Case of the Coming Crash and Burn

admin April 22, 2019 Comments Off on Case of the Coming Crash and Burn

By Tom Crouser

Being the creative and driving force behind a rapidly growing company isn’t all that’s required for a successful transition. At least that’s what David Summers is going to find out. His Premier Printing, a rapidly growing $2 million Portland, Oregon printing company has had sales increases averaging 28% per year for the last three years. Yet one great big obstacle lies in his path – transition of the business. Herman and Helen Summers, each 68, owns Premier Printing. David, 35, has effectively operated the company for the last ten years. Now, the interests of the three parties are beginning to collide and it’s about to get interesting.

This case is based upon a combination of consulting assignments of Crouser & Associates, Inc. and CPrint International. Names, cities and other facts have been changed to illustrate and simplify the case presented. As such, any resulting similarity to any one shop or person is coincidental.

When we ran across David in late 1999, he had some very definite concerns. Earnings were poor. Income before Owners Compensation was about 9% or less than half what we would target. He also said that cash was always a concern, and at times it was very critical. And, oh, yes. It’s about time the parents transitioned the business to David.

Herman Summers left Merriam, Wisconsin to see the world with the U.S. Navy in 1957. He was impressed most with Portland, Oregon as a perfect place to live with his bride, Helen. Once there, Herman and Helen started a sideline rubber stamp business to supplement Herman’s job as a shoe salesman. The little stamp business grew to a full scale, full time retail store for both in 1965. The little shop eventually included greeting cards, newspapers, convenience items, office supplies and gifts.

David, their son, grew up on the store. Like many of his age, he became fascinated early with computers – and it continued to be a life long interest. After high school and some college, he tried various attempts at employment and ultimately came back to the family business, although he mainly preferred working on the computer until the wee hours of the morning.

In the back of his parent’s store, David pounded out some crude type on his newly acquired Radio Shack computer in the early 1980’s. He quickly advanced to more sophistical equipment and by 1987, David had stepped up from incidental retail-based typesetting work to furnishing commercial type for printers.

They all were amazed as the sideline took the company in a new direction. By 1992, they all saw the potential in printing and decided to make additional changes – they leased a new facility, closed the retail store and added presses to the extensive pre-press equipment they had previously bought.

Not that success was easy or quick. Helen reported that there were times when expenses were not being covered and they narrowly avoided going bankrupt. She and Herman are now both looking for a return from this business so they can spend more time with grandchildren.

In September of this year, they purchased a $200,000 press to upgrade their printing facilities. Somewhere in that time, cash was getting tight, so they called for help.

Current Situation

Sales are booming. There is a projected 1999 increase of 30% on top of a 41% increase in 1998. The three-year sales average for this company is some 28% – a tremendous growth rate in anyone’s book. This company that did some $1 million in sales in 1995 should finish 1999 with $2 million in sales.

Why the growth? Wasn’t because of a sales effort. The real cause of the growth has been that the company’s customers have grown – mainly software firms entrenched in Oregon’s software valley. Many of these firms are populated with David’s nerdy friends from high school and college. Friends who have thrown printing his way.

Financials were found to be in good shape. Based on these good financials, the current ratio of 0.7 showed a lack of working capital – target is a 2:1. Days’ cash on hand was 2 – target is 30. This is a very common finding, especially among rapidly growing companies, but dangerous,
nonetheless. Businesses go out of business when they run out of working capital (cash). Usually we see this happening at the 0.4:1 current ratio range.

The asset turnover (sales / assets) indicates a 2.2 or $2.20 of annual sales for every $1 of assets. This is very low in our experience and indicates not enough sales for the equipment (assets) deployed. Usually $4-$5 of sales per $1 of assets shows management is getting the bang for the bucks invested – assuming all the assets are listed on the balance sheet and not financed through operating leases that may distort this

The box score or operational score finds direct materials at 23%, wages at 26% and overhead at 42% leaving some 9%. This indicates that pricing and wages paid to others are generally in line – but that a very high overhead is present usually due to high rent, lots of equipment, or lots of advertising. In this case it is equipment.

However, the projection also showed that David’s withdraw is about 5% and the cash flow is projected to a positive 6% or $110,000 after accounting for payments and offsetting deprecation. That means the company’s weak financial position isn’t generally caused by lack of earnings. Its management takes the cash out. Generally, David is paid about
$100,000 and then Herman and Helen take out more at the end of the year. That’s where the working capital goes.

Operations were unusual to say the least. Herman and Helen no longer have daily tasks in the business and it almost appears that David doesn’t either. David’s contribution is on a technical level he says. When we asked everyone else “What does David do all day?” they replied that he was there only two or three days a week. He usually works on weekends when no one is here. He is the visionary, the technical expert. They also noted he sometimes forgets jobs he has promised although he was good about getting the workers any equipment they needed.

