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Small business growing pains.

Small Business Growing Pains

I recently met a young heating and air conditioning (HVAC) contractor who had just filed a Chapter 11 bankruptcy and several of his creditors. The young businessman had many of the characteristics necessary for success in business: above average intelligence, neat personal appearance, good communication skills and a sincere personality. He knew his trade; he was ambitious and willing to work hard. His idea was simple. He would subcontract for general contractors, handling the HVAC aspects of their contracts.

His business grew rapidly. In the first 12 months he had sales of $1 million. However, he had not set up any real accounting or job cost system. Although he was slow to pay his bills, no one complained too loudly. Most suppliers are permissive with new companies. They let them borrow a little working capital by extending terms. Our friend thought he was doing well.

By the end of the second year, sales had jumped to $1.5 million. Meantime, an accountant had been hired. It was decided that a survey analysis and audit of the entire operation was needed to determine where the business stood and where it was headed.

The results showed that although the business was operating profitably, in effect, venture capital was being supplied by new wholesalers who were happy to sell to the new, fast-growing business. It was suggested that it would be wise to slow the business' growth to allow for profits to catch up with cash flow. Unfortunately, the advice was not heeded.

In the third year, the business grew more slowly. Sales reached only $1.7 million. With the slower growth rate, problems began to surface. No one was being paid on time, and credit was being cut off.

Some weeks it was almost impossible to come up with enough cash to meet the payroll. And it got worse. It was all he could do to keep the telephones connected and the lights turned on in the shop. The business was at the end of a three-year downhill slide into bankruptcy.

From the start, this business was managed for failure. The young contractor didn't understand the difference between cash flow and profit, that profit is less important than cash flow and that too few or too many sales can kill a company. Statistics clearly show that many companies, both large and small, have gone broke while making a profit.

Case history No. 2 involves a company that operates more efficiently today because it nearly went under. Sometimes, only a crisis can make a headstrong owner accept the fact that his business has been badly managed and that he must learn to heed the professional advice of others if the company is to survive.

The president of this closely-held company is a clever designer with 50 registered patents, but having a precise accounting system to run the business by the numbers was alien to him. He considered accountants and all such "figure-men" as "just more overhead." No outside accountant ever audited the books, and the company lost thousands of dollars over the years through poor purchasing practices and inadequate cost accounting procedures.

Professional accountants and business management consultants see it all the time -- management by ignorance. An owner doesn't realize his business is in trouble until it is too late. Many companies go under, and the owners don't even know what their problems are. All they know is they end up with no money and can't pay their bills.

Seat-of-the-pants operators fail to monitor all aspects of their businesses. They tend to think everything is fine if sales are increasing and there is money in the bank. Typically, they consider financial statements a necessary evil to get a bank loan. They don't realize that their actions are reflected in the financial statements. They don't pay much attention to the information accountants give them.

Profit margins are critical, and so is cash flow. But if you don't have someone monitoring them, you are asking for instant death. Once the break-even point is determined, a break-even analysis can be done by the owner as soon as monthly sales are known.

A federal bankruptcy district judge made the observation that at least 3/4 of the nation's bankruptcies could be avoided if businesses kept proper records.

Louis A. Orlando is a certified business/management consultant and a licensed public accountant. He holds an MBA in business administration, accounting and finance.
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Title Annotation:Debits & Credit; accounting for small business
Author:Orlando, Louis A.
Publication:The National Public Accountant
Article Type:column
Date:Feb 1, 1991
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