Huge, once highly profitable companies such as Ford or Kodak can see their market position deteriorate for years or even decades without closing. But small entrepreneurs rarely, if ever, have the luxury of being able to similarly ride their declining businesses slowly into the sunset. In the small business world, if revenues drop significantly for more than a few months, you must promptly both cut expenses and address the causes of the decline. If you don't, you risk quick and brutal failure.
How do you know when it's time to cut back? As a hands-on entrepreneur, you should immediately know about—or better, anticipate—negative news such as a precipitous sales drop, the loss of a big contract, the failure of a large account to pay on time, or the emergence of a tough new competitor. The problem is rarely spotting the disturbing event or trend, but admitting to yourself that it is serious enough to require quick and decisive action. For example, the owner of the small Reader's Corner bookstore who learns that Barnes & Noble is planning to open a superstore on the next corner is all too likely to hope for the best while carrying on business pretty much as usual. Similarly, the operator of a hotel in a pricey tourist area might do little or nothing even when future bookings drop by 30%.
Whistling a happy tune in the face of entrepreneurial adversity, especially a true recession, won't work. Once you see clearly that your business faces a boulder-strewn road, you must immediately come up with a workable plan to either clear the rocks, choose another path, or sensibly deal with the problem in some other way. Depending on your business and the severity of its financial problem, this might involve quickly cutting overhead, moving to a cheaper location, selling pricey equipment, introducing a new product or service, developing a better way to reach customers, cutting office expenses, selling the business (or a part of it), or closing down, before business losses gobble up all your family's assets.
But because survival depends on quickly reversing losses, what you do is usually less important than how fast you act. Delay even a couple of months too long and fast accumulating debt can turn the boulders in your path into gravestones.
EXAMPLE: All Wooden, a company that builds and replaces wooden windows in older houses, has operated successfully for 38 years when the recession hits. New orders slow dramatically; customers begin to pay late if at all. Owners Janet and Bill try to avoid layoffs by undertaking an expensive cable TV ad campaign. When that fails to bring in many new customers, they again consider layoffs, but decide to wait 60 days in the hope that business will improve.
But in less than a month, the bank, pointing out that All Wooden is in violation of two major covenants (they were operating at a loss, and their debt-to-equity ratio was out of balance), pulls their line of credit. Janet and Bill try to find a factor to buy their receivables, but because many of them were past due, there are no takers. With little cash and a gaggle of suddenly aggressive creditors, All Wooden files for bankruptcy.
Construction outfits often face severe problems during an economic downturn. Not only is their overhead higher, as a percentage of sales, but they also typically rely on suddenly iffy bank lines of credit to smooth out payment cycles. Some fail for a combination of reasons, the most important of which is that much of the new residential and commercial construction they typically rely on grinds to a halt at the same time that they don't cut expenses nearly fast enough.
EXAMPLE 1: Six months into the recession, new business at J&B Concrete begins to drop precipitously as residential and commercial construction severely contract. At the same time, payments to J&B for cement jobs begin to slow down as everyone from prime contractors to several municipal governments begins to hoard cash. Out of loyalty to longtime office workers and estimators, J&B is slow to cut overhead, hoping against hope that, as it always had, business will soon pickup. As a result, monthly payments for rent, equipment, and staff exceed income.
J&B turns to its bank with a request that it increase their line of credit. Instead, after seeing that J&B's negative cash flow already violates an existing loan covenant, the bank cancels the credit line. J&B immediately lays off 60% of its staff, tries desperately to collect on past-due receivables, and asks everyone from their landlord to trade creditors to accept late payment. But even though some of these efforts show promise, J&B runs out of money two weeks after the line of credit is canceled. They're unable to pay even their diminished payroll, so the state labor commissioner closes them down, and a bankruptcy filing follows.
When you realize that from start to finish, J&B's crash from solvency to bankruptcy took just five months, you'll understand just how financially fragile many construction outfits are. Nevertheless, had J&B moved faster to shrink overhead, it might have survived. So in, let's give J&B a second chance.
EXAMPLE 2: When J&B has its first bad month, the owners meet with their experienced advisory board and explain that with construction drying up everywhere, business is only likely to get worse. Following their advisers' good advice, J&B immediately cuts office staff from ten employees to three. In addition, it sells $100,000 worth of equipment, using the receipts to pay off several equipment loans. Telling the landlord they plan to move in six months when their lease was up elicits a counter proposal that they sign up for another two years at a 25% rent reduction, which J&B accepts. Applying an aggressive full-court-press strategy to their lagging accounts receivable, they collect many of them and sell several more to a factoring company that specializes in collecting from municipalities and other public entities.
Then, with their balance sheet more or less in order, Jim and Bart meet with the bank and present their plan to further shrink the business as necessary with the goal of quickly returning to profitability, no matter how deep the cuts need to be. Their loan officer, saying that he appreciates J&B's determination to take the steps necessary to operate in the black, renews their line of credit. When several other local concrete outfits go under, J&B's business stabilizes. After several months of savvy, low-cost marketing efforts focused on smaller home remodeling projects and solar panel installations, business actually improves.