Weather the Economic Storm
By J. Tol Broome, Jr. -- Gifts and Dec, 11/1/2008 12:00:00 AM
Storms are difficult. Often unexpected, ill-timed and unpredictable, storms cause damage in many ways, and the longer they last, the more damage they do. Economic downturns are a lot like storms.
We are in the middle of a prolonged financial storm right now. But you can weather any storm or slump if you take the right actions once it hits.
Assess Your Business Model
In a period of economic growth, even mediocre businesses thrive. But when things get tough, weak business models struggle.
Ask yourself hard questions:
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Is my location optimal?
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Do I meet customers' needs?
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Is this the right product mix?
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Do price points make sense?
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Do I have the right people?
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Is my cost structure too high?
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Am I doing better or worse than competitors?
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Can this business make enough money to justify the time and effort?
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What should I be doing that I'm not? What should I stop doing?
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Should I consider other sources of revenue generation?
Seek Professional Input
Seek outside counsel from trusted advisors. Start with your Certified Public Accountant, who can provide input to improve sales, increase margins and cut costs. A second source is your attorney. Many attorneys advise clients on business management issues. If you receive calls from creditors or fall behind on taxes, your attorney will ensure that you understand where you stand legally. Input can also come from other small business owners in the community or out-of-town business owners whom you met at trade shows.
Finally, the Service Corps of Retired Executives (SCORE), affiliated with the Small Business Administration, provides free, confidential advice, pairing small business owners with retired executives in similar industries. For more information, visit www.score.org.
Meet With Your Banker
Another advisor who can help you weather the storm is your banker. In my 25-year career in commercial lending, I have met with many business owners during difficult times. We want clients to stay in business and are motivated to help. It may be intimidating to share bad news with your banker, but it is important to be proactive. If you have borrowed money, the bank likely has a first lien on your assets and can shut you down by foreclosing. Get your banker on your side rather than risk an adversarial relationship.
Your bank will often be willing to extend loan terms. For instance, for a $50,000 loan at 9 percent with a two-year term, the monthly payment would be $2,285. By extending that loan to a three-year payback, the monthly obligation decreases to $1,590. This provides a monthly savings of $695 and annual cash flow enhancement of $8,340.
Banks will also sometimes allow interest-only payments during financial crises. The monthly interest payment on a $50,000 loan at 9 percent would be $375 ($4,500 per year). An interest-only repayment schedule would save $1,910 per month and $22,920 over a year. You can resume paying principal once the storm passes.
Cut Costs
Reduce payroll by at least the same level as your revenue drops. If your revenue was $500,000 and drops to $450,000 (10 percent), you should decrease payroll by at least 10 percent. This may not mean terminating employees. You can drop people to part-time, eliminate overtime and cut your salary. In addition, try to:
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Seek bids for insurance coverage
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Add a control system for ordering supplies
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Ask utilities whether they offer energy saving incentive programs
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Bid out contracts or cut back on landscaping and cleaning services
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Review service contracts to see if you are getting good value
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Reduce employee perks
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Review your cellular plan
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Consider outsourcing bookkeeping and payroll
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Renegotiate with your landlord
Manage Inventory
Now is the time to get rid of slow moving and low margin inventory. Mark it down and when it sells, don't replace it. Put the money into items that turn faster, or bank it.
The faster inventory turns and the lower your investment in inventory, the better your cash flow will be. To calculate the number of inventory days on hand: Inventory/Cost of Goods Sold x 360 = # of Days on Hand. Here is an example: Inventory = $100,000; COGS = $400,000; # of Inventory Days on Hand = $100,000/$400,000 x 360 = 90 days.
If you aren't tracking this, start. If your store had the above levels of inventory and COGS and reduced inventory days on hand from 90 to 60, cash flow would improve by $33,333 (30 days reduced/360 x $400,000)!
Use Your Trade Credit
Stay in close contact with trade creditors and let them know when they will be paid. But don't disclose too much to avoid alarming them and being put on a C.O.D. basis.
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Don't pay any bills early.
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Consider changing to a supplier with better trade terms even if the cost is a little higher.
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Shop for lower cost suppliers for all items you purchase.
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Try to extend terms with your suppliers. If a supplier normally offers net 30, ask for 45 or 60.
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Under-promise and over-deliver. Negotiate a bill due in 30 days to pay in 45 and then pay in 43. And don't let any get so far behind that the supplier cuts you off.
While you can often negotiate with trade creditors, the Internal Revenue Service and municipalities offer little flexibility. You must keep payroll taxes current. Not only can the IRS shut you down over delinquent withholdings for Federal, state, FICA and Medicare taxes, they also can pursue criminal charges in certain circumstances. You also must keep state sales taxes and any local taxes current. If you have a reporting period approaching and don't have the funds available, contact your attorney to discuss your options.
Obtain Outside Capital
Don't assume there are no options for capital during the downturn. If you have a good business model and a strong track record, many investors could help you get through.
The first place to look is personal resources. If you have cash and/or investments, consider investing in your business. Likewise, if you have equity available in your house, consider a home equity line of credit.
If you are personally tapped out, consider outside sources:
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Traditional Institutional Venture Capital Firms, sometimes referred to as a Private Equity Group, raise money from sources such as insurance companies, hedge funds, pension funds, endowments, banks and individuals. The minimum investment level is usually at least $250,000, and they expect an annualized return on investment of at least 20 percent over a three to seven year period. Traditional VC money is hard to come by during a slump.
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Small Business Investment Corporations (SBICs) use a combination of private funds and federal government dollars to provide equity capital, long term loans (up to 20 years) and management assistance to eligible small businesses. SBICs are more viable than traditional VC firms in an economic downturn. They will consider smaller investments (as low as $50,000) and may offer more flexible terms.
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“Angel” investors are individual capital providers. They are typically entrepreneurs who help small business owners to achieve high growth in exchange for a share of the profits. Angels might invest anywhere from $50,000 to $1 million or more in a business. The typical angel is a family member, friend or small business owner in the community.
If you aren't sure where to find sources of capital like those listed above, ask your CPA or banker.
As with all storms, the current economic slump will pass. Follow the steps above and your business should be around to see the clouds roll away at the next period of sustained economic growth.
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