Napier & Company, LCC

Over the past year I have met with a number of businesses to discuss prospective strategies to deal with a “down economy”. Whatever you want to call it—recession, economic downturn or other titles, you cannot deny times are tough out there. With the exception of certain industries such as bankruptcy law or required health care every business is feeling the economic contraction. So what are some common sense steps a business can take? Four strategies to consider are:

1. Every business should at the very least try to project their sales. Match your business cost structure to the projected sales.
2. Look at your credit practices—you should not be a bank for clients or customers.
3. Remove the dead weight from your balance sheet—this includes excess inventory, uncollectible accounts receivable or any other non performing assets.
4. Manage your debt—if you are in a liquidity “May Day”, prioritize your debt.

Sales Projection and Creating an Appropriate Expense Structure

Every business should be able to project their revenue for the year. This can be done by looking at past sales to customers and those included in the current marketing plan. All businesses no matter what industry should have a future market plan. This marketing plan should have a pretty good idea of future sales through existing and prospective customers. Once a good sales estimate has been made, structure your expenses to correspond. How is this done? First know your expenses. Business expenses can usually be put into four categories:

• Fixed—These remain the same over various sales volumes. Good examples are rent and insurance.
• Step fixed expenses—Over a certain volume these fixed expenses will increase. Rent would be an example again.
• Direct variable expenses — These are directly related to product costs—materials and labor or just labor for service industry businesses.
• Step variable expenses-These change over certain sales volumes i.e. marketing, selling and other expenses needed to facilitate an increase in sales

When consulting with a business usually one of the first questions I ask is “What is the production capacity under your current cost structure?”.

This question is important. Why? I use the analogy of a stair step to explain expense behavior over a range of volume. Your business should be at the top of a given step i.e.—your building facility should be fully utilized, not half empty. Variable costs will increase or decrease as sales go up or down. To determine a business break even point take the difference between your sales and all variable costs. This difference is the contribution margin. The business is at its break-even point when the contribution margin equals fixed costs. Sales/cost/volume analysis models are important for pricing a business’s product or service. Once a business has exceeded its break-even point it is possible to lower the selling price. Also, if in past years your sales were at $3 million and they have declined to $2 million, consider lowering your fixed costs. Examples would be sub-leasing unused space with short term leases or cutting down support expenses. Lastly look at discretionary expenses. Eliminate these if no foreseeable benefit is projected.

Look at Your Credit Practices—You Should Not be a Bank for Clients or Customers

What type of credit terms does your business offer for sales? How do you check a customer’s credit? How do you measure accounts receivable collections? What are your accounts receivable collection policies?

What Type of Credit Terms Does your Business Offer for Sales?

If the business provides contracting services and the contracts are sizable a retainer should be obtained. At least out of pocket material costs should be paid by the client. For new clients with no credit history, this should be mandatory.

How Do You Check a Customers Credit?

The common practice to check a customer’s credit is to obtain a credit report through Dunn and Bradstreet or other credit verification agencies. Some additional steps are to talk with the company’s bank, look at recent financial statements and ask for credit references from other creditors. Remember selling to a risky credit customer is analogous to giving your product or service away.

How Do You Measure Accounts Receivable Collections?

Knowing the number of times your accounts receivable turn over each year is important. Further, knowing the number of days it takes to collect accounts receivable is even more important. Ideally a business should collect an account within thirty days. Sometimes it depends on the industry. If many of your sales are to government agencies collection will take more than thirty days. How is accounts receivable turnover calculated? Divide total sales by average accounts receivable. To put the accounts receivable turnover in terms of days divide the turnover number into 365 days.

Whare are your Accounts Receivalbe Collection Policies?

If there are past due accounts receivable consider drastic collection measures. Initially, consistent calling and strong correspondence is best. Next a strongly worded attorney’s letter is the best step. The last step is to send the account to collection. Remember, collecting something is better than nothing.

Remove the Dead Weight from your Balance Sheet– this Includes Excess Inventory, Uncollectible Accounts Receivable or any Other Non Performing Assets.

Many times companies that either sell or manufacture products carry excess inventories. All businesses should study how fast their inventory moves. Are there obsolete inventory items? It is better to sell these items for a reduced price than holding on to the inventory.

The Other Side of the coin– managing debt.

Okay, let’s say liquidity is a problem. Business volume has gone down and debt is greater than cash flow can support. By debt I mean liabilities due to trade vendors, the IRS, state agencies, financial institutions and professionals; all creditors.
The first assignment is to prioritize debts. Highest priority is the IRS. For a business, this would usually be payroll related expenses such as employee wage withholdings and payroll taxes. Next, employees need to be paid. After that, secured creditors need to be paid. Vendors that provide a critical product or service needed to keep your business operating are next.
After that point in time, the choice is subjective. Frequently a repayment plan is required. Most creditors will be reluctant to accept a payment plan however this is sometimes better than out right bankruptcy.
Two important points: Set up a realistic plan with the creditor, and follow through with your commitments to the creditor.
These are some important considerations. There are many more we could discuss. Feel free to contact us to review your circumstances.

Summer 2009