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Business Failure: Cash is King, But Turnover Might Not Be

There are no two ways around it. In business, money doesn’t just talk, it rules. Even the most benevolent and altruistic of social enterprises are, at a fundamental level, out to make money, however it ends up being distributed.

For most of us, whether we run a business ourselves or simply work for one, our motivations for doing so are pretty straightforward – to make ourselves a nice little earning, and preferably acquire as much cash as possible.

Stripped down to its basics, then, business is nothing if not the pursuit of riches. But taking too narrow a view on this can be counter-productive. As paradoxical as it sounds, aiming to make a fast buck in business with little in the way of other considerations can actually be a recipe for disaster. It has even been demonstrated that rapid growth shows a surprisingly close correlation with speed of demise in business.

In other words, the faster you aim to make money, the more you accelerate the risk of failure.

The obvious conclusion to draw from this is that businesses setting out to grow rapidly take more risks, and therefore have more chance of running into trouble. But it isn’t just fast-growing, freewheeling enterprises that fail. Look at the topic of business failure more closely and it is possible to spot patterns that suggest it isn’t simply how fast we aim to make money that causes difficulties, but the way we measure and judge financial success.

Turnover versus profit

At the heart of this lies the distinction between turnover and profit. Both are used as intrinsic measures of business performance because both offer an indication of how much money is being made. Both are also routinely confused, not so much in terms of their technical definitions, but in what they actually have to say about a business’s present financial circumstances.

There is perhaps even an element of willful confusion here. Everyone in business knows that turnover tells you net income from sales, whereas profit tells you your earnings – how much money is left over – after costs have been taken out. Everyone with any experience in business should therefore know that profit is a much more reliable measure of financial health. Yet many, many businesses prioritise turnover in their planning, operations and evaluations.

This maybe boils down to the fact that people in business feel they have more control over turnover, that it is more immediate and less subject to the fluctuating whims of broader market forces – your suppliers hiking up their prices, for example, or exchange rates shifting in overseas trade.

Turnover also comes prior to profit. To secure a good margin, you have to be selling goods or services in the first place to generate income. The idea that boosting business performance is simply a matter of increasing sales, and therefore boosting the flow of cash into the business, offers many a comforting illusion which shelters them from the harsher complexities of managing for profit. Like a siren’s call, it is this illusion that drags so many businesses onto the rocks.

The costs of growth

One of the key issues is what you have to do to increase turnover. Find that you are losing market share to a rival? Then the age-old, knee-jerk response is to cut prices, offer customers a better deal than your competitors, and therefore increase sales volumes again. But the annals of business history are littered with examples of businesses wrecked by this race-to-the-bottom model of slash-and-burn pricing. There comes a point where discounting, regardless of what your competitors are doing, ceases to be economically viable because it erodes all margins.

Similarly, many businesses look to increase turnover by throwing cash at the problem, especially in the form of marketing campaigns. Again, a naive understanding of the economic equations in play here can quickly drag a business into trouble – yes, a well-funded, well-executed campaign might raise your income, but will it actually cover the costs you had to put into it?

Not surprisingly, the people who found the link between rate of business growth and lifespan also found that, over a period of decades, profits at the public companies they analysed had been on the decline, at an even faster rate again. This, they concluded, indicates that business strategy has taken a turn away from long-term value creation in favour of a short-term focus on growth.

This again might be framed as a choice between turnover and profit. Driving sales so a business appears to be cash rich and growing rapidly delivers the kind of quick wins that investors and shareholders like. Creating the conditions for adding value to a business, on the other hand, is a much more strategic, complex and longer game which can be a challenge to justify with headline figures in the short term.

The choice, however, is also whether you want your business to burn bright and brief only to fade away, or to stand the test of time, a bastion against the crashing waves of the market which keep making you money. If it is the latter you aim for, there is a much bigger picture at stake than turnover.