It is vital that business owners and managers can distinguish between the symptoms of business decline and potential failure and the causes of decline and failure.
If you think about this like a person who is not feeling well and experiencing a headache and high temperature. The headache and high temperature are not the causes of their ill-health but rather the symptoms, or early warnings signs.
If your doctor instructs you to take a headache pill and get some rest, he or she is actually treating the symptoms of the illness and not the cause. If however he carries out tests and discovers you have a bacterial infection and prescribes antibiotics, he is now treating the cause of the illness, and the rest and painkillers will help you feel better quickly. Using this example, if the doctor failed to do further tests and simply told the patient to rest and take pain relief they would have become sicker and this could have led to serious complications.
A business is very similar. If your business is in decline and you only treat the symptoms of the problem i.e. no cash in the business to cover costs, so you get a loan, the problem will continue to grow and cause major issues. If however you review your cost structures, pricing model, inventory and invoicing policies you attack the problem at the root cause. This means that the situation will improve and prevent the symptoms reoccurring in the future.
So in summary, the symptoms give us clues as to what might be wrong with the business; however, they provide no direction for required management action. You need to be able to analyse the symptoms to identify the root cause and then decide on the best way to solve the underlying problem.
Common Symptoms of Business Decline
1. Financial Data
I often say that business starts with the numbers and ends with the numbers, and everything in between is about people in some way or another. We will look at people in some of the following clues, but first let’s focus on the numbers as these are not as subjective.
If over time your sales revenue and profitability has been steadily declining then there is something wrong. This is an irrefutable fact and something that needs to be addressed. Therefore it’s essential that you monitor key trends in your P&L figures and ratios, which should include;
Your business’ 3-year historic performance trends:
- Revenue trend – $
- EBIT trend – $
- Profit after tax trend – $
Your business’ 3 year historic profitability ratios;
- Gross profit margin – %
- EBIT margin – %
- Net profit margin – %
Your business’ 3 year historic efficiency ratios:
- Total employee costs/Total revenue – %
- Total sales revenue/Total operating costs – %
- Total sales revenue/Total asset value – %
The objective in this exercise is simply to determine the trend, or to identify the financial symptoms. Is the business performing well and according to expectation, or has it entered a phase of decline?
To determine other financial indicators of health we turn our attention to the balance sheet, which provides a snap-shot of your business’ financial position. Yes, of course one can also determine trends in looking at the changing financial position of your business over time, however what we are more interested in here is the current financial well-being, liquidity, solvency, and capital structure of your business. This is an exercise in studying the key ratios to determine:
- The level of debt/ Owners’ equity in the business – times
- The level of current assets/Current liabilities – times
- EBIT/Debt interest obligations – times
These three simple balance sheet ratios should allow you to assess your businesses financial position against acceptable industry norms, what is acceptable to your lending bank and what may be sustainable into the future. Furthermore, all business owners should be acutely aware of the Australian legal ramifications of trading insolvency.
2. Profit Vs Cash
Profit is very different to free cash flow, we always advise clients to keep a close eye on the amount of cash available at any given point, after all costs are taken into account. Yes you may have 5 big invoices awaiting payment, however if you have not yet received the money you don’t have it available to pay creditors as they fall due.
If the business is generating very little or no free cash flow then funding for growth, business maintenance and ad-hoc poor trading months has to come from somewhere, and invariably this is debt, a situation which is simply not sustainable.
Therefore another financial symptom to watch out for is diminishing levels of free cash flow or no free cash flow at all.
3. Stakeholder Behaviour
The reality is that your business does not operate in a vacuum. It has many interested and involved parties often referred to as stakeholders. At the top of this list, we will find employees, a lending bank and creditor to name just a few. The fact is that if you don’t pick up these early warning signs, these stakeholders will and this will cause another set of different problems.
In the case of employees, their actions may be somewhat different to that of lending banks and creditors, but no-less damaging. Employees tend to have an innate ability to quickly cotton-on to the fact that management has fallen asleep at the wheel, and when they do the top performers jump ship first and the under performers tend to enjoy the ride while the rudderless ship goes down.
It is essential at this point that you very quickly treat the most visible symptoms to repair stakeholder confidence and show stakeholders that you are taking decisive and well-considered action, and are communicating this clearly to all involved. It is usually best to seek independent help as the chances are that you are part of the problem and unlikely to make the right decisions to save the business. This will allow the company adequate stakeholder support and time to recover.
4. Business Owner-Manager Behaviour
When it comes to symptoms of an ill business, a specialist advisor can often pick up on warning signs well before he or she opens the financial statements, by simply talking to the business owners, management, a selection of staff and walking the shop floor. The signs will be palpable to the experienced eye, particularly in a Family-Owned Business (FOB) where the stakes riding on success or failure are far higher.
The early symptoms to look for in this situation are signs of considerable stress on the business owner-managers, adverse and unhealthy workloads and an abnormal number of hours being shouldered by the owner-managers, a lack of coherent and clear thought by owner-managers, evidence of family marital or relationship tensions, an air of desperation and over eagerness, and a desire to avoid any action that may cost money to implement.
Yes, the fact is that FOB owner-managers are invariably very hard working people that are prepared to do what it takes, and it is true that when we conduct a risk analysis we almost always flag ‘key person risk’ and the fact the owner-managers have too much on their plates as one of the top risks to be aware of. However, what we also see is that in difficult times the owner-managers’ workload tends to be off the chart. What also tends to happen is that the business owner-manager’s world becomes extremely complicated, pressured and less clear, and the trick at this stage is for the independent advisor to slow things down, cut through the complexity and draw focus on a methodical plan of action.
Other potential symptoms of business ill-health include:
We often encounter entrepreneurs and business owners who have become married to their products which from a disinterested parties perspective really have very little chance of success.
Lack of a clear business strategy
The technical term for this is ‘stuck in the middle’ or not knowing which way to jump. This tends to manifest itself in analysis paralysis, too many staff meetings to debate issues, frustrations, finger pointing, a loss of business momentum, and ultimately the business dangling from the hangman’s noose kicking sporadically.
Desperate leaders can become autocratic, blasting orders and finding fault with everyone.
Lack of new investment in technology, plant and equipment
It’s quite obvious when one steps into a business that has not been able to reinvest in itself due to lack of free cash flow.
Extended creditor payment days
An obvious sign of financial stress is when a business stretches out its creditors for as long as possible. This situation is even worse when those creditors include the ATO and employee commitments;
Increased supplier tensions and dispute
Suppliers that are either not being paid or are being stretched unreasonably will inevitably become very unhappy and may even cut supplies;
Declining customer service
Desperate businesses have a tendency to chase the next dollar and new client transaction, whilst neglecting existing customers.
A lack of leadership
We often see that when the business needs strong, clear and inspirational leadership the most, that leaders sometimes tend to lose confidence, second guess themselves and withdraw.
Grasping at ‘silver bullets’
Desperate business owner-managers often exhibit a tendency to grasp at the next opportunity, the next solution and the next consultant in search of something that may help their situation.
Bank lending relationships becoming stressed
A clear breach of bank covenants is a clear give away that the company is experiencing financial pressures, and will almost always result in putting the business into a high-watch and report program with the bank.
Exhibiting any of these symptoms?
If you feel your business is exhibiting any of these symptoms of decline and you’d like advice on how to best navigate the challenges you're facing, chat to us, we're happy to help.