Tag Archives: Finance

Common Danger Signals of Company Decline

Previously, we have examined the internal and external elements of decline and some of the early warning signals of each. Notably, we have made the distinction that, while internal elements are easier to control, external elements are capable of being influenced as well. It is the responsibility of the executive team to coordinate marketing and sales, operations and finance in such a way as to anticipate changes in the environment and plan accordingly.

The clear danger signals of decline vary with the stages of decline, and become more serious as the decline intensifies. Some of the common danger signals are as follows:

Common Danger Signals

Early Decline:

  • shortage of cash
  • strained liquidity
  • reduced working capital
  • stretched accounts payable
  • late accounts receivable
  • reduction of return-on-investment (ROI) by 20-30 percent
  • flat sales
  • several quarters of losses
  • increased employee absenteeism
  • increased employee accidents
  • increased customer complaints (product quality, delivery)
  • late financial and management information

Mid-Term Decline:

  • increasing inventory
  • decreasing sales
  • decreasing margins
  • increased expenses
  • increased advances from banks
  • requests for additional considerations from banks
  • late and unreliable financial and management information
  • erosion of customer confidence
  • accelerated accounts payable from vendors
  • overdrafts at the bank
  • delayed accounts receivable from opportunistic customers
  • violation of loan covenants
  • bank used to cover payroll
  • increased interest rates on indebtedness from banks due to increased perception of risk

Late Decline:

  • little attention  paid to profit decrease
  • staff cutbacks without analyzing cause of problems
  • overdrawn bank accounts as substitute for line of credit
  • cash crisis
  • accounts payable 60-90 days late
  • accounts receivable 90+ days late
  • further decline in sales
  • extremely low employee morale
  • eroding company credibility
  • excessive decreased inventory turnover
  • supplier restrictions
  • fewer reports to bank
  • qualified opinion from auditor
  • bounced checks
  • cutoff on supplies
  • credit offsets
  • accounts receivable continuing to age
  • further decrease in margins
  • further decrease in volume of sales
  • increase in uncollectible receivables
  • no liquidity
  • depleted working capital
  • lack of funds for payroll
  • ineffective management
  • attempts to convince creditors that company is viable and that liquidation is not necessary

Signals That Can Occur At Any Stage:

  • decreased capital utilization
  • decreased market share in key product line(s)
  • increased overhead costs
  • increased management and employee turnover
  • salaries/benefits growing faster than productivity/profits
  • increased management layers
  • lost market share to competition, which is not keeping up with marketplace changes
  • management in conflict with corporate goals and objectives
  • opposing directions for company and management
  • sales forecasts that predict that company can sell its way out of difficulty
  • poor internal accounting
  • credit advances to customers who do not pay on time
  • non-seasonal borrowing
  • sudden overdrafts
  • increased trade credit inquiries (a signal that new vendors are being sought out)

Not all of these symptoms may appear; it is sufficient cause for self-examination if some of them occur. As the problems of the business increase, its reputation with suppliers, banks, current customers, and other stakeholders is severely diminished. A credibility gap may occur, placing the business in the position of having to defend itself not just from internal and external factors, but also from a loss of esteem in the business community. Credibility is a key factor to the success of a business. Just as a company’s credibility within the commercial and banking community can ensure its success, a lack of credibility can just as surely cause its demise.

 

(Internal) Early Warning Signals of Decline

As ominous as uncontrollable external elements may appear, they are not the major cause of business failure. Rather, controllable internal elements are most frequently the problem. The internal elements that affect businesses are finance, operations, and marketing and sales. These are the basic functions over which a company’s executive team exercises direct control. Any business function can be placed within these categories. 

Business management is the force that drives these functions; yet changes in internal elements are at the root of the majority of business failures. These failures do not occur overnight; rather, such business decline usually occurs in stages. Extensive research that the founder of our organization performed suggests that the basic reason companies fail to recognize the onset of decline is simple management myopia or ignorance.

When your team fails to recognize the internal signals of decline, rationalization often ensues, with blame attributed to uncontrollable external elements. This approach appears on the surface to absolve management of responsibility for the company’s problems. For example, a shortage of cash might be blamed on stricter banking standards or lack of demand for the product/service. This “problem” can then be attributed to the nation’s economy.

Management can then take smaller “leaps of logic” to shift the blame to increased competition, which has made the marketplace unpredictable. While a shortage of cash is a symptom of a problem and surely a major signal of decline, the shortage of cash itself is not the actual problem; the problem may be buried deep within the business’s management and accounting information systems. You may be making sales at a price that does not cover the fixed costs of operations, or accounting personnel may not have developed contribution margin, product cost, and direct cost of sales standards. If your “system” cannot measure the causes of unprofitability, how do you know what changes to make?

As with external elements, internal elements can also interact with one another. Finance, operations, and marketing and sale shave a natural interaction with each other and are, in fact, related to one another. any one of these internal elements may cause decline. As the problem persists, the other functions become involved. Operations techniques may become antiquated. Marketing and sales can be in the wrong market with the wrong product. Finance may be unaware of other departments’ changing financial requirements. Such a lack of information flow between departments also signals decline. Businesses cannot survive without information about both internal and external environments.

