Weathering The Economic Storm
Six steps to surviving today's troubled times
By J. Tol Broome Jr. -- Gifts and Dec, 1/1/2009 12:00:00 AM
ONLINE EXCLUSIVE Obtaining Outside Capital Don’t assume that there are no options for outside capital during the current economic downturn. If you have a good business model and a strong track record of performance during a growing economy, there are many investors that could be willing to provide much needed capital to help you get through this slump. The first place you should look is your own personal resources. If you have accumulated cash and/or investments during the past few years, consider investing it in your business until the storm passes. There is no better place to invest your capital than the business from which you derive your livelihood. Likewise, if you have equity available in your residence, consider a home equity line to generate capital for your business. If you are personally tapped out, there are other outside sources to consider: • Traditional Institutional Venture Capital Firms: Sometimes referred to as a Private Equity Group, a traditional VC firm raises money from private sources such as insurance companies, hedge funds, pension funds, endowments, banks and individuals. The minimum investment level generally is at least $250,000 for a traditional VC firm, 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 an economic slump. • Small Business Investment Corporations: The SBIC program is a public venture capital initiative that is sponsored by the federal government, which uses a combination of private funds and federal government dollars to provide three important needs for eligible small businesses: equity capital, long term loans (up to 20 years) and management assistance. SBICs are federally licensed, and they are scattered throughout the country. SBICs are a more viable option than traditional VC firms in an economic downturn, and they will consider smaller investments (as low as $50,000 in some cases) and may offer more flexible terms. • “Angel” investors: “Angel” investors are individual capital providers for small businesses. They typically are entrepreneurs who like to help small business owners to achieve high growth in exchange for a share of the profits from the business. Angels might invest anywhere from $50,000 to $1 million or more in a business. The typical profile of an angel is a family member, friend or small business owner in the community. — J. Tol Broome Jr. |
Storms are always difficult. They are often unexpected, ill-timed and unpredictable. Storms can cause damage in a number of ways, including wind, rain, sea surge and lightening. And the longer they last, the more damage they do.
Economic downturns are a lot like storms. And we are in the middle of a prolonged financial storm right now. Of course, you can weather any storm if you take the right actions once it hits—and the same holds true for surviving an economic recession. As you deal with trying to keep your head above water while the storm rages around you, follow these steps to significantly improve your chances of being in business when the sun finally comes out.
Assess your business model
This may sound counter-intuitive, but an economic storm is a good time to assess your business model. Why? It has been said that when the tide goes out, we find out who has been swimming naked. In a period of strong economic growth, even mediocre businesses can thrive. But when things get tough as they are now, those with a weak business model struggle and often don't survive.
First, ask yourself some hard questions:
1) Is my business location optimal?
2) Am I still meeting the needs of my customers?
3) Do I have the right product mix?
4) Do my price points make sense?
5) Do I have the right people in place to help me survive now and thrive later?
6) Is my cost structure too high?
7) How am I doing compared to my competitors?
8) Can I make enough money from this business to justify the time and effort I devote to it?
9) What should I be doing that I am not doing? What should I stop doing that I am doing now?
10) Should I consider other sources of revenue generation, such as online sales?
Second, you must be willing to make some difficult decisions if your business model is not on the right long term course. If you are struggling to stay afloat but refuse to consider any changes to your business model, you will find it very difficult to weather the storm. But if you are willing to ask the tough questions and act accordingly to change course, it might just be the difference between going under and survival.
Seek professional input
When times get tough, it is sometimes difficult for a business owner to decide unilaterally on the right track for survival. This is a good time for you to seek outside counsel from trusted advisors. Start with your Certified Public Accountant. Your CPA should be familiar with the financial strengths and weaknesses of your business and can provide valuable input to improve sales, increase margins and cut costs.
A second good source for counsel is your attorney. In addition to legal knowledge and advice, many attorneys have experience in advising clients on business management issues. And if you are receiving frequent calls from creditors or find that you are falling behind in keeping your taxes current, your attorney will ensure that you understand where you stand legally.
Another source of input can come from your business contacts. You should know other small business owners in the community who would be willing to provide advice on dealing with the financial problems you face. Additionally, if you have met other out-of-town toy business owners at trade shows, they might prove invaluable in providing input.
Finally, a well kept secret in the business world is an organization called the Service Corps of Retired Executives (SCORE). Affiliated with the Small Business Association, SCORE describes itself as “a nonprofit association dedicated to educating entrepreneurs and the formation, growth and success of small business nationwide.” With 389 chapters and 10,500 volunteers throughout the country, SCORE provides free and confidential advice for small business owners by pairing them with retired executives in the same or similar industries.
Meet with your banker
Another trusted advisor who can help you weather the storm is your banker. In my 25-year career in commercial lending, I have held many meetings with business owners during difficult times. In fact, this is one of the most important roles for any banker. We certainly want our clients to stay in business and generally are motivated to do what we can to help troubled businesses make it through trying times.
