It's a situation that happens quite often in business; the profitability of some operations or products disguises the lack of profitability of others. In a newsletter last year I wrote of a client, a business with a number of small profit centres. Whilst the business was profitable overall about 70% of the small profit centres were losing money. Now is that a profit leak or what?
A quick sum suggests most of these would need to increase sales by more than 33% to just break even, with one needing to increase by more than 120%. That sounds like pretty hard work to me.
Maybe increasing gross profit is not as hard? I'm a great believer in the power of gross profit. So we ran a 'what if' on increasing gross profit in each profit centre, but that didn't help much either. A significant lift in sales was still required.
The problem for my client was that these small profit(less) centres produced a steady stream of cash, unlike the profitable centres where the cash flow was extremely lumpy. I learnt many years ago that cash flow is king. You can't pay the bills without cash, no matter how profitable your business. But there is an inherent difficulty in considering cash as being more important than profit in the longer term.
Cash coming in is all very well but if a business is losing money then with each turn of the working capital wheel a bit is shaved off. You start with $100, it goes around and comes back as $99, around again and you have $98, and so on.
It's not exactly the way to make you flush with funds. You need a margin on the top that goes into your bank account for that.
What would you have done?
If neither increasing sales nor gross profits will change the situation then maybe the company is better of without those particular profit centres. "But we need the cash flow from them to pay the bills" I'm told. I've seen it before, people hanging onto operations despite profitless cash flow.
It is easy to say just close the unprofitable centres, but that doesn't solve the problem of the required consistent cash flow.
Well, negotiate an overdraft with the bank. After all that is what overdrafts are for, to allow businesses to even out the irregular or seasonal variations of income.
What are the options?
An overdraft is an easy solution, but are there others? It's always worth looking at all the options before adding debt, particularly in these troublesome times.
Evaluating options requires a good hard insightful look at all your strengths, all the positive things that underlie the successful side of the business. For example is there a market, a profitable market for your underlying skills, a market which will produce a consistent and positive cash flow? Is there value for others on how you do something, as well as what you provide? Solutions that would allow the irregular but profitable operations to build the bank balance quite nicely, rather than replenishing the sieve-like profitless operations.
In this case our client both plugged the profit leaks by closing or selling off the profitless centres and built a new profitable profit centre around their underlying skills. They developed a valuable product around how they did what they did. And the cash flow it provided is both consistent and profitable. The bank balance is at last building.
Profitless cash flows will imperil your business. Profit leaks can be plugged.
© Copyright 2009 Adam Gordon, Profits Leak Detective
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?