Case Study I: Our sales are up but our profits aren’t—what can we do?

The Tale of Two Companies

Overview: The first an upstart online retailer, generating strong gross margins that propelled rapid growth, the other an established services firm with strong sales growth, based locally and operating nationally. Industries apart they shared a common woe: lack of profitability hobbling continued growth and even viability.

Analysis: The symptom is easy to identify, but the cause and remedy can sometimes be a bitter pill to swallow for some businesses. This is one of the easier malaises to diagnose, as there are really only four principal causes:

• Insufficient top-line sales
• Excessive COGS eroding gross margins
• Disproportionate operating expenses, and the particularly unsavory
• Unviable business model

Both of these firms clearly were not having trouble generating sales. Also, neither was operating a fundamentally flawed business destined for failure. The first was generating healthy gross margins, so that solved the cause of their problem: high operating expenses.

The services company was a bit trickier because they operated in a space where gross margins typically aren’t relatively high, but the question was their GM sufficient or were their expenses also as the culprit? Of course their accounting books had to be a ball of yarn needing unraveling, but after some accounting cleanup and extensive historical analysis, it became clear that expenses were a modest issue. The core problem was poor and overly optimistic revenue forecasting combined with woefully inadequate related COGS projections.

Identifying the malady is half the battle. The other 90% is prescribing and administering a cure. The online retailer had a company culture established by the owners and managers that if a dime was to be earned tomorrow a dollar should be spent today. Very plainly, the owners and managers drained all the capital from the company, which was crippling cash flow and threatening business continuance.

The service provider had an executive management team eager to resolve their financial woes and embraced change initiatives to do so.

Result: The services company adopted more detailed and transparent sales forecasting tools all the managers reviewed, which required much more realistic and thorough COGS projections. Sales and sales support were held directly liable for managing to these budgets. Sales forecasting accuracy dramatically improved and within 90 days the gross margins and profitability problems were resolved.

Care to guess what happened to the online company? Within one month after increasing expense reporting by having owners and managers review each other’s expenses, costs radically declined and by month two they were profitable. If discipline had only been maintained. Within three months the owners convinced themselves the company was now strong and they missed their frequent perks, so they slowly stopped reviewing expenses and losses resumed as discretionary spending rose. Within months they had to look for outside equity investors to shore up their cash and capital positions.

These two cases serve to illustrate two opposite leadership approaches and their eventual impacts on business finances. Really this is like two patients diagnosed with heart disease requiring regimented exercise and meals. The one patient takes the diagnosis to heart, while the other has little inclination to discontinue his hamburger-happy ways.