Developing a Turnaround Plan

The holiday season is over. Those record orders and sales days have finally come to an end. You are feeling optimistic about the season ending but then—reality sets in! You now find your company very short on cash. What do you do? Where do you turn? How can your company continue to operate?

Welcome to the dilemmas of the mail order catalog business! Post-holiday rush is the time of year that many catalogers find they need to implement a turnaround plan to ease under-capitalization.

Under-capitalization is a common problem among small- to medium-sized catalog companies, especially in times of low activity when bottom-line losses are rampant. It can even plague larger businesses, such as J. Peterman & Co. A large percentage of mail order catalog companies simply do not have enough working capital to operate all year round. Considering the profitability of a typical consumer catalog company is between 5 percent and 6 percent before interest and taxes, one bad year can be devastating.

Without a strong personal financial statement, financing a catalog company can be very difficult. An entrepreneur’s personal financial situation can be used to guarantee any and all loans to the company. Financing is especially difficult to obtain because catalog companies have few “hard” or tangible assets to use as collateral, such as machines or equipment of any value. Of course, your company’s inventory is its single largest asset. But your company can’t buy the merchandise without cash. And, unfortunately, most lending institutions do not consider your most valuable asset, the house file, when making loans. At best, banks might extend a token amount of credit toward the list, but it would not begin to approach the true value of your company’s customer file.

From the banks’ perspective, a house file is a “soft” asset and is of very little value to them. Although it is critical to the continued operation of your business, it has little liquidation value if your company were to fail.

Since it is often difficult to secure financing for a catalog company, it is common for entrepreneurs to operate year after year on a shoe string budget. Although their market niche and concept may be innovative, entrepreneurs rarely have enough money up front to build their house file to a size that is self-supporting. Some businesspeople turn to friends, family, even venture capitalists for financing. Others never secure the proper funding.

Staying Out of Trouble

Under-capitalization is just one way catalogers get into financial fixes, which can further exacerbate the difficulties of getting necessary funding.

The most common mistake is trying to grow the company too fast. At first, it may seem profitable to add new pages of merchandise to a catalog, but it requires cash, since inventory must be purchased before the first sale can be made. Buying too much inventory early on can cause extreme cash problems. The decision to add merchandise to a company’s catalog should be made well ahead of time and should be executed based on a certain time-frame.

Over-circulation, or sending catalogs to too many prospect names, is another problem. Companies often find themselves short on cash when they over-circulate their catalogs. A house file can only support a certain level of prospecting depending on the economics of the company itself. Essentially, the higher the revenue per catalog mailed generated by the house file and the larger the house file, the higher the level of prospecting.

If the proper balance between mailings to the house file and mailings to prospects is lost, there could be a devastating impact on the bottom line. The decision to invest in prospecting requires careful planning. The proper financing should be in place before undertaking such a venture, since prospecting usually results in an intial incremental loss for the company. Trying to grow too fast can be very dangerous for your business. However, an investment in growing your catalog should always be part of a well-conceived strategy. Remember: it costs money to grow.

A lack of information and financial control can also lead to cash problems. Most entrepreneurs are marketing-oriented and/or merchandising-oriented and are less attuned to the accounting aspects of a business.

Successful catalogers usually have a competent financial or accounting person on staff. Entrepreneurs’ biggest mistake is waiting too long before they plan for cash flow shortages or recognize the need for an in-house accountant. I cannot stress enough the need for good internal financial controls. An in-house CPA, or an accountant with equivalent work experience, will know and understand your business much more than an outside accounting firm that conducts an annual audit and prepares your company’s tax return.

Entrepreneurs often overlook or put aside considerations of cash flow management in deference to sourcing their products and working on the catalog. In anticipation of potential cash flow problems, there are two general rules that should be followed:

Rule #1: Plan your funding needs in advance. It always takes longer than you expect to obtain the proper financing. If you are going to get turned down, it is better to know early on so you can develop an alternative plan.

Rule #2: Always ask for more money than you need! If your cash flow projections say you need $500,000, request $750,000 to $1 million. No matter how much money you think you may need, you will probably need more. Don’t try to get by on less.

Survival Strategies

As the spring and summer seasons approach, it is imperative that your company have a well-developed turnaround plan so that your business stays afloat during low-activity periods. Although the following strategies may be difficult to achieve for some entrepeneurs, they are nonetheless critical for managing adequate cash flow and for ensuring a successful future:

• Conserve cash. Cash is king. It is very important that you try and conserve your cash as much as possible.
You should build your reserves during the peak season when the cash is flowing in. Although you may be tempted to pay off vendors when business is good, it is much wiser to save your cash for those rainy days during the slow season. You should only pay what is absolutely necessary, i.e., payroll, utilities, taxes, bank interest, etc. Pay unsecured creditors only when you must.

