Uncovering the Root Causes of Financial Struggles

Financial problems often run deeper than they appear. To truly fix them, it’s essential to understand the entire picture—how your business operates in its specific industry, and what unique challenges you face. Every industry has its own financial pressures, and getting to the root of these issues is key to making lasting improvements.

In this article, I’ll walk you through a real-world experience that highlights these points, followed by a deep dive into diagnosing financial problems and taking action. By the end, you’ll have a clear path to addressing the root causes and driving your company toward financial stability.

The Trading Company: A Case Study in Root Cause Analysis

One of my most memorable experiences was working with a trading company that had over 250 resellers and partnerships with several international brands. The head of sales, Gregory, had 15 years of experience, but the company was facing serious liquidity issues despite seeming operational success. Here's a snapshot of the setup:

• 180 days credit from vendors on LC terms
• 60 days credit to debtors
• Post-dated cheques collected within 30 days from resellers
• 90 days to liquidate inventory
• Profit margins of 8-10%

We had to meet quarterly sales targets set by our international vendors, requiring us to place orders worth at least $250,000 every month. However, with only a $1.2 million bank facility limit, the company soon faced significant liquidity issues. Resellers couldn’t move inventory fast enough, sales began to drop, and imports continued at the same scale. On top of this, currency devaluation led to substantial debt, making survival an extreme challenge.

The situation demanded immediate action, and the first step was understanding the root causes of our financial struggles.

Diagnosing the Root Causes

To explain the issues to Gregory and the sales team, we needed to break down the financial ecosystem in which the company operated. This included analyzing key drivers like the product, clients, vendors, and the team's role in the company's success.

1. The Product

Understanding the product's role in a trading business is crucial. A thorough evaluation of product features and market analysis can answer critical questions:

• Selling Price: What’s the market price, and how can we introduce competitive pricing?
• Profit Margin: What are the direct costs, and how can we improve margins?
• Inventory Movement: What’s the average number of items sold per month, and where is the demand strongest?
• Scalability: How can we expand our market base?

These insights help determine the optimal inventory levels and identify which products to prioritize.

2. The Client

In a trading organization, the quality of the retailer base is more important than quantity. A few key considerations include:

• Credibility: Does the client have a solid reputation in the market?
• Creditworthiness: How much credit can be safely extended based on the client's reliability?
• Competition: What other brands or products is the client accustomed to selling?
• Security: Are there adequate security protocols, such as insurance, in place?

Successful business in this industry relies heavily on trust. If a post-dated cheque isn’t honored, it becomes a significant issue for the company.

3. The Vendor

When dealing with international trade, negotiating favorable terms with vendors is essential. Assessing products and choosing the ones that align best with your company’s needs can make a significant impact on profitability.

4. The Team

Success depends on a unified effort from both the sales team and senior management. Everyone needs to work together, prioritizing the company's success over individual interests. The alignment of goals is critical to resolving financial challenges.

Review and Action

In traditional businesses, the finance team’s role might be limited to bookkeeping. However, in a dynamic organization, every department needs to engage with financial data and make decisions accordingly. Here's what you should focus on:

Income Statement/Profit and Loss Statement

Start by reviewing high-level data to ensure it matches your perception of the business. Key data points include:

• Monthly Revenue
• COGS (direct expenses)
• Gross and Net Profit
• EBITDA
• Finance Costs
• Bad Debts

These insights allow you to perform a quick health check on your business. Dive deeper into product-specific sales, profitability, and bad debt analysis to understand how each product performs and what adjustments are needed.

Balance Sheet

Monitoring key data points in the balance sheet is crucial, particularly around working capital. Focus on:

• Debtors
• Creditors
• Inventory
• Short-term Loans

For instance, high debtor balances mean clients aren’t paying on time. This can have a ripple effect on cash flow. If necessary, halt sales to clients who are behind on payments and ensure adequate security (e.g., bank guarantees or post-dated cheques) is in place.

In a trading business, balancing inventory levels is also a key challenge. Here’s a quick breakdown of how to approach inventory management:

• Product A: High turnover suggests strong demand.
• Product B: Moderate movement may indicate potential bottlenecks.
• Product C: Slow movement is a red flag for potential obsolescence, calling for immediate action like discounts or promotions.

Regularly reviewing these areas is essential for avoiding long-term financial problems. The earlier you identify and act on issues, the better your chances of turning the situation around.

Turning the Ship Around

At the trading company, we faced tremendous challenges. To survive, we implemented several strategies:

• Scaled down vendor orders until existing stocks were cleared
• Offered discounts and rebates to clear inventory
• Factored post-dated cheques to improve cash flow, despite the high cost
• Converted letter of credit liabilities into import loans with extended credit periods
• Adjusted pricing to account for currency devaluation

These measures provided breathing space, but the losses were significant, and recovery was slow. Ideally, we should have acted sooner to manage the situation better.

Conclusion

Understanding the root causes of financial problems is the first step in transforming your company's financial health. By analyzing your business ecosystem, identifying key drivers, and taking decisive action, you can turn challenges into opportunities for long-term growth and profitability.