When we are ready to act to stop losses, we are thrown to think about cutting expenses. In this post I offer an alternative I see is more powerful for restoring profitability–one that can produce benefit from having encountered losses.
Profits are the lifeblood of the enterprise, and are especially critical to the small to medium private company. Profits provide growth capital as well as power for the business to survive the unanticipated, unavoidable breakdowns that are inherent in the nature of building companies.
Once we emerge from the start-up phase–that period where we're evolving our core offer, producing the organization and getting to breakeven–it is essential to sustain or recover profitability. Every month. Every quarter. Every year.
I don't want to do business with those who don't make a profit, because they can't give the best service. Richard Bach
The natural pattern of behavior for us as CEOs when we begin to lose money includes...
- Assuming its a one month aberration
- Finding ourselves in the narrative that we can't afford to reduce expenses
- Being upset at external causes–customers, the economy, competitors, etc.
- Being pulled to take care of the individuals who are part of our organization
- Being stopped from acting by our negative moods
- "Hoping" that revenues will increase to return us to profitability
- Avoiding taking action
The 5 stages of grief articulated by Elizabeth Kubler-Ross come to mind...
When we do act–usually after several months of losses and when all other options are exhausted–most of us think about what expenses we can cut and what individuals we can layoff. We focus on the current design of commitments as the starting point for our response.
A More Effective Response
Making profits is a fundamental and essential purpose of a business and one of the commitments of the role of CEO. When we anticipate or experience breaking even or losing money, it is a call to immediate action–to notice, observe and assess the cause. Sometimes a loss in one month has a unique cause that will not recur, however, this is the anomaly rather than the norm. Most often a loss reveals a change in market conditions that must be addressed.
Think about what you would do to recover profitability. The normal response is to think about cutting expenses. We look at the present set of expenses we have and ask, "Which of these can I reduce or eliminate"? This approach constrains our thinking inside the structure of commitments that have evolved for the roles and other committed expenses of our business. Many people think in terms of fixed expenses, forgetting that all expenses are commitments which can be stopped or modified. Of course some commitments take more work and time to change than others, such as moving facilities, but all expenses are just commitments and we can make different ones for a different situation.
My strategy for returning a business to profitability:
- Accept the situation immediately and design, prepare to act and act to restore profitability; move with alacrity; take care of your mood and your team's
- Assess anticipated future revenues you are confident of and total funds available after external expenditures such as materials or external services) ; this is the amount you have to spend on production, sales, G&A, and other costs
- Draw or write the current structure of financial commitments–staff, rents, outside services, professional fees, etc.; work to see the commitments as an integrated whole rather than in divisions such as departments or functions
- Look for waste or opportunities for decreased costs in the current design, calculate the gain from eliminating expenses you now say are unnecessary
- If this does not produce satisfactory profitability, analyze the costs you can afford for the level of future revenues you are confident you can produce to produce a minimum level of profitability (I recommend never lower then 5%)
- With this budget for all committed expenses, produce a new organizational design that you can accomplish with this budget; think about roles rather than current individuals; design the workflows required to sell and produce your offers
- Refine and evolve this design at least once after completion (in another design session with your key team)
- Design and craft the narrative for the organization of why we must take this action to cope with the threats, fulfill the obligations and exploit the opportunities of our present situation, and what new situation we are committed to producing
- Act with maximum velocity to implement and settle the organization in the new design
Embrace a Philosophy of Profitability
I never lost money by turning a profit. Bernard Baruch
Profits are a derivative of revenues, minus costs and expenses. We manage those elements to produce profitability. I hear people speak of profits like they just happen, like the weather. Without profits a business is weak, vulnerable and losing power. The "game" of business is to produce, maintain and increase power, and business power is best assessed by net cash flow produced.
I learned to continuously design the business with a commitment to a percentage of profitability. Over my career I have learned to enter or remain in businesses where I can commit to and produce a net operating margin of at least 10%. The higher net operating margin we can produce, the more valuable the enterprise. A businesses with higher profit margins commands higher premiums or multiples of earnings when raising capital or monetizing.
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