• Reduce operating expenses. Cut expenses ... NOW! Cut right down to the bone.
After you have made initial cuts, cut some more. Don’t bother with the rubber bands and paper clips—small expenses are not the problem. Focus on big expenses, such as labor. Too often, business owners waste a great deal of time and energy attempting to cut office supplies and other insignificant budget line items, which have a minimal impact on the total budget.

• Outsource. Convert a high percentage of fixed expenses to variable expenses by outsourcing.
For example, outsource circulation planning, order taking, even fulfillment obligations. Outsourcing may or may not save money over the course of a year, but in the short-term, it will help eliminate a large portion of internal, fixed expenses. By outsourcing, these expenses will become variable and will allow you to pay only for those orders actually received.

• Devise a payment plan. If you are in need of a turnaround plan, it is probably because you are receiving many phone calls from irate vendors demanding payment.
It will help to categorize your accounts payable (AP) by using what I call a simple 80/20 rule. Most likely, 80 percent (or more) of your outstanding AP balance is owed to only 20 percent (or fewer) of your total vendors. Put another way, 20 percent of your total AP balance is owed to 80 percent of your vendors. These are the vendors that take up the majority of your time and cause the most headaches.

Sort your AP lists according to how much is owed. You’ll probably find that a large percentage of this group is owed less than a given amount, e.g., $1,000. Take care of these vendors first! That is, pay off all vendors who are owed, for example, $1,000 or less (or whatever amount makes sense to you). Although this may only take care of up to 20 percent of your AP, it will eliminate a large portion of your nuisance calls.

Put all remaining vendors, those owed more than $1,000, on a payment plan as follows:

1). Pay up to 20 percent of the outstanding balance per month until the total amount due has been paid.

2). Agree to pay all current purchases on C.O.D. until the old balance is paid off.

Then, ask to go back on open account.

Now, what do you do with the 20 percent group that is owed 80 percent of your total outstanding AP balance? Fortunately, this group is less likely to cause you significant problems. These creditors want your continued business because you are a high-volume account for them. They want to get paid and they don’t want to take a significant loss or write-off. Therefore, they are likely to work out reasonable and satisfactory payment terms with you. The more you owe, the more likely the vendor will help you.

• Communicate with creditors. Always communicate honestly with your unsecured creditors. More than likely, they will be understanding of your cash flow problems and will acknowledge that it will take some time for you to turn around your financial situation.
You also will want to communicate regularly with your top creditors—those that represent 20 percent of your total AP. For example, if you know that you will miss a scheduled payment, warn your creditor in advance. Similarly, if you will be making a late payment, let them know when they can expect it. It is important that the unsecured creditors gain trust in you. Don’t ever jeopardize your creditability with them. Remember, you need them and they need you.

Avoiding Financial Pitfalls

In addition to the above list of tips to effectively manage a turnaround plan, there is one important thing not to do. Do not reduce page count as a way to save money.

If you do, you will only begin an irreversible downward spiral for your business. Since you have already reduced circulation, you will need all the sales and cash flow you can generate. Maintaining, or increasing, page count can increase response and help create more revenue. You will generally lose more in cash flow than you will gain by eliminating pages.

For example, let’s assume that your total cost (including the cost of rented names) per catalog in the mail is $0.60. This is the amount you will save on every catalog you don’t mail.

Trimming your catalog size will not decrease your postage costs (if you are mailing at the piece rate) and will have minor effects on your printing cost for manufacturing. Although you may save slightly on the cost of paper, the total savings generated by reducing page count will be minimal. However, the impact on sales and cash flow could be substantial.

Following the Plan

Disciplining yourself to manage a turnaround plan is not easy. In addition, it can often feel counter-productive to running your business on a day-to-day basis. It will require turning your attention from merchandising and marketing to cash flow management. You also will spend more time than you want trying to hold vendors at bay.

But if you develop a strong turnaround plan in advance, you can forecast many of the problems you will encounter during non-peak seasons and thus ensure a smoother flow of business throughout the year. Always be honest and communicate regularly with your creditors. Anticipate cash-flow problems early and secure adequate funding well ahead of time. Reduce expenses and manage your cash at hand. These tips will go a long way in helping you to turn your business around!

Stephen R. Lett is president of Lett Direct Inc., a consumer and business-to-business catalog consulting company based in Carmel, IN. He is also on the faculty at Indiana University, where he teaches direct marketing. Lett can be reached at (317) 844-8228 or by e-mail at slett@lettdirect.com