Glenn Carniello is a Construction CPA based in Southern California. Glenn is a Partner with SingerLewak LLP, a CPA firm specializing in serving contractors. Topics include surety, accounting/reporting and tax matters, legal, succession planning, information technology, etc. If you wish to ensure delivery of new content as it is posted, please complete the subscription link below (to the right) and click on the confirmation link sent via email once received.
Tuesday, September 2, 2008
Planning for Bad Business Climates
The credit crisis, energy prices, the residential real estate market, consumer spending, food prices…all of these are contributing factors to our struggling economy. Certain sectors within the construction industry are feeling it more than others, however virtually all sectors go through cycles of outperformance and underperformance relative to their baselines. Many business advisors talk about preparing annual budgets, forecasts, plans (pick your favorite word choice) and talk about their importance in the success of your business. Many also agree that these plans are not static, they must be continuously adjusted based on current conditions. I agree with these assertions wholeheartedly. It is important to measure actual results against a plan in a timely fashion and make management decisions to ensure the organization reaches its financial objectives. There is another plan which is the focus of this article, the plan for “when business goes in the tank”.
The best business decisions are made when there is no time pressure and dispassionate, thoughtful and analytical thinking prevail. The problem many businesses face is that they often times make decisions that are reactive, emotional and in a rush. One such scenario is when business begins to suffer, normally defined by revenue declines. Take a look around the residential construction sector and you’ll see drastic declines in new housing starts, top line revenues and head counts in the field. We’re all well aware of it, whether you are a homeowner, looking to buy a home, or simply watch the business news or read the papers. The best of class businesses in this space reacted swiftly, had a plan in place and avoided the financial bloodbath others endured, many of which are no longer in business. There are many sectors under the umbrella of “construction contractor” and from my own observations it seems that commercial construction, although margins are not quite as high as perhaps a few years ago, is still chugging along. There is more competition, more contractors on the bid lists (we’ve heard of 30, 40 and more) but the work is still out there albeit with perhaps a few delays here and there. Contractors in the public works sector appear to be going strong at this time. Although it is clearly late for those in the residential sector to plan for the downturn they are currently facing, it is not too late for the other categories of contractors just discussed.
What does it mean for business to “go in the tank?” Different people will have different definitions. The fact is it is somewhat subjective and not very important. What is important is to create a plan for when business gets bad. You could use a 20% decline in revenues for Case A, 50% for Case B and perhaps an 80% decline for Case C. Some of those in the residential construction space saw declines in the latter range, so it is not unreasonable to create a plan for that scenario. Think of these plans as insurance…you have them but hope you never have to use them.
The plans should contain financial metrics, forecasted income statements and balance sheets, etc. with the revenue line in the income statement adjusted for each down scenario. Further, operation decisions should be contemplated and outlined in the plan. For example, if revenue decreases 20% how many of your field people would you let go? Are there any office personnel you would consider releasing? Which ones? What type of capital expenditures would you reduce or put a hold on? Would you sublease space? Would you consider moving into other types of projects? Is that really a good idea? What other types of general and administrative expenses would you cut? Could you re assess your insurance premiums based on sales and modify your insurance payments? You get the picture…ask all sorts of “What if?” questions about your business and document your best answers. This exercise, although not having a “due date”, is best done in the next month or two at the most while your business is not declining by 20%, 50% or more. You can be more effective when you are not in the midst of declining business, concerned management and employees, mounting expenses and accounts receivable not being collected in a timely fashion, etc.
Businesses are generally good about filing their corporate tax returns (or extension) by March 15th, owners meet the April 15th filing deadline, etc. When it comes to estate planning, succession planning and planning for poor business conditions most companies fail to make the grade because these are not due, no one is pounding the table asking for these plans by a certain date with failure to comply meaning negative consequences. In addition to death and taxes, it is certain that business at some point will significantly deteriorate. It is important to be prepared for the day when your contract revenues start declining and backlogs start delaying, cancelling and dwindling. Having a plan in place can help mitigate losses and even mean the continuation of your business will little negative financial impact. When the time comes, will you be ready with your plan already prepared and ready to execute?