It may be intimidating to go to your banker and share bad news, but it is important to be proactive when the storm hits. Bankers don't like surprises, so the earlier you seek the counsel of your banker, the better. If you have borrowed money, the bank likely has a first lien on your company's assets and can shut you down by foreclosing. So, it's advantageous to get your banker on your side rather than risk an adversarial relationship.
One way your bank may be willing to help is by extending loan terms. For instance, for a $50,000 loan at 9 percent interest with a two year term, the monthly payment would be $2,285. By extending that same loan to a three-year payback, the monthly obligation decreases to $1,590. This translates to a monthly savings of $695 and annual cash flow enhancement of $8,340.
Banks also will sometimes allow interest-only payments for six months or a year during financial crises. The cash flow enhancement in this case is even more advantageous. The monthly interest payment on a $50,000 loan at 9 percent would be $375 ($4,500 per year). Modifying the two year loan used in the example above to an interest-only repayment schedule would save $1,910 per month and $22,920 over a whole year. You can then resume monthly payments of principal and interest once the storm passes.
Cut your costs
Small business owners sometimes are reluctant to reduce expenses during an economic downturn. This is often because payroll makes up the largest line item component of expenses, and cutting payroll means either cutting employees' hours or letting some of them go. This can be difficult if your employees have a long tenure in your business or if they are family members; however, failure to reduce your payroll when the storm hits might lead to the complete failure of your business—and no jobs for anyone.
A good rule of thumb is to reduce your payroll by at least the same level as your revenue drops. For example, if your annual revenue was $500,000 when the economy was stronger, and it drops to $450,000 (10 percent), then you should seek to decrease your payroll by at least 10 percent. This may not mean termination for any employees. You can achieve payroll reduction by dropping some people to part-time, eliminating overtime and cutting your own salary, for example.
Of course, your payroll is not the only operating expense for your business. You can cut expenses in other areas. Try some of these cost cutting measures:
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Seek bids for your various insurance coverages at the next renewal dates.
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Initiate a control system for ordering supplies.
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Ask your utilities providers about any energy saving incentive programs.
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Bid out contracts for and/or cut back on landscaping and cleaning services.
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Review other service contracts, such as for your office equipment, to see if you are really getting value to match their expense.
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Reduce certain employee “perks.”
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Review your cellular plan.
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Consider outsourcing services such as bookkeeping and payroll.
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Renegotiate with your landlord the next time your lease expires.
Manage your inventory
While you certainly have to keep inventory in your store to generate sales, an economic storm is a good time to evaluate your inventory strategy. While it may seem prudent to carry a little bit of everything, this can prove detrimental to your cash flow when every dollar counts. Now is the time to get rid of slow moving and low margin inventory.
Try sticking around your business location for a few evenings after closing one week and taking inventory of the dead stuff. Mark this material down to “Have I got a deal for you!” prices. When it sells, don't replace it. Put the extra money into your niche items that turn much faster, or put it in the bank.
The faster your inventory turns and the lower your investment in inventory, the better your cash flow will be. This is pretty easy to understand when it comes to selling inventory that is not replaced. Every dollar that you get rid of provides a dollar to keep your business afloat. But it is a sometimes tougher to comprehend the potential impact on cash flow of improving your inventory turns.
The following computation is used to calculate the number of inventory days on hand: Inventory/Cost of Goods Sold x 360 = # of Days on Hand
Here is an example:
If Inventory = $100,000 and COGS = $400,000, then:
# of Inventory Days on Hand = $100,000/$400,000 x 360 = 90 days
If you aren't tracking this now, you need to start. An improvement in inventory turns can substantially increase your chances of surviving the storm. For example, if your store currently had the above levels of inventory ($100,000) and COGS ($400,000) and you could successfully reduce your inventory days on hand from 90 to 60 days, you would positively impact your cash flow by $33,333 (30 days reduced/360 x $400,000).
Use your trade credit
Maintaining a good rapport with trade creditors is critical during a financial downturn. Stay in close contact with your trade creditors and let them know when they will be paid. But don't disclose too much (i.e. “Hey Fred, we barely made payroll last week.”) so as to avoid alarming them and running the risk of being put on a C.O.D. basis.
Here are a few recommended steps to take in dealing with trade suppliers:
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Don't pay 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, from your primary vendors to your basic office supplies.
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Try to extend terms with your existing suppliers for a temporary period.
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Under-promise and over-deliver. Negotiate a bill due in 30 days to pay it in 45 and then pay it in 43.
While you can often negotiate with your trade creditors, the Internal Revenue Service and other government entities offer little flexibility. You must keep payroll taxes current at all costs. Not only can the IRS shut you down over delinquent withholdings for federal, state, FICA and Medicare taxes due, 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 options.
While the near future may be challenging, remember that the current economic slump will eventually pass. Follow the steps outlined here and your business should be around to see the clouds part and the sun return when we reach the next period of economic growth.
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