For small business owners and big business alike, COVID caused a huge operational wake-up call that will be evident for the next decades and beyond. Business as we have known it has changed forever and it is for the better. Last month’s blog covered the New Workforce Paradigm as a result of COVID’s wrath. This month’s blog is focused on COVID’s role in heightening poor management and operational practices, specifically around profitability and spending.
Our Economic Vitality Study, conducted prior to COVID, was already documenting key factors associated with business failures and what it takes in sustaining year-over-year business growth. The importance of building a high Intelligence Quotient (IQ), Emotional Quotient (EQ), Velocity Quotient (VQ) and Profitability Quotient (PQ) was being validated. Our Economic Vitality® model, based on the study, continued to be reinforced amidst COVID in heightening awareness of what should have been understood in best practices, business acumen, and economic excellence.
According to Forbes, 55 percent of businesses that closed during COVID never reopened. According to a 2021 Wall Street Journal article, 200,000 more business closures than normal, which were attributed to COVID’s impact due to the forced shut down. The reality is that businesses didn’t go out of business because of COVID, while they may claim this to be the case. They went out of business because of internal issues being ignored before COVID in how the business was being operated and managed.
COVID didn’t cause business failures. COVID ignited business opportunity. In 2020, there was a 24 percent increase in new business EIN applications according to the U.S. Census Bureau, which means new business ventures were being inspired by COVID challenges. The National Bureau of Economic Research has confirmed unprecedented new business venture activity that has remained strong since the pandemic. Existing businesses also needed to embrace the opportunity that existed from a global unprecedented challenge. This required strategic, agile thinking, and capital investment. And this is where the Profitability Quotient comes in.
Bottom Line Rule #1
It’s not about sales; it’s about profits.
1. Allocating Profits Four Ways: A high Profitability Quotient entails allocating profits on an ongoing basis in four ways. Most businesses, even those who have survived COVID, fail at this miserably.
High Profitability Quotient
Profits in Reserve
Profits for Capacity Building
Profits for Sharing
Profits for Building Value
What if you have high net profit? This is where business leaders and owners get it wrong. High profits do not equate to a high Profitability Quotient unless those profits are being allocated in all four of the ways cited above. The percentage of allocation depends on your goals and growth plan, however, each area should be getting attention on an ongoing basis.
What if you don’t have any profits? I get this question a lot, especially from start-up businesses. Shift to how you approach your spending plan and how you are investing for the future success of your company. If businesses started with this four-allocation approach, there would not be business failures at the rate that occurred even before COVID. We have the audacity to believe that there is such a thing as 100% business success. That is what drives our research and innovation around entrepreneurial best practices.
Bottom Line Rule #6
Allocate spending three ways at all times.
What if you have been in business for a while, and don’t have profits to spend? You need to be looking at this approach as a combination of establishing a security safety net and more effectively leveraging your current spending strategy. The security safety net aspect is around profits in reserve. The strategy is around sharing, capacity building, and value building in where funds are being spent. Whether you are using a working capital loan, loaning money to your business, or deciding how to adjust what you have already budgeted, think in terms of how you are allocating your spending in sharing, capacity building and value building.
Another area you should be exploring is why you aren’t more profitable? Take a look at your customer base and segment according to profitability. Then adjust your focus on attracting and retaining the more profitable sectors of customers purchasing your most profitable offerings. When our firm began working with a paper rolls manufacturing client, we uncovered that their multimillion-dollar contract won as the lowest bid was actually losing the company money, even though the sales numbers were impressive. Know what is profitable!
2. Profits in Reserve: According to a white paper on the topic of corporate saving trends related to COVID’s impact, the authors concluded that there will be an increased focus on corporate savings compared to pre-COVID. This doesn’t surprise me at all, and should have been a focus of business long before COVID.
Too many businesses live client check to client check or month-to-month on receivables.
Take into consideration what JP Morgan Chase research confirmed about business cash reserve practices and it reinforces my point. While for most small business, cash reserves are a critical tool for meeting liquidity needs, before 2020, the median small business held 27 days buffer in cash in reserve. Yes that’s right. Less than one month’s worth of operating expenses. The research also confirmed that 25 percent held fewer than 13 days buffer, and another 25 percent held 62 days in reserve.
No wonder businesses were dropping like swatted flies within months after COVID hit! Stimulus hadn’t been put into place yet. The conclusion of the white paper was that interventions need to support and educate businesses on what a financially healthy bottom line in operating expenditures looks like.
In our research interviewing companies validating the Economic Vitality model principles, businesses deemed to be in the strongest position for economic vitality were reserving anywhere from 12 to 18 months of operating expenses in cash. With COVID exceeding 18 months in its impact, these businesses were in a much more agile position than a majority of businesses.
Your goal should be to allocate a higher portion to reserves until you reach a 12-month minimum safety net, and then reduce the percentage contribution to building reserves as it nears your desired cash on hand.
Bottom Line Rule #22
A minimum safety net of 12 months
operating expenses in reserve.
