How do you know when it’s time to close your business?
Sometimes, in spite of your best efforts as a business owner, you have to think about shutting your doors.
The decision to close a business is one of the most difficult decisions you’ll make as an owner. You may deal with feelings of failure, 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, and the steps required to complete the process.
Rip the Bandage Off
No one likes to consider bad news.
Like a bandage on a wound, we’d all prefer to ignore what’s underneath.
Before you start the analysis of your business, you must be willing to accept and deal with the bad news that comes your way. Keep in mind: many entrepreneurs try multiple business ideas before they succeed. Closing your business is a step toward finding success in a new venture.
Go ahead. Rip off the bandage and face the problem head-on. In the long run, you’ll be better off for it.
Meet Jim – He May Need to Close His Business
Jim owns and operates Premier Windows, a company that manufactures custom-made windows for the residential home market.
After years of growing sales and profits, the company has seen a sharp decline in sales over the last three years, and the business now operates at a loss. Jim generates the majority of his sales from new home construction, and home building is in a downward trend.
In addition, a competitor is using new technology to manufacture windows at a total cost that is 20% below Premier’s cost, and Jim is losing business to the rival firm.
How does Jim make an informed decision about closing his business?
Monitoring The Business’s Financial Dashboard
Your car’s dashboard alerts you to key information that affects your car’s performance, such as your current speed, the amount of gas you have, and your engine’s temperature. These metrics are in your view as you drive so that you can respond quickly.
In a similar way, Jim should pay attention to some key metrics that indicate how his business is performing. In some cases, these metrics can help a business owner decide if it’s time to close the business.
Here are several important data points for your company’s financial dashboard:
Operating Income vs. Non-Operating Income
Operating income is generated from the day-to-day activities of running your business. Your company must be able to produce the vast majority of net income from operating income activities because operating income is sustainable. In Jim’s case, window production and sales are the operating activity.
On the other hand, non-operating income is not consistent or predictable, and no company can survive over the long-term by relying on non-operating income to produce annual profits. If, for example, Premier sells a piece of equipment for a gain, the sale generates non-operating income.
If operating income is declining, and the owner does not have a viable plan to reverse the slide, it may be time to close the business.
Profit Margins Shrinking
Profit margin is defined as (profit divided by sales), and this ratio measures the profit that Premier Windows earns on each dollar of sales.
If a competitor is able to produce windows at a lower cost and offer a more attractive sales price, Jim’s firm must also lower prices to compete. Unless Jim can lower his total costs, the lower sales price will shrink the company’s profit margin. This scenario is a warning sign for a business.
Cash Inflows Are Not Sufficient
Your firm’s cash inflows must be sufficient to fund business operations
Declining cash flows may be caused by several factors. Some companies see a decline in cash collections because they don’t implement a collection policy for accounts receivable.
Your accounting software should provide an aging schedule for accounts receivable, which groups your receivables based on when the invoice was issued. You should monitor this report and implement a collections process to email and possibly call clients to ask for payment.
Declining sales, however, is a more serious problem that impacts cash collections. If sales and cash inflows are trending downward, your firm may have to borrow funds to operate and incur interest costs on the loan.
If you can’t reverse the trend and increase sales, you run the risk of taking on more debt, and loan repayments may become impossible. Common sense should tell you that this trend can’t last forever, and you may need to shut down your operation
Take a close look at your dashboard metrics each week, and think carefully about the trends that these metrics reveal. Take action to make improvements by lowering costs, increasing cash collections, and maintaining prices that generate profits.
Finally, be honest with yourself.
If business results are moving in a negative direction, and you can’t implement a realistic plan to correct the problems, consider shutting down your business.
Seek out friends, family, and business associates, and ask them for honest feedback. Don’t make this difficult decision on your own.
Managing a Business Closure
It’s a difficult but sometimes necessary decision.
If you decide to close your business, what is the process?
Use these steps to close your business.
1. Getting the Word Out
Every business has stakeholders who will be impacted by a closure, and you need to inform these people of your plans. Create a plan to inform your customers, vendors, creditors, and industry regulators.
Work with your accountant and your attorney to plan for the regulatory and tax filings required to shut down your business, and to plan the repayment of all outstanding liabilities.
2. Addressing Sunk Costs
Sunk costs, or past costs, are fixed costs that cannot be eliminated in the short term, and many businesses that close have sunk costs in place.
Assume, for example, that Jim has three years remaining on a building lease. If the contract cannot be voided or renegotiated, Jim must continue to pay on the lease until the contract ends. If he starts a new venture, however, he may be able to use the building in his new business.
Your business closure plan must include the continuing expenses related to any sunk costs.
Liquidating the Business
If Jim decides to close the business, he can generate cash from selling assets, and use that cash to pay off any outstanding liabilities, and also set aside funds to pay the sunk costs that remain. If assets are greater than liabilities, this “liquidation” process will leave Jim with an ending cash balance, which he may use to fund a new business venture.
Closing a business involves non-financial costs that may impact Jim moving forward, and every owner should consider these factors.
If the business is closed, Jim will have to let employees go, and former staff members may criticize Jim’s decision in conversations with other people, or on social media.
Many people may question the owner’s ability to manage a new business venture after the shutdown. Jim may find it difficult to attract investors, and he may have to explain his business closure to potential new employees, vendors, and even to customers.
Think carefully about these costs, because they can impact an owner long after the business is closed.
Closing a business is a tough decision, and you must evaluate both the financial and non-financial impact of your decision. However, in many cases, closing a business is the right thing to do.
Use the wisdom you gained from your failed venture to begin again. With careful thought, you can succeed in a new business.