Recently I interviewed a small business person who was seeking some mentoring assistance. It was an unusual request, as this business exhibited none of the usual problems of a rapidly growing small business.
Although only operating for three years, sales were increasing rapidly, it was profitable, cashflow was not a problem, but I am nervous.
There are a couple of reasons for that:
Rapid growth typically leads to a business hitting a brick wall, as I’ve written about before. The brick wall has three major elements:
The skills that lead you to set up your small business, to strike out on your own, are no longer sufficient to handle your growing business. Studies have found that lack of management skills is the cause of most small business failure, and that key elements within this in particular are a lack of understanding of finance, of marketing, and of management.
Now that’s not surprising, as most small businesses are started on the technical expertise of the owner, not their management experience.
Then there's reporting - the problem if you are not regularly looking at how your business is travelling, is that any one of those three elements can smack you in the face. If you don’t see them coming, it's hard to avoid that brick wall.
And that is where regular management reporting comes in, reporting that covers not just what has happened in key areas of your business, but also lead indicators of future business.
Cash flow problems are the ones that cause most loss of sleep. How do you pay your staff, how do you pay your suppliers, can you afford to buy in more stock, and so on.
Two issues arise with cash flow problems:
• Can you forecast it?
• How do you fix the cash flow problem?
Good cash flow management requires you to know exactly how much money is going in and out of your business, and is likely to be flowing in the period ahead. It will guide every decision you make. Keeping a close watch on cash is one of the fundamentals of business survival.
My prospective mentee needs to think about this. Cash flow is not currently a problem, but it could become so, insidiously creeping up on him like a thief in the night.
Some years ago, I had discussed this possibility with a business man. He assured me that it was not a problem, everything was under control. Three months later he turned up in my office, somewhat distraught, and said “That problem you warned about – it’s happened.”
The key action is to diagnose the cause of the problem. If it is left untreated, that profit leak has to be funded, either by your bank, or by your creditors (who are not getting paid). The latter is very dangerous territory in which it be travelling.
Cash flow problems can be temporary, such as having to bring in stock or materials for a major project or event, the returns recovering the outlay.
But if it is an ongoing problem, there are two basic causes:
• Insufficient sales
• Low margins
As I’ve often preached, it’s not the volume of Sales that is critical, but the volume of Gross Profits. And that depends on the market you are in. If the margins are appropriate in your market, then you need to look at why your sales are insufficient.
Dr. Greg Chapman identifies five reasons why your marketing may not be working:
1. Your marketing is not generating enough enquiries
2. Your marketing is not generating the right kind of enquiries
3. You can’t find the right market for your products
4. You are getting sufficient number of enquiries, but can’t turn them into sales
5. Your offer has insufficient market appeal
I would add the entry of a major new competitor or disruptor into your market who pinches your sales.
Margins being too low is the other issue. This can certainly impact on the volume of Gross Profits you generate. Margins are a factor of costs and price. You must generate sufficient margin to cover you Cost of Sales and leave some Gross Profit, and sufficient sales so that the Gross Profits cover all overheads and leave you a nice Nett Profit.
I have had clients who had so little understanding of their costs that their Cost of Sales was greater than their Sales. The more they sold, the more they lost.
Most small and medium businesses cannot generate the volume of sales necessary to survive on low margins. They need to have the margins that generate good profits at their likely level of sales.
And that means concentrating on value.
Unless my potential mentee makes some changes, I suspect he will hit that brick wall, and damage it causes will be evidenced through cash flow problems.
When clients approach me for coaching, so often they are not getting the clients they need, the right clients, or the sales they need at the margins they need. Eight times out of ten this comes down to not knowing what is working in their business.
For more than 30 years I’ve been helping small business owners use the right tactics to plug the profit leaks in their business and restoring their cash flows by assisting them understand how to use the 80-20 rule to determine their most profitable customers, and to determine the offer to bring them on board.
If you would like to discuss with me how you might do that, book a Strategy Consult here.
© Copyright 2018 Adam Gordon, The Profits Leak Detective Except for those bits by Greg Chapman.
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?