Businesses experience financial difficulties for many different reasons in all economic environments. While a recession is never good news, things can go off the tracks even when the economy is booming. Business longevity is no guarantee of continued profitability – even a business that has been around for decades can find itself in a turnaround situation. The important thing is for business owners to recognize that they are in a turnaround situation and promptly figure out the underlying cause and take action. Simply hoping that things will somehow improve on their own (highly unlikely) is not a good strategy.
Signs of a Struggle: Does Your Business Require a Turnaround Management Strategy?
How do you know your business requires a turnaround? Here are some of the tell-tale signs:
- Conversations with your bank are becoming uncomfortable. You may be close to breaching one or more covenants in your loan agreement.
- You have been telling yourself that you just have to get past this next month/quarter, and things will get better, but there is no real reason to expect that the situation will improve.
- Your investors are becoming frustrated and impatient because your financial performance is far below expectations.
- You have been in business for many years, but it is a struggle to turn a profit. Note: In a start-up phase where growth, rather than profitability, is the key objective and growth targets are being met, that does not indicate a turnaround situation.
- Your company’s profitability is much lower than the average for your industry.
- Even though the business is generating revenue, you constantly have problems with cash flow/ and liquidity.
5 Steps to Analyze Business Profitability
Acknowledging that the business is struggling and that things are not going to improve on their own is an important step. It means you have accepted that you need help. But what help? When you see a doctor because you feel unwell, they do not prescribe a course of treatment before examining you and analyzing the causes of your symptoms to make an informed diagnosis. When your business is not doing well, you need to analyze the financial symptoms before designing a “treatment plan.”
1. Start with revenues.Is your industry facing a temporary problem hitting sales (such as a shortage of raw materials)? Or, are your revenues declining faster than the industry average? Are you struggling while your competitors are doing fine or even gaining market share (yours?). If you have multiple product lines or different types of services, which are most important in terms of revenues and unit sales? How has that changed over time?
2. Understand what drives your margins.Understanding what drives profit margins will require an analysis of gross profits by product line or type of service . Analysis may also involve drilling down to the SKU level to determine sales growth vs, profitability. If unit sales for a vital product line are steady or even growing, but gross profits are shrinking, that is an important clue.
3. Analyze profitability by customer.
Analyzing profitability by customer means determining your gross margin per customer and the cost of acquiring and supporting that customer (or the average customer acquisition cost for a business where revenues are spread out over a large number of customers).
Sometimes, companies will do anything to get a big company as a client, even lowering prices to where the relationship is not profitable. That is not always a problem – if having that big client boosts your brand, improves your visibility, and brings in other new business; it could be worthwhile. But, it could run you into the ground if you have to devote too many resources to service that client, and the margins you earn (or losses you incur) do not justify it. On the other hand, if a relationship does not require much support, even a small profit margin can be justified in dollar terms.
Customer profitability can be tricky to analyze. A business has to spend money to acquire customers and maintain those relationships, but this should be measured and evaluated in terms of costs and benefits. What does it cost, in terms of sales and marketing expenses, to acquire a customer? When money is spent on marketing, do you measure conversion rates? Does your customer lifetime value exceed your customer acquisition costs?
4. Look at your cost structure, starting with headcount.
Personnel costs often represent the most significant expense category – potentially 60%-80% of operating costs. Are you keeping employees who are not contributing what you need? What are the other big expense categories? Have they changed significantly in recent years? If so, why? Optimizing your cost structure will require buy-in from the leadership team, as well as a certain level of financial discipline.
5. Analyze R&D spending, which drives growth.
Is product development taking longer than expected, assuming you have a good estimate of how long it should take and what that should cost? Are you releasing new products less frequently than your competitors? You might be underinvesting and not innovating at the rate needed to stay competitive in your industry. What level of growth are you projecting from releasing new products? If your forecasts are not anticipating an increase in sales from new products, you may be underinvesting or taking too long to come to market.
As an entrepreneur, you need to take chances. As Steve Jobs once said:
“Our job is to figure out what (people) are going to want before they do. I think Henry Ford once said, ‘If I'd ask customers what they wanted, they would've told me a faster horse.’”
The challenge is to generate a profit with existing products that can finance the development of new ones. If your business cannot do that, it is a sign of a turnaround situation.
G-Squared has deep experience in identifying and addressing the challenges that put businesses into a turnaround situation. To discuss your company’s situation, get in touch with our team.