When I approach a business with financial challenges, and most have financial challenges, I use a triage approach I call “The Financial Holy Trinity.” Really, it is this approach that informs almost everything I do in a business.
My belief is that there short, medium and long-term financial concerns in a business. The Financial Holy Trinity is:
Short-term Cash
Medium-term Profitability
Long-term Value Creation
Short-term
In the short-term, cash is the biggest concern. I define short-term as immediate to the next few months. Even if a company is profitable, that won’t matter if they cannot generate cash. Lots of accounts receivable and inventory will not help the organization meet their payroll obligations. Cash is king and always will be. Cash is best generated through profitable operations. But sometimes that isn’t enough. Borrowing (debt), raising capital (equity) or liquidation of assets, even at a book loss, are other ways to raise cash. If a company is profitable but cannot raise cash, they will be unable to meet their obligations. This is why profitable businesses sometimes go bankrupt.
Medium-term
In the medium-term, I believe profitability is the most important concern for a business. In fact, if there were any financial panacea for business, profit would be it. As noted above, profitability isn’t enough, particularly in the short-term. But with profitable operations, cash flow is really just a timing challenge. And that timing challenge can usually be overcome by borrowing against future accounts receivable collections or inventory.
Profitability is often measured at a couple of levels. Gross margin is the first and it is important. It is the measure of your value proposition. But the profitability we’re really talking about here is the Net Income or Net Margin; the bottom line.
Long-term
In the long-term what we strive for is increasing the value of the business. These three pieces of the Holy Trinity aren’t independent, of course. In fact, the biggest driver of company value is profitability. Usually businesses are valued at a multiple of earnings or of EBITDA (earnings before interest, taxes, depreciation and amortization). But other factors come into play in the creation of long-term value. Factors such as competitive position, unique selling proposition, management quality, good processes and systems, up-to-date technology and barriers to entry into the industry. And many more. But these factors mean little if the company isn’t profitable.
Triage
When a company is in a financial plight, my triage approach is to focus first on cash, for the reasons mentioned above. Sometimes the effort to save a company is a desperate struggle that resembles a street fight. It isn’t for the faint of heart or those who lack imagination.
Once the immediate cash concerns have been handled it is time to look at profitability issues. These include increasing sales, reducing costs of sales and reducing overhead expenses. There is no end to the possibilities here and one needs to start on those things that provide the biggest financial impact for the time and energy spent. The typical approach is to scrutinize cell phone bills and office supplies. Those seem to the favorite expenses everybody loves to hate. But typically 80 percent of business costs are people related. Difficult as it is, taking a hard look at employees is where there is the most potential for cost savings.
When short-term cash concerns and profitability issues have been taken care of management has the ability to think about increasing the long-term value of the company. What a luxury! We can all aspire to this.
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