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WHY BUSINESSES GET INTO TROUBLED WATERS

WHY BUSINESSES GET INTO TROUBLED WATERS

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The Cause

Trouble can be caused by external forces, and not under the control of management. Among the most frequently mentioned are recession, interest rate changes, changes in government policy, inflation, the entry of new competition, and industry product obsolescence.

However, those who manage turnarounds find that while such circumstances define the environment to which a troubled company needs to adjust, they are rarely the sole reason for company failure. External shocks impact all companies in an industry, and only some of them fail. Others survive and prosper.

 

Most causes of failure can be found within company management. Although there are many causes of trouble, the most frequently cited fall into three broad areas: inattention to strategic issues, general management problems, and poor financial/accounting system and practices. There is a striking similarity between these causes of trouble and the causes of failure for startups.

 

Strategic Issues

Misunderstanding Market Niche

The first of these issues is a failure to understand the company’s market niche and to focus on growth without considering profitability. Instead of developing a strategy, these firms take on low-margin business and add capacity in an effort to grow. They then run out of cash.

 

Mismanaged Relationships with Suppliers

Related to the issue of not understanding the market niche is the failure to understand the economics of relationships with suppliers and customers. For example, some firms allow practices in the industry to dictate payment terms, when they may be in a position to dictate their own terms.

 

Diversification Into An Unrelated Business Area

A common failing of cash-rich firms that suffer from the growth syndrome is diversification into unrelated business areas. These companies use the cash flow generated in one business to start another without good reason. As one turnaround consultant said, “I couldn’t believe it. There was no synergy at all. They added to their overhead but not to their contribution. No common sense!”

 

Mousetrap Myopia

Related to the problem of starting a firm around an idea rather than an opportunity, is the problem of firms that have “great products” and are looking for other markets where they can be sold. This is done without analyzing the firm’s opportunities.

 

The Big Project

The company gears up for a “big project” without looking at the cash flow implications. Cash is expended by adding capacity and hiring personnel. When sales do not materialize or take longer than expected to materialize, there is trouble.

 

Sometimes the “big project” is required by the nature of the business opportunity. An example of this would be the high -technology startup that needs to capitalize on a first-mover advantage. The company needs to prove the products “right to life” and grow quickly to the point where it can achieve a public market or become an attractive acquisition candidate for a larger company. This ensures that a larger company cannot use its advantages in scale and existing distribution channels, after copying the technology, to achieve dominance over the startup.

 

Lack of Contingency Planning 

As has been stated over and over, the path to growth is not a smooth curve upward. Firms need to be geared to think about what happens if things go sour, sales fall, or collections slow. There need to be planned in place for layoffs and capacity reduction.

 

Management Issues

Lack of Management Skills, Experience and Know-how

While companies grow, managers need to change their managerial mode from doing to managing managers.

 

Weak Finance Function

Often, in a new emerging company, the finance function is nothing more than a bookkeeper. One company was five years old, with $20 million in sales, before the founders hired a financial professional.

 

Turnover in Key Management Personnel

Although the turnover of key management personnel can be difficult in any firm, it is a critical concern in businesses that deal in specialized or proprietary knowledge. For example, one firm lost a bookkeeper who was only the person who really understood what was happening in the business.

 

Big-company Influence in Accounting

A mistake that some companies often make is to focus on accruals, rather than cash.

 

Poor Planning, Financial/Accounting Systems, Practices, and Controls

Poor Pricing, Overextension of Credit and Excessive Leverage

Some of the reasons for excess use of leverage can result from growth outstripping the company’s internal financing capabilities. The company then relies increasingly on short-term notes until a cash flow problem develops.

Another reason a company becomes overleveraged is by using guaranteed loans in place of equity for either startup or expansion financing. One entrepreneur remarked, “(The guaranteed loan) looked just like equity when we started, but when trouble came, it looked more like a debt.”

 

Lack of cash budget/projections

This is the most frequently cited cause of the trouble. In small companies, cash budget/projections are often not done.

 

Poor Management Reporting

While some firms have good financial reporting, they suffer from poor management reporting. As one financial consultant stated, “(The financial statement) just tells where the company has been. It doesn’t help manage the business. If you look at the important management reports, – inventory analysis – they are usually late or not produced at all. The same goes for billing procedures. Lots of emerging companies don’t get their skills out on time.”

 

Lack of Standard Costing

Poor management reporting extends to issues of cost too. Many emerging businesses have no standard costs against which they can compare the actual costs of manufacturing products. The result is that they have no variance reporting. The company cannot identify problems in the process and take corrective action. The company will know only after the fact of how profitable a product is.

 

Even when standard costs are used, it is not uncommon to find that engineering, manufacturing, and accounting each has its own version of the bill of material. The product is designed one way, manufactured a second way, and costed a third.

 

Poorly Understood Cost Behaviour

Companies often do not understand the relationship between fixed and variable costs. For example, one manufacturing company thought it was saving money by closing on Saturday. In this way, management felt it would save paying overtime. It had to be pointed out to the lead entrepreneur by a turnaround consultant that, “He had a lot of high-margin product in his manufacturing backlog that more than justified the overtime.”

 

It is also important for entrepreneurs to understand the difference between theory and practice in this area. The turnaround consultant mentioned above said, “Accounting theory says that all costs are variable in the long run, In practice, almost all costs are fixed. The only truly variable cost  is a sales commission.”

Bernard TaiwoBernard Taiwo
Bernard Taiwo
I am Management strategist, Editor and Publisher.

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