As we head into the second half of a very tumultuous 2020, your professional service firm may be asking, “Where do we go from here?” Hopefully you have been able to battle through the unexpected and sudden impact COVID-19 has had on nearly all businesses and their clients.
In the back of your mind you may be thinking, why bother planning for your business when unforeseen circumstances continue to undermine your planning? Will it really make a difference? As entrepreneurs and advisers to entrepreneurs, we know that running and owning a business is never easy, but looking ahead is always necessary. Below are a few areas on which we suggest you focus your energies.
As Albert Einstein said, “In the midst of every crisis lies an opportunity.” Now is a critical time to focus on key real-time, short-term metrics that drive profitability and cash flow. At the same time, it’s important to keep your strategic antenna up for longer-term opportunities that will allow your firm to thrive as we come out of this recovery.
Internally, Cohen & Company has been focusing on “sprints” with a lens driven, initially, by evaluating daily results but then turning our focus on the weeks and months ahead in two week increments. Similarly, many of you have taken advantage of our Cash Management Model, an Excel based cash flow model to analyze your company over the next 13 weeks. If you have not used this or a similar tool to keep yourself laser focused on your cash flow, now is the time to get started. Many businesses have also used a Power BI liquidity dashboard to determine where they stand, or attempted to focus on their individual Key Performance Indicators — hopefully not still based on pre-pandemic budgets and goals.
A cash model will become even more critical as many complete the utilization period of funding provided by the U.S. Small Business Administration’s (SBA) Paycheck Protection Program (PPP) loan program. Although this program has been extremely beneficial to many businesses, don’t let it mask more significant issues in your business — which could lead to potentially unsustainable cost decisions in an effort to maximize the loan and forgiveness opportunities. For example, in a short-sighted decision, some PPP recipients may not focus on cash collections since they have the loan to use as cash flow. A loan recipient might not focus enough on employee productivity, or might keep unproductive or excess employees simply to meet the forgiveness standards.
But you may be asking, with all the numbers at your disposal, where should we focus our efforts to maximize our profitability? Based on information as provided by PSMJ Resources, Inc., which focuses on the challenges of architectural and engineering firms. Their research indicates the focus should be on the following three combined factors:
Using these three factors in the following equation can help you determine your profitability:
Profitability = 1 - NLOH
DLM x UR
The goal is for the combination of these three factors to exceed profitability of 20% as applied to the entire firm, a division or an office. This is obviously not easy in this environment, as in many cases, the decline in revenue exceeds the decline in labor and overhead costs. The key then is to manage towards that goal and not focus on just one of the three factors, which often results in unintended consequences.
This formula results in a direct correlation to profitability for that industry and, although the factors may need modified slightly for different service firm business sectors, it can be a very good tool to guide your planning and accountability especially in a declining revenue environment.
One of the keys you will need to determine in a declining revenue environment is how to reduce the correct “break-even costs” and make sure you are making a return on the investment of those dollars spent. PSMJ again focuses on, and tracks in their annual surveys, a factor they call ROO (Return on Overhead).
ROO = Profit (defined as earnings before bonuses and taxes)
Overhead
The key is to reduce costs that really matter. Consider:
In all of this, NO SACRED COWS!
As noted before, many businesses obtained forgivable PPP loans through the SBA in accordance with CARES Act, but as a result may be masking bigger cash flow issues.
Focus on the following:
For times like these, the key is a short-term focus on data driven key indicators of cash flow and success with an eye towards longer-term strategic client relationships and opportunities. Keep your foot on the gas and use your internal team and external advisers to keep your business on the path to be leaner and meaner in the days ahead.
Contact Tom Bechtel at tbechtel@cohencpa.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.