Case Study: how a business owner ended up with an un-viable business and in debt
Business is always about growing pains and navigating challenges. One of the biggest challenges I come across daily in my consulting work, for small and large businesses, is the lack of clarity and understanding of the business model.
It seems so simple:
business owners have a great idea or opportunity
they get started and set up their business
they sometimes know the costs (I say sometimes because most have no budget or robust projection); and
they believe that if they just get some sales, they will make loads of money
What most businesses, old and new, fail to really focus on is their business model. In simple terms, this includes:
gross margin calculations (how much they make from selling their goods or services)
knowing their fixed overheads (the costs that need to be incurred regardless);
their break-even point; and
their net profit margin.
I will tell you a quick story about how one of my small business clients didn’t know her business model and ended up in significant debt because the business would never make a profit without significant changes.
The business operated on a 7% gross profit margin and the fixed overheads were roughly $70,000 (rent, software, accounting, insurance etc.). The business was a full time job for her and she managed to grow the business to roughly $250,000 within a year. The money was coming in each month and it seemed like the business was doing well – until the quarterly BASs and superannuation debts were due and suddenly there was not enough money and she had to go on payment plans to pay the quarterly BASs which kept compounding each quarter as things progressively got worse throughout the year. By the end of the first year, the business had made a loss and she had ATO debts in excess of $30,000, plus she had no cash.
She found it confusing to work out her actual profit margin because she included GST in her income estimate (i.e. overinflated the income by 10%) and didn’t factor in other outgoings like superannuation on wages.
She was forced to ask some difficult questions:
Should I continue the business despite making significant losses
Will the future income be enough to pay the old tax debts
Will I have enough cash to pay the bills and survive
I worked out that she would have to generate $1 million in sales turnover per annum just to break-even. That’s:
$70,000 fixed overheads / 7% gross profit margin = $1,000,000 sales
Getting to $1 million in sales was very difficult in her industry and would require significant investment in marketing and sales support. Essentially, the business model didn’t work and she would either have to increase the gross profit margin or decrease her overheads in order to make it viable.
This is all too common and sadly a part of business.
“9 out of 10 business fail and it’s usually because the business model is not viable and needs tweaking and/or business runs out of cash.”
Know your numbers upfront before you get into hot water! A simple business model analysis is critical so you know how much you need to sell just to survive, how small tweeks in your margins and overheads can impact the profit and how much cash you need.