Avoid growing into bankruptcy by getting choosier about the clients you take on and retain
In business, growth is a great thing. And new clients, customers, and revenue streams are always welcome additions to any expanding company, right?
Not so fast.
If you are running a business – especially a rapidly growing one – it’s essential to recognize a hard truth: Not all customers are good for your business, and not all opportunities yield the same return. Successful organizations have to discriminate when it comes to their bottom line. This means only working with the most profitable customers or product lines, which often represent as little as 20% of a total portfolio.
But what about the other 80% of customers, products, and services? The hard truth is many of them are albatrosses to your business’s growth. We’ve worked with clients who we’ve advised to cut almost 50% of their client base. The results were stunning: revenue dropped by 60% but profits doubled. This is generally known as the 80/20 principle and, if applied properly, it can help streamline your business to achieve a whole new level of profitability.
Firing your “best” clients: The 80/20 rule and small business cash flow
When looking to grow their businesses, a lot of owners get excited by any form of growth and revenue – neglecting cash flow, which is the key to stability and successful growth. If you let them, those “albatrosses,” the 80% of customers that I just mentioned, eat up your cash while providing relatively little net profit in return. It pays to fire many of your less-profitable customers.
At first, letting go of some big clients could seem like shooting yourself in the foot. You (or one of your employees) might have worked very hard to close some of these deals. But if you take a closer look at the numbers and the customers in question are simply not providing a big enough margin, give yourself the permission to just say NO. Remember, you’re not running a charity – and ultimately it’s cash flow and profit that counts, not the size and revenue of an account.
Is that customer “worth it”?
To assess whether a client/product/service makes the cut, here are a few of the factors you should look at:
• Revenue minus expenses = profit. The first assessment is, of course, the most basic one. A large account that brings in big dollars is pointless if easily quantifiable expenses eat up the lion’s share of that revenue.
Calculate the hard expenses involved in servicing a customer or product line, including material, overhead, and other tangible expenses, then compare the profit margin to other accounts.
Problem accounts below a certain threshold should be cut, especially if they max out infrastructure and prevent you from quickly bringing on new, more profitable accounts.
• Don’t forget about factoring in soft or ambiguous expenses. Does a certain customer ask for numerous revisions or customer service calls? Do they demand exacting processes or unique specifications that are far above and beyond those required by your other clients? Anything that eats up the time your employees spend on the account should factor into the equation, regardless of whether these workers are paid on an hourly or salaried basis.
The time of salaried workers, in particular, can become a hidden expense since they are paid the same regardless of their effort. What many businesses fail to account for is the opportunity cost of spending time servicing a difficult customer when those hours may be far more efficiently spent on several less-demanding clients. Also add in distribution costs, borrowing costs if they pay late, and any “freebies” you add in to keep them happy.
• Take a close look at payment structure and cash flow. Customers or product lines which are chronic late payers, or those which require a lengthy, upfront investment before you can bill them, may, on paper, look like any other profitable customer – but they can be causing headaches when it comes to your cash flow. They might seem like they yield the same profit as other customers or product lines – but given the fact that time is money, this is an illusion. In addition, they may threaten your ideal cash flow, which is the lifeblood of a stable business.
If you’re on the fence about firing a client – perhaps one that’s mildly profitable but requires a lot of time and infrastructure investment (or one that provides a huge name-brand boost to your business) – consider re-negotiating the deal in your favor. Raise your rates, reduce the scope of your services, or find some other way to squeeze more out of the deal. And if that doesn’t work out, I’ll say it again: just say NO.
80/20 cash flow: Making sure your clients pay on time
When it comes to deciding which clients to ditch, it’s important to remember that cash flow isn’t just about theoretical profitability or receivables; it’s about how quickly cash is actually flowing into the bank. If your contract stipulates that your client won’t pay until 120 days after you’ve rendered services (or if it stipulates 30 days and they just wait for 120), that waiting period could be causing your business a serious cash flow issue.
While it may be time to say goodbye to clients that habitually pay late, it’s definitely time to renegotiate with clients that have a long waiting period built into their contract.
For seasonal businesses, keeping a tighter grip on your cash flow may mean charging customers in advance during specific parts of the year, plus avoiding hiring permanent employees during the high season who could become a financial burden during slower months.
Successful businesses discriminate
When it comes to new or existing lines of business, it’s important to be picky. Take a detailed look at your existing customers, products, or services and get rid of the ones that are holding you back from growing your business, or focusing on your more profitable revenue streams.
When evaluating a new opportunity, don’t be wowed by the dollar signs: Project the amount of time, resources, and infrastructure that will actually go into receiving that check.
Not all opportunities are created equal.
Profit Point Consulting’s mission is to accelerate the growth of small and medium-sized companies through sound, strategic advice, and proactive financial management. If you need a trusted advisor to help develop and execute your vision, call us at (973) 659-1430 or fill out our contact form.