Company’s Toughest Decision: Knowing When to Say When
Your suppliers have withdrawn their credit, revenue has been falling for months, and the landlord has just bumped up the rent, pushing your fixed costs even higher.
Are these red flags that you’re trapped in a failing business? Or are they merely bellwethers of a temporary trough in the choppy seas of modern business?
According to the Small Business Administration, nearly half of those small-business owners who ask themselves those questions discover they are captains of a sinking ship.
As part of a landmark five-year study, SBA found that nearly half of small businesses existing in 1990 had closed their doors by 1995. SBA considers “small” any business with 500 or fewer employees, a designation that encompasses the vast majority of all businesses in the United States.
While the reasons for a business’ demise are myriad, experts in business management say the mile markers of a “wrong turn” are often the same for a broad array of commercial endeavors. Such signs include chronic cash-flow problems, growing debt and stepped-up competition.
Business owners obviously don’t set out to drive their ventures into the ground. But frequently, entrepreneurs are so focused on making their products or delivering their services, they fail to pay enough attention to the business of their business, said William Gartner, a professor of entrepreneurship at USC.
“A lot of people really don’t know what’s going on in their business,” Gartner said. “People a lot of times operate on feel, and that’s just not enough anymore.”
It’s not surprising then that business owners flying blind may be shocked to learn that their endeavors are sputtering. While some of their problems are correctable, others are all but irreversible or even lethal. For the unschooled, determining which is which may be difficult. Yet knowing when to bail out of a foundering business can keep thousands of dollars in good money from joining the slow spiral down the drainpipe after bad.
Money, in fact, is the primary key to understanding the health of any business, experts say. Simply put, businesses should be taking in more money than they are paying out. If they’re not, they’ve got problems.
Alfred Osborne, professor of business economics at UCLA, calls it the “question of cash.”
“If you don’t have any cash,” he said, “you can’t do anything.”
Yet, negative cash flow isn’t always an automatic signal that a business is doomed, said Allan Sher, head of a local group of retired executives who counsel business owners on behalf of SBA. Sher said as long as revenue continues to grow, despite red ink on the balance sheet, businesses are generally still viable. “If revenues are going up every month, even if you’re losing money, there might be some hope,” he said.
On the other hand, Sher cautioned, revenue that’s dropping or plateauing in the face of higher costs could be the first spasm in the death throes of a moribund business. “At that point,” he said, “I think you really have to do an analysis to see if you stand a chance.”
Part of that analysis, Sher advised, should be to figure out exactly how long revenue has been slipping. Even four months of shrinking returns should give any business owner cause for concern.
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But before cashing in their chips, business owners should look to see if there’s any way to squeeze profit from their venture, declining income notwithstanding, said Eric Flamholtz, a professor of entrepreneurial management at UCLA. “If there’s revenue, there should be profit somewhere,” he said. “It’s just a matter of tailoring your company to be profitable.”
Gartner suggests one of the first places to probe for latent profitability is the price a business charges for its goods or services. If cash flow is negative, he said, prices may be set too low. Yet businesses in competitive markets may not have much latitude to raise prices. “For most businesses, when you have to price below what your costs are, you should just get out of the business,” Gartner said. “Or you have to change your cost structure.”
Cutting costs, however, may not be easy. It could mean having to lay off longtime employees, abandon a cherished location and even rethink the purpose of the business.
For many business owners, Gartner said, those issues may be too difficult to even broach.
“Small-business owners are among the most optimistic, hopeful people around,” he said.
As reassuring as a positive outlook may be, though, business owners also need a dose of practicality, said Gordon Klein, an accountant who lectures at UCLA on bankruptcy and small-business management issues.
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Klein said businesses should always be aware of how their assets stack up against their liabilities and also how their cash flow compares with the interest payments on their debts. For established businesses, Klein said, both assets and cash flow should outpace liabilities and interest payments respectively by 1.5 to 1. For start-ups, the ratios should be no less than 2 to 1.
Often, Klein said, banks will require leveraged businesses to adhere to similar ratios, warning that if they drop below a predetermined level, the banks will call in their loans with little or no notice.
Sher also recommends that business owners establish a threshold of money that they will not exceed in their efforts to shore up their ailing ventures. The threshold, he said, could be linked to the business’ cash flow. Business owners, for example, could decide that after a set number of months of falling or flat revenue, they will stop investing money in the business, whether their own or somebody else’s.
“They have to figure out how to do more business than they’re doing or they’ve got to throw in the towel,” Sher said.
