During a time of financial stress for a business, it is often hard to determine what the problem actually is, and what the proper strategy that can be implemented to reduce the stress. What makes this even more challenging is that there is no one-size fits all solution that will positively change each incident of financial stress.
The first step when a company has a loss is to divide the costs associated with generating revenue into fixed and variable costs. Fixed costs remain the same no matter how many items are produced or sold. In a business some examples of fixed costs would be rent, salary levels required to keep the doors open, and utilities. Variable costs change with sales or production. Examples of variable costs would be supplies, raw materials, and wages that are based upon production. Charting the revenue line against the fixed and variable costs provides a useful picture of what is happening in the company and what may be a proper strategy.
I once had some used car dealers financed who were successful until the “cash for clunkers” program hit a few years back. Sales plummeted for both dealers; one dropped much lower than the other dealer due to the rural market they were located. In fact, revenues dropped to under 50% of fixed costs for the next six months. In this case the first strategy was to reduce fixed costs or for the sponsor to have a large pile of cash personally to fund losses. Since the second option was not available, the business owner shut down two locations and consolidated all lots into one location. This saved additional costs of rent, utilities, and some management staff at the closed locations.
A contractor I worked was saddled with a couple of years of losses from failed subdivisions after the crash in 2008. Their situation was not as dire as the car dealer as they were close to being profitable but were not quite there. Their strategy involved changing their pricing of their work after they studied what a minimum profit margin would need to be in order to be above breakeven. This increase lowered the revenue but made each revenue dollar more profitable. They also decided to sell a marginally profitable line of business and use the funds to reduce debt and lower fixed costs. These two strategies together made a huge difference in the performance of the firm. It also shows that at times, more than one strategy is needed to manage the financial stress.
At times, the answer to financial stress lies in better management of variable costs or just increasing production. A small fragrance manufacturer was bouncing between a small profit and small loss for several years. Their solution was two-fold. First, they discovered that the containers they were packing the product in, could be outsourced to another manufacturer at a 33% cost reduction than their in-house costs. This created a large reduction in variable costs with the removal of this production line. They even reduced some fixed costs by selling some machinery that was used to create the containers.
The company did not want to reduce staff, so they switched the staff working on the containers to producing more fragrances. This increased throughput, combined with lower variable costs, caused profits to soar. In this case, the answer to leaving the financial doldrums was selling assets to lower fixed costs, reducing variable costs, and increasing production.
A normal operating corridor for a business is when each dollar of revenue is able to produce some cents for profit, and also taking care of fixed and variable costs associated to generate that dollar. In the case of a business that is operating above breakeven, the answer to raise profitability is to increase sales. Each new dollar will increase profits and will tend to increase profits at a larger rate with fixed costs staying the same.
When a company is in financial stress, once you determine the various fixed and variable costs of revenue, there are several answers to alleviating the pressure. This may involve reducing fixed costs by asset sales, refinancing, or reducing fixed staff. It may also involve increasing profits by better pricing, reducing variable costs, or increasing the output. It may also require multiple strategies to achieve success. It is important to understand what strategy to take and what is the end goal of the action.