David’s profile showed him as a developer. That’s a strong individual who continually seeks new horizons. He’s very self-reliant and prefers to find his own solutions. He’s free of constraining influences – such as budgets and plans or organizational charts. He often can come up with imaginative and innovative solutions. On the other hand, he tends to be a loner when things need to be done and somewhat belligerent if forced to
work within a group. He can also be sharply critical when his standards aren’t met.

Well, if David’s not going to run things, who is? Appears he has appointed several “department heads” without anyone being in charge overall. Reminds me of leaving kids at home with the instruction for each to look after the other. Chaos is the usual result.

“If everyone does their job, everything will go smoothly.” David asserts. Problem is, everyone doesn’t always do his or her job. Team management is not abdication of supervision. Someone has to be at the helm otherwise costs go up, deadlines are missed, and customers are disappointed. It’s not surprising that we found some of these conditions at this company. It is most surprising that we didn’t find more of them.

Workers said, “We need an organized way of prioritizing jobs. We constantly overload production. We spend a lot of time verifying work orders. Sometimes it is a week between delivery and billing. There is a lot of conflict between managers, particularly two of them. We have inconsistent leadership. Sometimes, we spend more time pointing fingers when we just need to correct the problem. We need to clearly define responsibilities. We need improved communication on jobs. We have enormous potential if we can be focused on where we are going and develop some systems to help us manage workflow.”

Tom’s Comments

TWe’ve seen much of this before in previous articles, but some we haven’t. Here’s the stuff we have seen. Production management is non-existent. People are being left to figure things out for themselves. Doesn’t work. Best system I can think of to help would be a real supervisor in charge of setting priorities and directing work.

There’s also lots of equipment here creating little sales but lots of depreciation and equipment payments as well as high overhead. David doesn’t work with a budget or any constraint for that matter. If he needs equipment, he gets it. That’s why overhead is 44% of sales and why the company is making much less than it should (9% vs. 20% or a difference of about $110,000). Should even a slowing in sales occur, management would be in a world of hurt, especially with such a low current ratio and the big equipment payments.

The budget, when and if used, is based on increasing sales, not controlling expenses. The company’s growth makes the problem with working capital worse. But then, no one pays attention to it anyway.

There’s no working capital. There will be no working capital unless money’s left in the business. That’s why cash is always tight and sometimes very critical.

This is a classic example of a company increasing sales but not income or strength (working capital). Grow or go? That’s not the question, but the answer is this company will grow and go if it doesn’t change. The
company needs to slow down, make money, and keep cash to bolster the current ratio. The company will continue as a very high-risk business until it is done. But you’ve heard me say all of this before.

Now, here’s the new part we don’t normally see and neither does David. Mom and Dad want to retire and be paid off. They’re 68. This isn’t going to be something that will happen in 15 years – it is happening now.

David has known this for awhile but ignored it while he’s been up in the tower doing important things. A transition is imminent – whether it is forced upon him or whether he leads it. Herman and Helen want David to pay them money for the business. David wants them to give it to him. Humm. Could be interesting.

I suggest they value the business as it stands. David should create an agreement with Mom and Dad that they get so much money over time in exchange for the stock being transferred. We help broker deals like this between generations frequently and it is straightforward.

However, this transition will require that David step up to the management responsibilities of making and meeting all budgets. David must decide what is going to happen and then make it so. I know this isn’t the thing that is most fun for him – but it is the thing that is most important to maintain control.

What if David would hire someone else to run this business? Easier said than done. If he’s paying Mom and Dad, and paying this other person, and himself – well, considering the poor performance of the business –where does the money come from? And, secondly, what guarantee do we have the outsider will be able to run the business? This is a very poor plan.

Perhaps he could reduce overhead and get the cash to hire someone. I don’t see that happening now. Most of the high overhead is hard wired into the budget and the company would take a bath getting it reduced – long term leases, equipment depreciation and the like.

I see three choices. One, step up to the responsibilities of running the business, pay off Mom and Dad and then live happily ever after. Or, two, let Mom and Dad sell to someone else – at which time David will have a pity party and take his marbles and go somewhere else. This will come as a surprise to Mom and Dad, because he will threaten to do this before the sale to the outsider leaving the parents hostage to David. And,
of course, it will also come as a surprise to Mom and Dad that an outsider will never value this business highly because of the hostage situation you create.

Of course, choice three is for David to leave the business and leave the parents hanging. That happens.

Humm. Maybe there’s only one choice after all. Perhaps, it’s time for someone to run the business. And that appears to be David. It would have been better if this situation hadn’t developed so, perhaps, someone should have been running this business all along. Perhaps we should have organized around functions, not people. Perhaps we should have paid attention to our working capital. Perhaps Herman and Helen should have put money aside as they went instead of relying on David. Perhaps. But it didn’t happen. So, here we are with one choice left. David will step up to the responsibilities of running the business or it will crash and burn.

Tom Crouser

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