Recently, I’ve been in a position to watch a curious thing.
A business owner, who we’ll call Brian, owns five stores. He started well. He managed his first store for several years, building sales, reducing turnover and otherwise improving things across the board. He paid down some of his acquisition debt, purchased some land at a great price, and moved into a freestanding building on his new land. Everything is great.
All of this was even more spectacular because this store was in an inner-city location with lots of problems. Robberies, shootings, internal theft, insurance claims for stupid reasons—you name it.
Brian’s early company growth was well-managed. Not too fast and not so slow as to lose momentum. He bought a second store and developed it. Then a third. Two years later, a fourth. Finally, a fifth.
But between stores four and five, Brian made some changes to his company structure. He appointed a supervisor—a questionable move for a 4-store company, but it could work with continued growth. Brian began holding two weekly meetings. One meeting was for managers and the other was for the assistants. Brian looked around for an office so he could move his company operations out of his home. He was planning on more growth.
Brian, who watched his contribution margin ruthlessly when he owned and operated a single store, grew careless with his cash as his company grew. He took managers on training activities out of town. He bought managers lunch after the meetings. He instituted new bonus programs.
The Fifth Store
The deal was sweet. The price was reasonable for an underperforming store, given its sales history and location. Best of all, the owner would hold the note, removing any obstacles concerning credit and lengthy loan applications. He wasn’t sure why it was underperforming, but he was certain that his positive attitude would overcome any problems. The 50% drop in sales over the past 2-3 years didn’t trouble Brian at all.
About $40,000 in cash went out right away in upgrades. He spent heavily in advertising on this new store. That store received roughly triple the local advertising of his other stores. Mailouts, flyers, promotions with other businesses, aggressive price points. He gave it the works.
A hundred thousand dollars later, sales had barely budged, and the company was hemorrhaging cash badly.
After about a year, he changed managers. That initially helped sales by a couple of percent, and some key costs came down (and then rose as the new manager’s initial zeal waned), but the store was still losing money.
The combination of frivolous spending and a cash-negative acquisition was about to cost him his entire business, a business that cost him over $1 million and 10 years to build.
On top of that hurdle, the company entered a seasonal sales slump and the overall economy went from weak to weaker. The four stores that had been carrying the fifth stopped producing cash. During some weeks, only one store produced more money than it spent. Brian looked to refinance some long-term debt, only to find that banks were reducing his credit limit, as they were to many other people.
Because there was no cash, there was no possibility of improvement. Accounts fell behind, which meant that costs went up as the company sought alternate providers and paid fines and late fees. Advertising stopped, which saved cash but meant that the next week’s sales would be flat or down, too. Manager bonuses stopped, which reduced morale and incentive to perform. Increased demands on the managers for less pay resulted in cheating on paperwork. All of these factors made it harder to get out of the hole.
In an attempt to recover, Brian depleted his entire retirement fund. He borrowed money from family. Attempting to stave off current cash-flow problems created years of long-term difficulty.
Begun this death spiral had.
How Do You Avoid It?
It is far easier to avoid this kind of problem than it is to recover from it.
Maintain a cash reserve. Don’t spend the cash reserve except for legitimate emergencies or to cover known and predictable sales cycles.
Choose a method of setting up a cash reserve. Set a dollar amount or (better yet) a multiple of months’ worth of expenses. If your store sees a seasonal variation, you might want to change your cash reserve requirements periodically throughout the year. You might need more money to build inventory for Christmas, for example.
Set an advertising budget and stick to it. Spend a careful, measured amount according to the business’s needs. This spending also might vary in amount and direction according to seasonal sales, so don’t feel like you’re locked into a set amount. You might spend $600 during the summer and $400 during the slower months. You might maintain radio all year but change your print ad frequency according to the new release cycle. Don’t use advertising as a discretionary expense based on cash flow. Treat it like a bill and “pay” it every month.
Pay a Fair Salary
The 1st edition DMG had a great line of truth in it: “High pay is not a sign of strong leadership” Or something like that (I’m sure some zealot will provide me with the precise wording). Pay according to the job done and don’t overpay when things go well. If you ever have to reduce pay, even when you’re overpaying compared to your competitors, your crew will resent it.
Spend Your Success Wisely
Spend your first bit of excess cash on assets, preferably assets you can leverage if your cash gets low again. Additional inventory can be good. Paying down debt early is awesome, especially your acquisition debt. Once that comes off the P&L, profitability and cash flow go up.
One of the things I like to do when considering how I want to reinvest capital is to compare the effectiveness of my spending with other options. If I have $1,000 to spend, I compare the value of whatever I’m considering versus existing options. What if I spent that $1,000 on labor and materials to run an additional miniatures game league? What if I spent it on booth fees and travel for 2 more conventions? What’s the best use of that money? Do I really need a third-party mystery customer program?
If you spend money on frou-frou expenses, make sure it’s extra money first. Don’t spend necessary operating capital on indulgences.
Since I wrote this article, I’ve updated it a couple of times. Read here and here.