3. Profits for Capacity Building: Too many businesses operate in a reactive mode towards growth versus a proactive mode. This results in scrambling to meet demand instead of welcoming demand with open arms and a ramping up attitude. When it comes to goal setting, oftentimes business owners only focus on increasing sales numbers, not taking into consideration the capacity necessary to reach the sales growth. Capacity planning should be a part of every business strategy. Setting goals around these areas of capacity will keep your business one step ahead of your demand.
Businesses were most unprepared from a capacity standpoint during COVID related to technology. In my book, 50 Marketing Secrets of Growth Companies in Down Economic Times, Secret #9 shared the importance of understanding the difference between an expense and an investment. The five areas that high-growth companies would not cut, even during economically down times, were in the areas of image/marketing, staffing, training, facility, and technology. They understood that an ongoing focus on building capacity was essential. This was proven during the Great Recession and again during COVID.
Momentum-Building Decision #15
It’s not just sales; it’s having the capacity to execute.
According to a McKinsey Global Survey, COVID sped up the adoption of digital technology by several years, representing a tipping point in technology transformation. While it was clear that technology was among the top investments for capacity-building during COVID, it should have been a focus long before the pandemic. A majority of businesses were forced into it, adopting technology and not prepared at all.
Areas of technology that are now considered essential in business are online offerings, online access, customer user experience, collaborative technology, automation, and machine learning.
4. Profits for Sharing: The first concept that comes to mind for most business owners when exploring profits for sharing is profit sharing. That is only a small part of what allocating profits for sharing is about. This is also where the accounting side of the business gets in a frenzy in how profits being shared are being defined. Sharing your profits is about showing how much you care — about your team members, your customers, your industry, your marketplace and the communities where your employees live. Sharing profits can actually drive more profits.
Paying a higher salary or hourly wage is an example of sharing, even though it is viewed as a payroll expense. COVID certainly escalated the need to pay people more, and it was about time. Minimum wage was in dire need of being corrected to cost of living standards of today. What someone is paid has an impact on their mentality and them feeling valued and appreciated for the work being performed.
Momentum-Building Decision #9
Sharing is caring. Caring is a game-changer.
Benefits are also an example of sharing, which I went into great detail in my last blog. Sharing also entails giving back and making a difference, which is also becoming a hot aspect of consideration for younger generation employees in deciding to work for a company. How are you giving back, supporting a cause, and leveraging some of your profits for societal good?
Your reputation in business is now based on how you are leveraging your success to advance, help, or improve on many fronts.
5. Profits for Value Building: Too many business owners are not thinking about the value of their businesses. While you may be thinking about the value you bring to your customer segments, you need to be thinking about both.
Do you have anything of worth? Do you have a business another company would want to acquire, or another person would want to buy? Do you have capital assets? Do you have proprietary holdings, offerings, processes, or approaches?
Do you have systems, processes, and protocols to replicate success in a streamlined efficient manner? Do you have reoccurring cash flow through residual offerings, service agreements, or contracts? Is your business sustainable without you being in it? Do you have positive cash flow and profitability? Are you paying attention and tracking your earnings before interest, taxes, depreciation, and amortization (EBITA)
The commoditization of a business is the death of a business. Offering sustainable competitive value takes building value that elevates your business, to a level of preference, profitability, and distinction. Building value means you have built a business the industry cannot imagine being without, because of your innovation and leadership. It means your business is one, employees cannot imagine working anywhere else and suppliers and contractors are true partners impassioned to support your business vision and mission. It means your business is one where the marketplaces you serve and communities you are located cannot imagine being without you due to your corporate giving, engagement, and charitable impact.
Bottom Line Rule #7
(IQ + EQ + VQ) x PQ = Economic Vitality®
Most important to re-emphasize is that having a high profit margin does not equate to having a high Profitability Quotient. The only way to accomplish a high Profitability Quotient for exponential growth, security, and agility is through ongoing allocation of profits in reserve and spending in the areas of sharing, building capacity and building value.
While lack of reserve is what put many businesses out of business with no safety net, businesses that had the savvy to allocate spending towards capacity building, value building, sharing, while also having cash in reserve, were in a more agile position to pivot.
Yours in economic vitality,
Sherre' L. DeMao, CGS
P.S. As an added bonus on profitability, read Secret #5 from my book the 50 Marketing Secrets of Growth Companies in Down Economic Times.
P.S.S. Want to know all of my Bottom-Line Rules and Momentum-Building Decision Insights? Then keep reading as new ones will be revealed each month in BizGrowth 5.0!
Sherré DeMao, CGS, is author of Dream Wide Awake, 50 Secrets of Growth Companies in Down Economic Times, and Me, Myself & Inc. – a Synergized World, An Energized Business, Living Your Ultimate Life, and the CEO/founder of BizGrowth Inc. an award-winning growth strategy, training, and intellectual property development firm based in Denver, NC. Serving clients across the United States her firm and her blog seek to help entrepreneurs build businesses with economic value, worth and preference in their industries and marketplaces.