You undoubtedly put in your best efforts as a business owner. But sometimes you must think about closing a company division or product line.
Exiting a particular business is one of the most difficult decisions you’ll make as an owner. You may deal with feelings of failure and rejection, given how much effort you’ve put into the operation.
So, how do you make an informed decision?
Use these tips to understand the financial and non-financial issues related to closing a business.
Meet Abeer, He’s Considering Closing a Division
Abeer owns Quality Sporting Goods. His company manufactures cricket, basketball, and hockey equipment. The company’s Aero Gloves division produces cricket gloves. Also, the division has lost money for the last three years.
Management has tried various strategies to improve Aero’s results. Abeer invested more money in sales and marketing. In addition to this, he attempted to negotiate lower material costs with vendors. Aero’s glove competitors sell a high-quality glove at a low price. Also, Abeer’s firm cannot gain any market share.
Abeer is now considering shutting down the Aero division.
Where Are You Now?
The income statement indicates that Aero generated a Rs. 3.05 million loss for the year. Also, this report separates costs into the cost of sales and operating expenses.
Cost of sales includes material costs (leather and plastic) and labor costs that are directly related to production. If the division is closed, these costs are eliminated.
Operating expenses include costs that are not directly related to production. Also, this category requires more analysis.
Dealing With Sunk Costs
Sunk costs are expenses that will continue, even if you close a division or product line. In addition to this, these costs need to be carefully reviewed.
Aero, for example, has five years remaining on the home office lease. This will cost Rs. 1 million over the remaining lease term. All other costs can be eliminated.
If the division is closed, all of the incoming revenue will stop. Similarly, all division costs would be eliminated- except for the Rs. 1 million in lease payments.
Liquidating the Balance Sheet
If Abeer decides to close the division, he can generate cash from selling assets. He can then use that cash to pay off any outstanding liabilities. If assets are greater than liabilities, this “liquidation” process will leave Abeer with an ending cash balance. Here’s the balance sheet impact if the Aero division is closed:
In addition to the Rs. 3 million cash balance, Abeer collects the Rs. 5 million in receivables from customers. Also, he sells the Rs. 2 million glove inventory to the existing client base. The business also sells the machinery and equipment. Aero receives a total of Rs. 13 million from asset sales and the original cash balance.
Abeer pays Rs. 2.1 million to eliminate the accounts payable balance, and repays both the Rs. 1.4 million current portion and Rs. 7 million long-term portion of the bank balance.
The net impact of liquidating the balance sheet is a Rs. 2.5 million increase in cash, which equals owner’s equity. The equity balance is the current amount of cash and other assets that Abeer invested in the business.
The bottom line is that Abeer will recover his Rs. 2.5 million equity investment in the business, and Abeer will have to pay Rs. 1 million to finish the lease term. However, Quality Sporting Goods may be able to use the office for some other purpose until the lease ends.
Closing a division involves non-financial costs that will impact your business, and Abeer should carefully think about the impact of closing his company division.
If the division is closed, it will impact on employee morale. The staff may wonder if other departments will be closed and if more jobs will be eliminated. Low morale can impact productivity, and some workers may consider leaving the business.
Investors, creditors, and vendors may question management’s ability to operate the business moving forward. Investors may consider selling their ownership interest, and creditors may ask for more collateral to secure a business loan. Vendors may be hesitant to sell goods and services to Quality Sporting Goods unless cash is paid up front.
When a company division is closed, many people will question the owner’s ability to manage the business.
Take Everything Into Account
Closing a division is a tough decision, and you must evaluate both the financial and non-financial impact of your change. However, in many cases, closing a business unit is the right thing to do, and will allow you to focus on more profitable areas of your company.
Think carefully about this decision, and take everything into account, so you can grow your business profitability.