Signs of a Business in Trouble
In a poorly managed business the owner/manager will realise too late that his business is in trouble. This will be because of a general lack of management and financial information, and poor understanding of the financial characteristics of the business. In the absence of detailed financial information, it helps at least to be aware of the outward signs that the business is heading into trouble. The following indicators have been identified by business consultants and researchers over many years of troubleshooting experience. The downhill slide is gradual to begin with but steepens seriously in the middle stages before the final uncontrollable collapse into receivership. Like any other kind of cancer, early detection and treatment is the key to recovery.
The Early Signs
Plateaued sales with rising costs
Stable stocks with dropping sales
Deteriorating gross margins
Slow payment to creditors
Deteriorating cash balances
The Signs of More Serious Trouble
Gross margins are dropping noticeably
Working capital is very scarce
Suppliers are requiring payment before delivery
Trade credit is difficult to arrange
Meeting the payroll becomes a weekly challenge
The bank is showing concern
Employee morale is dropping
Some good people leave the firm
The Terminal Stages
There are many quality problems
All supply terms are – COD plus part of the past debt
Covering the overdraft becomes the main function of management
There is very limited financial reporting
The bank account is passed to the recovery section
Many staff try to get new jobs
Collapse is imminent
Although recovery is possible even at late stages in the decline, the task is much more difficult. In New Zealand, receivership situations that are traded out of the difficulty account for only 3% of the total cases. In the other 97% of cases the assets are sold under pressure at market rates to achieve the best recovery of debt for the secured creditor.
Potential for a turnaround
If you find yourself heading for trouble, here are some things you can consider to bring your business back on track.
Profit and Loss Account
- Can you reverse a declining sales trend? Get closer to your customers and re-evaluate the marketing strategy. Can you change the product mix, the product design, the location, or your selling and promotion methods and skills?
- Can you improve a poor gross profitmargin? Can you eliminate waste in a production area, improve capacity utilisation or reduce cycle times? Check that everything is invoiced correctly and that delivery dockets for materials coming in match the delivered items. Check your costing Mind your stock and cash security. Know your margins for each product and look for ways to build sales in high-margin products. High labour costs indicate low productivity. High material costs indicate excessive purchase prices, wastage or theft. Can you reduce distance or movement, improve staff skills, combine or eliminate steps in the production process? Can you redesign products for faster processing and redesign layouts to give a better flow of materials? Can you increase checks and balances to avoid stock losses?
- Can you reduce your salary? Your salary should be in line with market rates for the scope of responsibility and difficulty of the tasks involved in the management of your particular firm. Are you paying yourself too much?
- Can you improve earnings before interest and tax (EBIT)? EBIT indicates how efficient you are at managing operational costs relative to sales. Can you reduce any of your overhead costs, especially the two big ones – rent and wages?
- Can you improve retained earnings? Profits can be paid out as dividends or held in the firm as retained earnings. Retained earnings sustain working capital, owner’s equity and growth. Dividends paid to shareholders reduce the capital available for the business.
- Can you improve the structure of the balance sheet? Are long-term assets being funded by long-term finance and short-term assets funded by short-term finance? Long-term assets that are funded by short-term finance is an immediate sign of asset vulnerability and you need to rearrange your financing to match long-lived assets with long-term money.
- Can you improve shareholderfunds? Is lack of profits destroying shareholder funds? You need retained earnings or injections of new capital to improve your equity position.
- Can you improve the return on owners’ equity (ROE)? ROE is driven by return on assets and the ownership ratio. ROA can be improved by increasing profits or reducing assets. Can you maintain current sales with fewer assets by increasing capacity utilisation and reducing cycle times?
- Can you improve the debtto equity ratio? If equity is too low can you put some more equity into the business by rearranging your personal finances including your mortgages and loans? You can talk to your bank about restructuring all of your borrowings to arrive at a better overall position.
