Since ABC Company began business several years ago, it has been remarkably successful. Sales and profits are growing respectably, the bank has increased its lending limits, and it recently expanded its building space.

When the company entered the industry, the marketplace was fragmented but it has now begun to consolidate. Competition has increased, and it has lost some business from repeat customers. To overcome increased competitive pressures, the sales manager reduced prices. With this discounted pricing, he is now forecasting record sales growth.

The bookkeeper is projecting that when the new sales forecast is shipped, ABC Company will exceed the goals of its annual budget, which also serves as the company’s business plan. To meet the increased demand for product, the manufacturing manager has increased inventory and hired more employees to ensure he can deliver more orders.

In fact, things seem to be going so well that the most important decision facing the company’s owner this week is where to have the company picnic.

If this hypothetical business owner sounds like you, wake up to reality! Although ABC Company seems to be running along smoothly on the surface, it is ignoring some early warning signs of financial and operational distress that, if left unchecked, could cause significant trouble.

Over 50,000 firms in the U.S. file for bankruptcy each year, with over 2,000 firms in Minnesota going under last year. While the reasons for failure are varied, in my firm’s experience working with over 200 troubled organizations, we have observed three common themes for failure which are often ignored:

Ill-conceived or non-existent direction, goals and objectives

The old saying "if you don’t know here you’re going, any road will get you there" certainly holds true here. At ABC Company (and at many failed companies) the only document that describes the business owner’s goals and objectives is the company’s annual budget.

Most companies create and follow an annual budget, but budgets are generally driven by overly optimistic sales projections and do not go into the depth needed to clearly analyze, create, and communicate goals and strategies. Annual budgets are also driven by internal factors, rather than by external market factors that impact your success.

A meaningful business plan should address some fundamental questions:

• Is your market large enough to support a company like yours? How fast is your market growing? How much of the market is yours?
• Who are your competitors? How big is their market share? How well do you compete against them? Can you take more business from them?
• Can you sell your products / services profitably with a high enough gross profit and net profit margins to grow?

ABC Company’s owner should pay closer attention to external factors especially because they are in a consolidating market. When businesses are merging, acquiring, or consolidating, they are able to produce more products and/or services quicker, better, and cheaper. Competition will intensify, and industry profit margins will be compressed. If a business ignores these external factors, its only defense is to lower prices. This is not a sustainable strategy.

After this analysis, establish measurable goals, strategies, and action items that will help you gain a competitive advantage and allow you more wins in the marketplace. Figure out how to beat your competition without lowering prices.

Planning and setting goals and objectives is not easy, especially for entrepreneurs, because it involves analysis. It’s not playing to their strong suit, and in this situation the same qualities that make for good entrepreneurs can also be their greatest liability. A lot of business owners we’ve encountered carry their business plans in their head, but haven’t taken the time to reduce it down to writing.

Once you’ve decided on the plan, communicate, communicate, communicate and then execute, execute, execute! A business plan is only interesting words on paper until an integrated group of motivated people takes action and achieves results. Don’t fall into the temptation to react to market pressures and change strategy without a lot of careful analysis --- remain focused. We believe that even a bad strategy or plan, well executed, can be a success.

Not understanding the economics of the business

The bookkeeper at ABC Company should have advised the owner against cutting prices to beat the competition, because it was done without an analysis that gave a clear picture of the economic impact of that action. With the competitive intensity the company is experiencing in the marketplace, the bookkeeper should
have also advised against increasing inventory and hiring new employees. More careful analysis into the economics of the business would show that although sales are growing, operating expenses are increasing and profit margins are decreasing.

For example, let’s say that this business was selling 10,000 units a year at $100 each, resulting in $1 million in annual sales. With a gross profit margin of 50 percent, it has $500,000 in gross profit. After $400,000 in operating expenses, the company would realize an annual net profit of $100,000.

But let’s look at what happens when unit prices were decreased 20% to $80. Although the company can sell 50% more units (15,000 units) resulting in $1.2 million in annual revenue, gross profit margin has decreased to 40 percent because of lower prices. That results in $480,000 in gross profit, but by hiring more people, paying more sales commissions, and increasing inventory, expenses have increased 10 percent to $440,000. The end result --- a decrease in net profit to only $40,000.

This may be a simple example, but a lot of business owners don’t understand these economics. Why? Because they manage from the P&L statement instead of the balance sheet. The P&L statement is a good indicator of
whether over time a company can be profitable, but it is not a good predictor of cash. ABC Company’s business owner is lacking cash flow projections and other useful financial information (such as accounts receivables again) on a timely basis. Armed with this information, the decision to reduce prices would have been halted.

Running an Ineffective or Dysfunctional Organization

I characterize ABC Company as dysfunctional because the management team is not communicating well amongst themselves, with their employees, or with their customers. Many businesses fail because employees are not familiar with the organization’s goals or how what they do contributes to the achievement of those goals. The management style of such businesses is a knee-jerk reaction, rather than being proactive in ways to create customers. In fact, the employees of such companies become so accustomed to the "strategy de jour" that they eventually dismiss every strategy as just another exercise on which nobody will ever follow through.

Organizations that are not operating well are also characterized by a lack of communication among and between management and employees, a lack of training for employees, too many unnecessary and ineffective meetings, and an autocratic management style that is reluctant to delegate authority.

Because goals and strategic actions are not clear, everybody just does their own thing in the best way they can. As a result, "turf" becomes the imperative and management’s focus is on the political "intramural sports" vs. winning in the marketplace.

It’s easy to get lulled into a false sense of security when sales and profits are growing, but don’t spend too much time planning the company picnic. Instead, focus on your business plan, analyzing the economics of your business, and running an efficient organization. If you can do these things, you won’t be whistling past the graveyard anymore.