Coping With Internal Elements

It is unfortunate when managerial tools are not used for maximum benefit. Many companies fail to manage by cash projections; instead they rely on “looking backward” statements like balance sheets and P&L. Budgets comparing projections to performance are critical to effective management. When budgets are tasks rather than tools, your management is weak. Balance sheets can show working capital reserves even when a company is in decline. Changes in accounts is important to track–it can point you to root causes and symptoms of real problems.

Controlling Internal Elements

The internal elements are the factors that should be most familiar to executive teams, but they are often the most overlooked. The very nature of the internal elements is dynamic; they are continually evolving and require constant monitoring. Since managers may be unable to understand the dynamic nature of the internal elements, a decline may go unnoticed for a while. Management’s primary role is to use these elements to maximize profits. Controlling finance, marketing, and operations requires monitoring of all the functions to identify potential signals of decline.

 

Early Warning Signals (External) of Business Decline

Early warning signals companies should look for in the external environment include all legal, political, competitive, technological, economic, and social changes that affect them. Regular review of social media, trade periodicals, business publications, and newspapers will help to keep you current. A technological advance, for example, often affects buyer attitudes and expectations, thereby causing social changes that need to be addressed in product/service design and delivery/sales. If your organization is uninformed with regard to the changes–either that they occur or the extent to which they occur–company performance may lag behind competitors. 

Early Warning Signals – External

Management often tends to dismiss the external signals of decline as elements beyond their control. They believe that a downward trend will end when external elements (e.g. economic conditions) improve. Problematic external elements can include the following:

  • increased competition
  • rapidly changing technology
  • unpredictable economic fluctuations
  • cultural/social changes
  • legal/political swings

Within these external elements are market changes, customer preference changes, foreign competition, capital and commodity market movements, legal precedents, and unresponsive political solutions. While these elements cannot be controlled, they can be influenced. Also, since all businesses in an industry are similarly affected by external elements, management’s ability to survive these changes will determine future  viability. Some businesses weather external changes and emerge with increased market share and profitability; others fail.

Two major problems with these elements are their uncontrollable nature as well as their interaction with each other. Upon close scrutiny, it becomes apparent that factors affecting one of them can have a secondary effect upon another. For example, a cultural/social shift can result in a legal/political change. This change can affect the economic environment, which will interact with technological development. the rate of technological development consequently affects the status of competition. This process of action and reaction comes full circle when we realize that the status of competition then affects the economy and cultural/social change.

Businesses fail to realize that they can plan for external changes and safeguard their hard work. Their management teams have the ability to influence the external elements if they can predict their occurrence. Such foresight allows the executive team to influence the elements through the use of promotion, persuasion, buyer education, accelerated product development, process improvements or elimination, unit growth plans, new markets, and adjusted sales practices. 

Adaptation to the change is the result. For example, construction companies that build prefabricated residences have known for years about the external changes affecting the prefab sector of the home building industry. They have been affected by  cultural/social and legal/political changes for the last several decades. In response, they developed new products, such as modular multifamily housing, to offset their declining mobile home product sales. They invested in additional research to determine the number of potential single-family and multifamily buyers who preferred the cost savings that their construction process generates. They invested in new manufacturing capabilities, which would use material specifications offering a competitive advantage. These companies understood the early warning signals of the external elements and acted to offset them through:

  1. promotion and persuasion to keep their customers,
  2. additional market research about market size and buyer profiles,
  3. buyer education based on research findings,
  4. product improvements, and
  5. product elimination.

These tools allowed this segment  of the building industry to adapt to changes in the market. What are you doing in your business to a.) study the external environment, b.) adapt to the changes, and c.) position yourself in the eyes of prospects and existing customers to become more competitive? You can influence your own outcome!

 

Recognizing a Declining Business

In the past week, we have taken the time to look at characteristics of successful companies. In case you missed one of the posts, feel free to catch up by reading them in order (links below):

  1. How Successful Businesses Plan For Growth
  2. How Successful Companies Market
  3. How Successful Businesses Manage Their Finances
  4. How Successful Businesses Manage Their Operations
  5. How Successful Businesses Create Positive Cash Flow
  6. Revenue, Cost & Capital In Your Business
  7. How Successful Businesses Maintain Organizational Morale

This week, we are “flipping the equation” on you and examining what a business in decline looks like. As you track with the principles shared and lessons learned, you may find yourself to closely resemble a declining business in one way or another. Don’t despair! Knowing what needs to be fixed is important. You are that much closer to success than someone who doesn’t even realize that crisis is around the next corner because of ignorance.

No one is consistently successful. When things start to go wrong, however, the shrewd executive must recognize those events that are catastrophic and those that are not. Early warning signals of imminent business decline can occur both inside and outside a business. Changes in the operating environment due to external and internal elements may signal the beginning of decline. Once an executive team determines that the business is showing some symptoms of decline, the next step is to determine whether the decline is shaping up to be a twenty-four-hour bug or a terminal disease. Can it be treated? Can it be cured?

