After spending 7 years and $7 billion, Shell Oil recently decided to suspend drilling operations in Alaska. They were patient for a prolonged period, but they simply could not afford to keep waiting for oil prices to rise.
Granted, a major corporation can afford to spend mountains of money before deciding to cut losses. As a small business owner, however, you can't afford to watch cash flow out in hopes of better times in the future. Here are five tips on how to keep a hand poised on the cash spigot and how to know when to shut it down.
1. Think critically before acting
If you have a great accountant, you probably know the precise cost of each product or service and can clearly identify the ones that are earning profits or creating losses. You know the products that are perfectly-priced and you can spot the ones that are so popular that they deserve a price increase.
But, can you do the same thing to repair loss situations? You shouldn't always remove unprofitable products from your line. Your yummy chocolate chip cupcakes might cost you more to make than you can recoup in sales. Sure, you can stop selling them or cut costs by using fewer chips. But, how many customers will you lose and how many other profitable products will see reductions in sales as a result?
Those cupcakes may be loss-leaders. Cupcake-lovers will come back with their friends — and they will return when they need high-margin birthday cakes for office parties. Service businesses are not immune from the loss-leader concept either. A 15-minute therapeutic massage may only break even, but that relaxed customer will probably come back for 30 or 60 minute sessions, particularly during gardening, leaf-raking or snow-shoveling seasons.
In other words, don't cut off the nose to spite the face. Look at the big picture before deciding to cut products or quality.
2. Keep a close eye on results
By vigilantly monitoring every operation, you catch potential losses early in the process and keep losses to a minimum. You may need to make revisions on the fly to stop losses and start generating profits.
Let's say your law office initially decided to offer fixed-cost standard wills to increase clientele. Close monitoring tells you that this new plan has created significant losses because your new clients are not shy about requesting time-consuming special services that you can't refuse. Perhaps, you can reduce the initial base cost for a will while adding fixed prices for each type of special service. Done correctly, your clients still save money while your bottom line moves from red to black.
3. Recognize that projects are not always do-it-yourself ventures
Products or services do not always costs less or earn more when you handle every detail in-house. Small businesses can often turn losses into profits by looking outside of their own walls.
Your business may make top-notch widgets, but are you equally good at creating the packaging? Consider your in-house costs for designing and printing the boxes. Maybe you can shave dollars off of your production costs and turn losses into profits. In fact, professional packaging might even attract more customers.
Service businesses can look at this same concept from a different perspective by recognizing when they can increase profits by turning certain kinds of business away. How much does it cost to bring a patient into a medical office for a simple blood test? They take up time and space while creating paperwork. If patients do not need a doctor, you can save money by sending them directly to a blood-testing lab, bringing them back only when the test results show a need for treatment.
4. Look for small solutions
The difference between profit and loss is not always an all-or-nothing proposition. Sometimes, relatively small solutions can help make the transition. Maybe an analysis of spending shows that your employees are making wasteful choices that can be fixed by initiating a new spending authorization process. Or, perhaps switching to vendors who provide parts on-demand can reduce your warehousing costs.
5. Know when to get out
Spending money to make money does not always work. Particularly if you have already spent a bundle on a venture, studies show that your natural instincts are to spend more to fix the problem. Given endless time and money, this approach may work. More likely, you will lose your shirt.
If you cannot envision a way to turn losses into profits, the best choice may be to get out while you still have money in the bank.
Don't let tax write-offs drive your decisions
Short or medium term losses are a natural part of expanding business and tax write-offs can help weather the storm until you move into profitability. But, don't be fooled into viewing write-offs as income.
By all means, take the risks that can help your business prosper and grow. Do it wisely, keep a close eye on results, remain flexible to change — and know when and how to get out to avoid going under.
Carol Roth is a radio host on WGN, a CNBC TV contributor, a ‘recovering’ investment banker & a bestselling author of The Entrepreneur Equation. You can find her on Twitter @CarolJSRoth or at www.CarolRoth.com. She also has an action figure made in her likeness.