Phone Services Reseller Wants to Reach Out and Touch Profit
When DeVaux McLean’s 14-year-old granddaughter moved in, he finally had to admit his small business had overstayed its welcome in the living room of the two-bedroom condo he shares with his wife.
He was ready to move ProDial Communications Inc. and two part-time employees into outside offices and expand the telephone services reseller, but didn’t have the money or a game plan to carry it out.
McLean wasn’t sure how much of an investment he would need or whether to target venture capitalists or a bank. He knew it was time to push the company to the next step but didn’t know where to start.
“That’s our biggest problem, getting over that hurdle,” said McLean, who runs the day-to-day operations but shares ownership with a partner.
The owners were wary of making a misstep just as the Agoura Hills company was becoming profitable. They “badly underestimated” how long it would take the start-up to build revenue in the first place, McLean said. The six-month sales target wasn’t reached for almost a year and a half. ProDial didn’t receive its first check for almost four months. The amount: $4.50.
“We cashed it,” McLean said. “Now I wish we hadn’t, but at the time we probably needed to buy some macaroni.”
He’s eating better these days, but as the company hits the three-year point this month, expansion remains a priority.
To reach that goal, said Paul Ratoff, a financial and management consultant at Moss Adams in Los Angeles, ProDial needs to create a step-by-step expansion strategy.
“All these issues were coming at him, and he really had no way to organize the process,” said Ratoff, a 22-year veteran of the consulting business.
Ratoff recommended a three-stage expansion plan that would work in general terms for many small businesses. The first step is to conduct a detailed financial analysis of the existing business, he said. Second, create a 12-month game plan. Third, borrow the money needed for expansion.
Ratoff approved ProDial’s use of QuickBooks accounting software but found fault with some of the data being entered.
“The information he [was able to give] me was very limited and in some cases, inaccurate,” Ratoff said.
It turned out, for example, that there was a wealth of untapped information in the single commission check the company received each month from its telephone services supplier. Usually the company simply posted the net amount to its company account.
When McLean and Ratoff sat down and analyzed five months of commission checks, though, they uncovered some critical information. More than half of the commission revenue was owed to companies that sold phone services for ProDial, which was entitled to only a small share of their commissions. The volume of sales made by some of those companies was declining. And the bad debt on ProDial’s sales was high, according to Ratoff, at 8.8% of the total.
In fact, contrary to the company’s assumption that it was just becoming profitable, ProDial was operating slightly in the red, said Ratoff, who expects the company to move into the black shortly. Over the last year, though, the company “was not aware of the extent of the bad debt loss and the impact of that on its business,” Ratoff said.
McLean agreed.
“I hadn’t really felt we were in the red,” he said. “But when I look back, I see we recently used our line of credit sometimes.” Bad debt, he said, was largely to blame and the company has taken several steps to screen potential customers more carefully.
“It is so critical for small companies to really understand their business,” Ratoff said. “They need to be able to track it in as great a detail as possible, especially in a key area, in this case the commission structure.”
To get an accurate picture, Ratoff said, a business owner should ask: “What was my total revenue and what different categories of revenue did I have? What were the expenses associated with that? What were my bad debts and write-offs and other adjustments?” Just entering net amounts onto the financial statements won’t do, he said.
“The language of business is numbers,” he said.
The close look at ProDial’s numbers convinced Ratoff to slightly scale back Step 2 of the expansion strategy: creating and implementing a 12-month game plan.
He had expected to recommend that the company hire a third employee, a full-time administrative assistant who would free McLean to concentrate on building the sales organization.
“The reason DeVaux is successful is not because of his accounting skills. He’s basically a sales manager and has terrific experience building large sales organizations,” said Ratoff, referring in part to McLean’s years as a vice president in marketing at a subsidiary of the former Executive Life Insurance Co. (For most small-business owners, the consultant said, it makes sense to acquire financial expertise by hiring an outside accountant or advisor.)
As part of his original recommendation, Ratoff also reasoned that the third employee would require the company to move to larger, outside offices. With the company, by his calculations, still $200 to $300 a month in the red, Ratoff instead advised choosing very modest outside office space and replacing one of the two part-time customer assistants with the full-time administrative assistant. In effect, the company would add just half a position.
“We want to take very small steps,” Ratoff said.
As part of their calculations for the 12-month game plan, Ratoff and McLean figured it would cost about $2,900 a month to pay for the full-time employee and move to outside office space. Their initial financial analysis revealed the company’s current monthly expenses to be about $9,100.
Creating a new “break-even” analysis will show the company what sales goals it must hit to cover the new expenses, Ratoff said.
“We take this plan and lay it out on a spreadsheet, and we see how long it’s going to take before we get to the new break-even point,” he said. At the company’s current rate of growth, about $200 in new revenue each month, it would take ProDial about 14 months before it reached that point, Ratoff said. In the meantime, the company would have lost about $19,000.