The Stages of Decline

Stages of decline include early, mid-term, and late periods, and recognition of these stages has an impact on the steps to reverse the decline. In early decline, it is very probable that the business can be totally saved and profitability restored quickly–often within a matter of months. In mid-term decline, the business has been suffering some erosion of value, and it may take a year or more to restore the value and resume profitable operations. Finally, there is a late decline. Sadly, fewer that one-third of companies in this type of serious trouble are able to reverse their decline and emerge on the other side “whole”–with existing management, ownership, and operations intact.

Before examining the warning signals of decline, we should look at the root causes leading to those signals. The earlier these causes of decline are observed, the easier it is to resolve them. The most common causes of decline–from both internal and external elements–are as follows:

The Causes of Decline

  • management by exception rather than by flexible planning
  • delegation without inspection or control–no feedback, review, or reinforcement
  • vertical organization chart with little if any interaction between departments (silos)
  • managers with responsibility for more than five direct reports
  • employees with more than one boss
  • chain of command broken when employees think necessary
  • breakdown in formal communications
  • overreliance on strategic plan
  • overreliance on management by objectives
  • senior managers’ abuse of outside activities and company benefits
  • marketing the wrong products
  • marketing in the wrong locations
  • aging workflow management techniques
  • inadequate research
  • inadequate staffing
  • inappropriate sales methods
  • unresponsive financial information systems
  • loss of competitive advantage
  • displacement by competition
  • changing technology
  • buyer preference changes
  • regulatory changes
  • economic changes
  • inadequate understanding of buyer needs
  • inadequate information flows, both between business functions and between company and customer
  • one department or business function dictating the mission, goals, and objectives of the company

All of the above causes for business decline are valid, and any one of them can precipitate the downfall of even an experienced team. Recognizing the warning signals of decline is the next step in righting the ship…

Revenue, Cost & Capital in Your Business

Positive cash flow is desirable for everyone in business. It is achieved universally through generating substantial revenues, controlling costs, and structuring capital wisely. Some tips and techniques are shared below:

Generating Revenue

Successful businesses excel at making sales. You know the saying, “the rich get richer?” Well,the corollary is that those who have revenues get more revenues as a factor of customers wanting to be associated with a successful brand. One thought you should consider is to go after markets that are less susceptible to the uncertainties of interest rates and the economy. If you were a homebuilder (you’d be an industry famous for tracking closely with the economy), you would be wise, for example to pursue both upper-income retirees and “move-up” families. These two demographic groups tend to be less affected by economic turns  and have demonstrated a time-tested pattern of purchasing homes in most any economy. Knowing the segments of your market well enough to follow suit and service the buyers with money to spend will position your company to operate for maximum profitability.

Successful executive teams know that targeting buyers with focused offerings is key to penetrating your ideal market. Regardless your market dynamics, the goal is to increase volume. With higher volumes come higher velocity cash flows. This increased velocity creates the favorable setting for financing terms that suit your financial model. Yet, it is clear that profit margins must be maintained else increased velocity exacerbate losses.

Controlling Costs

The focus of controlling costs is to optimize expenses as investments–not eliminate them! Cost management evaluates not only the amplitude of the individual expense, but its impact on organizational performance. While the general principle is to control the growth of costs, there are strategic advantages to be gained from choosing to incur the right expense for the right reason at the right time. Another major shortcoming in the financial management of many companies is the effort to wring cost out of processes and retain all of the benefit of the exercise in the hands of a greedy few. Passing along savings to customers is a great way to build a customer base advocacy. Not all of the profits, mind you, …but enough to become even more competitive.

If your organization does not have a process to monitor and eliminate waste, it needs one! Sharing items like technology, administrative labor, equipment, and offices/desks is “low hanging fruit” in this area. Most resources do not need to be dedicated to one person or department because they cannot be utilized enough to justify the additional expense. Look at ways to speed up the delivery of your product/service to market–scheduling and workflow management process improvements drive profits to the bottom line quickly, as well as freeing up needed cash flow.

Monitor invoices–make sure that payments are for things ordered  and received by specification and terms. Evaluate reporting systems. Dashboard feedback on expenses, margins, and cash activity help executives manage rather than being managed.

Structuring Capital

Get a god fix on the financial capital structure of your business and how it compares to competitors. Doing so will drive planning relative to debt capacity, valuation, growth, and many other categories. Taking the approach that debt is always a short-term tool and is to be repaid as soon as possible will increase a company’s capacity to take on debt when absolutely necessary. Think through cash reserves and how they speak loudly to others as to your management acumen and company viability.

When preparing pro-forma projections of anticipated cash flows, make sure that worst case scenarios are considered. Money on deposit is a precious commodity and those who have it are in a position of strength. Having products or services in development that can be brought to market quickly is an asset for those well-capitalized, a liability for those who are not.  Your unique debt to equity ratio should be stronger than your industry–and should reflect the commitment of the executive team to run the business according to thoughtful metrics and attention to details.