Economic Concepts III

Shock-Test Your Business...Now!!!

 

My practice, Key Consulting, Inc. , is built on "turnarounds" of severely wounded companies.  Stressful but rewarding work.

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One of the most common questions I get is, "so how do these companies get to the point of a near bankruptcy?"

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There are really only a handful of reasons companies fail.  One of the most common is the completion of a major expansion right into the teeth of downturn.  The company simply cannot "right size" the business fast enough to avoid a crisis.

 

Can you expand your business in a substantial way without putting the entire operation at risk?  The answer is likely yes.  It just requires some intense analysis and the willingness to answer some very hard questions.

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In short, you need to take the time to prepare a financial plan/budget for your expected results AND a meltdown scenario.  Now when I say meltdown, I mean a severe recession like 2009 or the shutdown in 2020 due to the alleged pandemic.

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Experienced lenders (and economists) will often refer to that as a "shock-test" and you should prepare one.

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Let's take a look at this.  You should have a formal financial plan for your business covering this year and at least the next three.  So take the plan for next year, with the expansion incorporated into the numbers.  Now lop 35% off sales.  You will likely collapse into losses.  It is likely you will violate your loan covenants.  That is where the analysis can pay off.  Big time.

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Take 35% off sales.  Remove unneeded employees.  Cut operating expenses to the bone.  Reduce your own take.  Now what does this say about your company in a downturn?

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Consider what this will do to your EBITDA coverage ratio.  If you borrowed $3 million for the expansion, your annual debt service would exceed $622,444 per year.  Is the expansion manageable or are you going to take down the whole ship?

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Is it possible to alter the expansion into two phases to assure that in an economic storm you survive?  How is your working capital surplus?  What would your burn rate be on a monthly basis?  Might you require some form of equity infusion and do you have the ability to fund it?

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I admire guts.  Growth and expansion is critical for a business to succeed long-term.  There is one caveat.

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Never endanger the existence of the company itself.

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