You are forced to draw on a line of credit or find new money to put into the business.
How the Five Questions Can Pinpoint the Source of Trouble:
Question 1: What are your margins, by product?
A business that doesn’t understand its unit costs cannot know its true margins per product. The WeWork fiasco has generated a lot of talk about getting back to basics and understanding unit costs, or “unit economics”. That includes knowing what it costs to service the average customer, ongoing commissions paid to sales and service reps, and what your average customer pays per product. Business owners usually know their raw materials costs but don’t know their true profitability by product.
Question 2: Do you have the right staff on hand?
Service businesses, in particular, need to focus on the productivity of their sales and support staff. How much of your client service team’s time is directly billable to clients or clearly responsible for client retention? What is the average percentage of the team’s time that is directly billed to customers? How much of the sales team’s time is spent on developing a pipeline and closing business? Bottom line: do you have the right staff spending a high percentage of their time on revenue-generating activities?
Question 3: How long do raw materials and finished goods sit in inventory?
For manufacturing businesses, if raw materials are sitting around for months before they are used, you’re sending cash to suppliers long before you’ll bring in cash from customers. Similarly, if inventory is sitting around too long, that’s tying up cash. That can be a big drain for retailers and even service businesses like restaurants (unused food spoils, wine inventory is costly). There is a balance that needs to be struck between having enough inventory to meet your needs versus tying up excess cash in excess inventory.
Question 4: How much does it cost to acquire a new customer?
Businesses often have only a vague sense of their customer acquisition costs. If you have a long sales cycle, your sales team has to spend a lot of time to bring in every new client – that’s costly, but have you quantified it? If you exhibit at trade shows, do you know how much new business came in as a result, and whether the costs (including exhibit fees, travel and entertainment) were worth it? Ironically, for businesses that are doing well, CEO overconfidence can be a problem in this area. As the boss, have you started thinking that every idea you have for pursuing new business is a winner?
Question 5: How much do you make from each client or customer?
Customer profitability is an often-overlooked source of financial problems. Giving a discount to a big customer may seem like a good idea, but not if the relationship is unprofitable when you consider all of your costs – that includes salaries and commissions paid to your sales team and the cost of customer service reps’ time spent supporting each customer (see #1 above). You may need to reduce or end a discount or simply tell a customer you can’t afford to do business with them. We recently worked with a company that was losing money and had maxed out its bank credit line. We performed an in-depth analysis and determined that some of its largest customers were unprofitable. As a result they terminated or restructured some those relationships and returned the business to profitability. Today, the company has a good amount of cash in the bank and is debt free.
Business owners often sense they’re having financial trouble but resist hiring a CFO because it would add to overhead and they’re accustomed to just having a bookkeeper, so they just don’t take that next step. In many respects, it's like being physically fit and active in your 20’s, putting on weight in your 40’s while telling yourself you’re going to make changes, then finding yourself seriously overweight at 60, at risk for a heart attack. With hindsight, you knew where you were headed and could have prevented it with the right kind of intervention and advice.
Outsourced CFO services can be a mirror to show you what you already know but may not want to face. If you have a good product or service but your cash flows or margins are struggling, an expert CFO can figure out why by examining the financial drivers captured in the five questions above. There will always be things in business you can’t control, but what you can control you need to understand, measure and manage. A thorough financial analysis by a strong CFO can provide the answers you need to do that.