If McLean dedicates 70% of his time to building and managing his sales force and 20% of his time developing his own new accounts, which are more profitable for the company, ProDial could grow faster and reach its new break-even point sooner, Ratoff said. The company would still rack up thousands of dollars in losses, he said.
Financing the expected losses is the third step in the expansion game plan, Ratoff said.
He recommended a series of financial moves that would position the company to qualify for a $25,000 line of credit, the amount he estimates it will need to safely reach its 12-month expansion goals. Those moves would lower existing debt on the company’s balance sheet, increase the owners’ investment in the business and reduce the company’s reliance on the personal financial guarantees of its wealthier partner, Dr. Lewis J. Kanter, an allergist in Camarillo.
Specifically, Ratoff suggested the company immediately pay off the $1,000 balance on an existing, $10,000 line of credit. The owners should also pay the company for their stock, currently listed on the books as a $15,000 I.O.U.
McLean could borrow the money for his half from his partner, offering the partner the stock as security. The money from the stock sale should be used to pay off part of the start-up loan provided by Kanter.
Ratoff also suggested the company prepare for the bank a set of year-end financial statements on an “accrual” basis, an accounting term that means the company can show income earned but not yet received. That will allow ProDial to count commissions earned but not yet received.
ProDial will need a loan that will match its income stream, Ratoff said. He estimated it would take six to eight months before the company’s cash flow increased to the point where it could begin paying off the loan.
“As long as the bank understands how the loan will be repaid, it can structure the loan in whatever way is necessary,” he said.
If sales don’t come in as fast as expected, Ratoff advised that the company consider doing without the part-time assistant or having McLean devote more of his time to selling.
That will help the company avoid the problem many entrepreneurs suffer when they attempt to expand, Ratoff said.
“They don’t think it through,” he said. “They underestimate the cost of expansion, and then they don’t have enough reserves or a backup plan.”
McLean and his partner aren’t wasting time. The company has begun the painstaking financial analyses Ratoff recommended, they’ve applied for the new line of credit, and they’re looking for a new administrative assistant.
“Personally, I feel we will grow much faster than Paul predicts,” McLean said. “But then again, I’m a sales and marketing guy, and we’re known for our optimism.”
His enthusiasm isn’t misplaced, Ratoff said. Consumers are becoming more comfortable with the idea of buying long-distance service, 800 numbers, calling cards and other telephone-related products from companies other than the Big Three: AT&T;, MCI and Sprint.
Companies such as ProDial, which offers long-distance rates of 9.9 cents per minute, are carving out niches in the fast-growing telecommunications field. And McLean is taking early steps to position his sales organization to resell electricity service when competition comes to that industry.
“This could be a very lucrative business for him,” Ratoff said. “The markets are opening up. The key is to develop a sales organization that can handle a variety of products. Once you put together a sales organization, that becomes the real value of your business.”
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
This Week’s Business Make-Over
Company name: ProDial Communications Inc.
Headquarters: Agoura Hills
Type of business: Telephone services reseller
Status: Private corporation
Owners: DeVaux McLean and Lewis J. Kanter
Financing: $10,000 bank loan, $26,000 in savings, $20,000 on credit cards
Annual gross sales: $1.2 million in fiscal 1996; $2.4 million estimated for 12 months ended Sept. 30, 1997
Employees: Two part-time customer assistants, 50 commission-only sales representatives in 26 states
Founded: 1994
Customers/clients: 3,700 nationwide, including a large Santa Monica-based insurance company
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Main business problem
How to plan and pay for expansion: Company has outgrown its home-based office and needs more administrative help.
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Goal
Increase monthly billable long-distance time from the current $250,000 to more than $1 million.
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Recommendations
* Improve financial data available by breaking out sources of income and bad debt reflected in monthly commission check the company receives, and correct balance sheet by listing payroll tax as an expense and excluding one-time fees and adjustments from regular income.
* Review financial statements each month with accountant to track progress and to ensure that basic financial assumptions about the business haven’t changed.
* Create 12-month expansion plan that includes these steps:
* Hiring of a full-time administrative assistant to replace one part-time assistant and to free owner to concentrate on building the sales organization.
* Allocation of 70% of owner’s time to managing the sales force, 20% to opening his own new accounts and 10% to finding new products to sell.
* Setting of monthly sales goals for each sales rep and the owners. Development of specific strategies to hit those targets.
* Creation of monthly expense budget and comparison of actual costs and revenues to the budget each month.
* Relocation to an outside office.
* Financing of expansion with a $25,000 bank line of credit.
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Meet the Consultant
Paul Ratoff, a business consultant for the last 22 years, is a financial and management consultant at Los Angeles-based Moss Adams, one of the 15 largest accounting and consulting firms in the U.S. Ratoff was formerly vice president and chief financial officer at Hadron Inc., a laser-equipment manufacturer in Southern California.