- Can you improve the current ratio? As a rough rule of thumb a current ratio of at least 2:1 is desirable. The surplus of current assets over current liabilities is your working capital. If too much of your equity is tied up funding fixed assets, then working capital will be starved. Can you rearrange your financing to free up equity for current assets?
- Can you improve stock turns and debtorageing? Low stock turns indicate poor stock control, lack of sales analysis and operational inefficiency. An increase in the average age of debtors indicates poor credit control and collections. If stock turns are falling, you probably have dead stock that needs to move off the shelves. If debtors’ ageing is increasing, you need to put more effort into collections. Then you can reinvest the freed up cash into fast-moving lines and working capital.
- Can you improve your cash flowforecasting and reporting? Cash flow forecasts provide you with a monitoring tool and by measuring actuals against forecasts you have an early warning system.
- Can you improve debtorcollections? An increase in the number of days that accounts receivable are outstanding indicates a deteriorating debt collection rate, and an increasing investment in debtors with the accompanying strain on cash flow.
- Can you shorten the production cycle? Long lead times on material supplies and slow production cycles result in unnecessarily high inventories of raw materials and work in progress. Long production cycles usually are caused by inefficient production control or a product range that is too extensive.
- Can any component of wages expensebe renegotiated into commission systems or subcontract arrangements? By making wages a variable cost instead of a fixed overhead cost, you can lower your break-even point and enjoy better profits.
- Can you delete old product lines and liquidate obsolete stock? Obsolete or slow-selling stock can be blocking your cash flow. You need to identify and eliminate it with clearance sales and discounts.
- Can you sharpen the focus on your target market? Focus your precious resources as accurately as possible into market segments that produce results. Target the most attractive segments on the basis of fit, access and profitability. Lack of segmentation and targeting often explains low sales figures.
- Can you realign your product or servicedesign closer to the market’s needs? Good marketing practice involves continuously aligning your offer with the customers’ needs and wants.
- Can you reduce cycle times? Long cycle times incur high inventory costs, reduce the productivity of equipment and people, and reduce customer satisfaction. Internet systems connecting suppliers and customers into your system can greatly reduce order entry and supplier lead times. Long internal cycle times tend to be caused by poor production planning and control methods. Can you fix this problem by hiring some specialised skills or by finding a suitable software solution?
- Can you reduce the levels of raw material, work in process and finished goods? High raw material stocks point to poor performance by suppliers and undesirable lead times. High levels of work in progress may be caused by an excessive product range and poor planning, but also by inefficient production processes. High finished goods stocks may also result from an excessive product range but it is often caused by a make-to-stock mentality driven by the lack of a good production planning and control system.
- Can you adopt just-in-timein parts of your production system? Just-in-time systems and short planning periods can reduce the total inventory to 24 – 48 hours’ worth of stock in many businesses. Even part progress towards just-in-time in combination with efficient production planning and control will significantly reduce stocks.
- Can you improve your quality? Improved quality produces increased profitability. The prevention of problems reduces manufacturing costs and servicing costs. Improved quality also improves reputation and develops market share, enabling you to command higher prices. Higher prices, in combination with lower costs produces increased profits.
- Can you improve the ‘culture’ of the firm? Your values and beliefs will be reflected in the attitudes and behaviour of your employees. Teamwork and a strong spirit will only grow through careful cultivation, whereas a lack of good spirit will be accompanied by low morale, high staff turnover and low productivity.
- Can you improve the systems of communication? Good communication systems are essential for good organisation and management. Information must be available to staff so that they can perform their tasks. Shared information and experience should be ‘networked’ within the team.
- Can you improve your leadership of the team? What levels of leadership, motivation and training are present in your business? Your staff can be your competitive advantage. This requires skill in leading and motivating people, and providing support for teamwork so that synergies are achieved.
- Can you improve the reward system? People are motivated by intrinsic factors such as job satisfaction and being included in the decision-making process. If the reward system fails to motivate staff, productivity.