Yes! This is a serious business-centric article that discusses eating cockroaches for purposes of illustrating some important business doctrines. However, before we discuss insect consumption, I need to set the stage…
Many years ago Tracey and I thought about selling our home, so I made an appointment with a real estate professional. She arrived at the residence and complimented us for our choice in furnishings and my wife’s decorating skills. Then she got down to business and picked our home apart.
“Paint this room.”
“Replace the carpet in the master bedroom.”
“Remove the wallpaper in the laundry room.”
“Get rid of that couch.”
“Buy a new faucet for the bathroom.”
“Update the lamps in the living room.”
“Put a new roof on the house.”
“Replace the dated dishwasher.”
What? I reminded the agent that we intended on selling the home, not remodeling it. She agreed and responded with a persuasive argument.
“Look Steve. The investment in these areas will help you sell the house for more money, faster. Addressing the needs I identified will make your home more attractive to more buyers. Yes, it will depersonalize your home, but you’re not the buyer. The buyer will have different tastes and needs. If for some reason the home doesn’t sell, you’ll have a wonderful new home to enjoy.”
It was a win-win. The house didn’t sell that year. New carpet, faucets, paint, and her other suggestions helped us put our home at the top of its game.
Ever sell a car? Smart sellers will wash, wax, and vacuum their vehicle, change the oil, and take other actions to make it more attractive before advertising it for sale. Why? For the same reasons as addressing the needs of our home. Sell it for more money, faster. If it doesn’t sell, it’s a nicer ride.
The same philosophy holds true in business. I’ve been part of the process of preparing approximately 50 businesses for sale and know the philosophy holds true in this arena as well.
Does the physical plant need a makeover?
Have inventory turns been reasonable over the past few years?
Is your EBITDA trending in the right direction?
Does the business have positive ratings with the BBB? Social media?
Is the business growing?
Are you carrying dead weight on your staff?
Is internal and external shrinkage under control?
Is the business gaining or losing customers?
Is your inventory recorded accurately?
Addressing these issues isn’t always easy in the short term and may tighten your resources as you attempt to address them. Regardless, addressing them is extremely important. Here’s an example of the need and the difficulty:
Several years ago I was approached by a company interested in improving one of its divisions; with the ultimate goal of selling the entity. Once on the ground and working the situation I discovered actual saleable inventory was considerably less than company records suggested.
A few staff members, strategically placed within the management hierarchy, had been accumulating broken, stale, and aged inventory; and storing that inventory in a subterranean storage facility. From an operations perspective, items placed there were removed from existence. Accounting records, however, continued to carry that inventory as active.
The $64,000 question… WHY?
I’m glad you asked. Here’s why:
Three people in the corporate food chain received monthly bonus checks that were, in part, based upon gross profit on sales for the previous month. They were aware the cost of merchandise removed from inventory was included in the formula for computing their monthly bonus. The bonus structure computations included merchandise no longer active due to sales, theft, or disposal. However, the three people realized if they disposed of damaged inventory regularly and adjusted inventory accordingly, each bonus check would have been smaller. Therefore, they chose to maximize their monthly bonus checks by playing a shell game with the merchandise. Although the accounting department believed the inventory was active and saleable, it was actually gathering dust on shelves in the basement. No wonder inventory turns were at unacceptable levels.
EXAMPLE OF WHAT SHOULD HAVE OCCURRED (simplified)
$100,000 Total Sales for the Month
– 50,000 Cost of Goods Sold
– 5,000 Broken Discarded Inventory
= 45,000 Gross Profit
x 1% Bonus Percentage on Gross Profit
= $450 Bonus
These examples reflect how correctly handling a single month might impact a bonus check. What if a 9-month accumulation of dead inventory (accumulating at $5000 per month) was charged off during a single month?
EXAMPLE OF A 9-MONTH CHARGE OFF (simplified)
$100,000 Total Sales for the Month
– 50,000 Cost of Goods Sold
– 45,000 Broken Discarded Inventory
= 5,000 Gross Profit
x 1% Bonus Percentage on Gross Profit
= $50 Bonus
GROSS PROFIT: $50,000 vs $5,000
BONUS CHECK: $500 vs $50
Smaller profit = smaller bonus. Additionally, a single month’s activities (as described above) would seem disastrous and not reflect accurately on the business for that period. Staff members might avoid doing the right thing if their actions resulted in lower personal compensation.
About 3 years of “dead” inventory had accumulated by the time I arrived. My compensation was also impacted by bonus calculations. However, I recognized it was extremely important and in the best interest of the company to remove useless inventory from the books, so a potential sale wouldn’t get derailed when a buyer’s audit revealed bloated inventory figures. It was important to make those adjustments, sooner rather than later, because EBITDA would also be affected. Immediate adjustments to inventory assisted us in expanding the distance between a period of lower earnings and future discussions with a potential buyer; resulting in a more accurate representation of the business.
Inventory was properly adjusted shortly after I joined the company and my actions were not popular. While not well received, they were extremely important and, although my compensation took a large hit, I have no reservations about the decision. It was the correct thing to do.
Moreover, I needed to make certain the mistakes of the past weren’t repeated. I’ve seen this happen too often, with too many companies. It’s all about cockroaches. Eating cockroaches is an effective way to illustrate the problem.
Most people have probably heard many food products contain small quantities of insect parts, rodent hair, small animal droppings, etc… I recall hearing this as a child when my 5th-grade teacher shared that peanut butter, cold cereal, and other foodstuffs contain a small amount of things we wouldn’t choose to eat; but avoiding them is almost impossible.
Let’s assume that each jar of peanut butter you buy and consume contains one small part of a cockroach. Half a leg, part of a wing, antennae pieces. You get the idea. Let’s say over the course of 5 years you eat enough peanut butter to have consumed a full cockroach. You probably never thought about eating cockroaches each time you chomped on your peanut butter and jelly sandwich, and it certainly didn’t affect the taste.
What if the peanut butter company was able to hold out each cockroach part from every jar and save all the parts in their basement? Let’s assume it would take 5 years for a full Frankensteinian cockroach to be constructed from the parts they saved. Five years later the peanut butter company fills a jar with peanut butter and tops it off with a whole cockroach you were required to eat with your next peanut butter sandwich.
You get the picture. If you’re scarcely aware or don’t even notice the roaches, then eating them is manageable. However, if you have to eat an entire cockroach in a single sitting it’s pretty tough to take. Charging off inventory is no different. It’s better not to let it accumulate and charge it off regularly, than to take a big hit in a single accounting period.
Back to the subject of preparing to place your business on the market…
Cockroach problems and other ongoing business needs should be fully addressed (as reasonably as possible) before making your business available for sale. Your business will probably be more profitable and, if you take those EBITDA hits long before a potential suitor comes knocking, you’ll probably reap greater rewards when you sell your business. Moreover, if your business doesn’t sell, then our real estate agent’s philosophy was right on the mark.
If you address important needs in preparation for the sale of your business, and it doesn’t sell, you’ll probably have a better business going forward. Perhaps it’ll be so good you’ll realize that selling it would have been a mistake.
Large Dead Cockroach photo courtesy of Wikimedia Commons
Walking Cockroach photo courtesy of Jeremy Page
For Sale photo courtesy of Kevin Shorter
Roller Brush photo courtesy of Milind Alvares
Volkswagen photo courtesy of Angus Stewart
Damaged Goods photo courtesy of Thomas Hawk
Lumax Art courtesy of Scott Maxwell
Old Computers photo courtesy of Ep Jhu
Eating a Bug photo courtesy of George Arriola
Dead Roach photo courtesy of Anil Jadhav
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