How can small business owners ride out the storm of a tough economy and even make a profit? Here are four things they must do to continue growing in spite of a shrinking market.
I have come to view my marketing clients as my “canaries in the coal mine” on the business climate. Having a marketing related business in every city where we have clients (i.e. Boston to Portland), gives me a great pulse on the market all across the US. I can evaluate their real financial condition since we see their numbers and forecast their results through the end of the year for cash flow and tax planning.
Our other industries seem to be muddling along, but if my canaries are right, the effect will start to hit most other industries soon.
Decade of the Winners and Losers:
Given the prospect of government spending cuts and low to no growth in GDP, it is evident that we are entering the Decade of the Winners and Losers. In this market, there are limited areas that will experience growth. For the broader market (especially for small business clients under $10 million in revenue) the only gains will come from being the company that can win new business away from the competition as your means of growth. It is a different dynamic to grow in this type of marketplace rather than catching the wave in a growth market. If your market is shrinking, you could almost consider it growth for you to just remain level.
How to be one of the Winners:
With tight credit and low growth, entrepreneurs will have little room for error. There are 4 key ingredients to the recipe for staying afloat in a shrinking market:
1. Profitability – Whatever business you have, you must meet minimum profitability requirements. For most businesses, at 5% pre-tax profit you are on life support, at 10% you are a good business and at 15% you are a great business. Anything above 15% will attract competition so take it while you can get it. As for competition, you will be amazed at how long the bad competition can hang around before they capitulate and exit either voluntarily or involuntarily. Therefore, expect a long battle for market share.
2. Labor Productivity – The number one key to profitability is productivity of all labor (direct, sales and management). You will need to measure each labor segment and monitor productivity per labor dollar for each and make adjustments as you see trends develop. Gone are the days of waiting 6 months or a year to see if things improve, you will need to make productivity adjustments within a month or less of a developing trend.
3. Retain profits to self fund growth – To the extent possible, your best bet for financial stability is to self fund your growth needs. The banks will able to provide accounts receivable and equipment financing to a limited degree, but do not expect much lending support for any business that loses money for any length of time or tries to finance inventory.
4. Outside Capital from Long-term Investors – If you have a strong business that needs growth capital, we will see a new breed of investor that is not expecting an exit, but a strong rate of return for their investment. Properly valued operating businesses can return 20% to 100% return on capital if there is an alignment of the Company Management and the Investor as to the realistic goals for the business. Business valuations have been skewed by overvalued businesses being bought by desperate publicly traded businesses that need to buy growth. With the Dow trading at 15 times EBITDA, any company valued at that level could never pay for itself out of their earnings and the multiples have been built on future growth expectations. If growth expectations are taken out of the market, average multiples will likely fall to 9 to 11 (the premium value is only for liquidity). We see hope in establishing an environment where money and effort can learn to play nicely.
Greg Crabtree has worked in the financial industry for more than thirty years and founded Crabtree, Rowe & Berger, PC, a CPA firm dedicated to helping entrepreneurs build the economic engine of their business. In addition to serving as the firm’s CEO, Crabtree leads the business consulting team—helping clients align their financial goals with their profit model and their core business values. He is the author of Simple Numbers, Straight Talk, Big Profits! For more information, please visit: http://www.seeingbeyondnumbers.com/.