Sustainability tests

Evaluate the longevity of your business

It’s often uncomfortable to talk about business failure.  But it’s only half the picture. The other half is business success.

They’re the yin and yang of doing business. Pro football teams review their prior weeks’ games to determine what worked and what didn’t. They repeat or enhance plays that worked. They discard or tweak plays that failed.

The U.S. Bureau of Labor Statistics tracks, by year, the number of business starts and the number of businesses that are still in existence – in essence, the “success rate.” Between the first and second year, about one in five businesses disappears. Around year five, about half of businesses are gone.

Not all businesses disappear because someone has failed. Some are sold. Owners close their businesses for other reasons.

Our focus should be on all tools and methods that help increase the success rate and reduce the failure rate. In this article, success and failure are captured in the phrase “business longevity.” Calculating it is similar to the way we predict the lifespan of three types of people:

  1. Planned, deliberate people who are extraordinarily health-conscious and measure many aspects of their lives.
  2. Happy-go-lucky people who let life evolve. Their motto is, “que sera, sera” (whatever will be, will be).
  3. People who overindulge. They don’t control their eating or drinking habits. As a result, they’re overweight, out of shape and in poor health.

If we evaluate these three on their lifespan, which person has the highest chance of dying first?

Some people have even begun to use health longevity specialists. These are physicians who focus on helping them extend the quantity and quality of life.

In the business world, three types of businesses fit the same profile:

  1. A planful organization makes and executes plans and measures the resulting success or failure.
  2. A company goes from activity to activity depending on where the opportunity is most significant. It might also believe that generating sales will solve all the problems.
  3. The third type of company isn’t planful and has no discipline when it comes to finances, employees, etc.

Which of these three is most likely to experience financial difficulties and potentially fail?

How to measure your business longevity

This leads us to the concept of business longevity, the practice of assessing where an organization is, determining where it would like to be, and then creating the action steps for the business to get there.

This might sound similar to business planning, yet it’s much more expansive. The ideal assessment would include areas such as evaluating historical financial trends, an industry analysis and a competitor analysis.

It would include environmental scanning using tools known as PESTLE, which measure the political, economic, social, technological, legal and environmental components that affect the business environment.

Finally, it would include identifying strengths, weaknesses, opportunities and threats (SWOT) and a robust evaluation of future innovations and changes in society.

One of my favorite tools is the Altman Z-score. It’s usually used to depict the likelihood of bankruptcy. However, I use it to measure the health of an organization the way a doctor uses a blood pressure analysis.

Consider expanding the length of time for which you review your financial information. Current financial practices of comparing this year’s results to prior years are too shortsighted.

If you looked at any two successive years for Sears, the story of its failure isn’t apparent. If you reviewed 10 years of the department store chain’s financial information, however, it’s plain to see how the company was declining.

At a minimum, a company should understand its key financial metrics, including the Z-score and selected ratios, especially the current ratio, for a minimum of 10 years or the length of time the business has been in existence.

Do you understand yours?

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Jim Lindell, CPA, CGMA, CSP is a Vistage Chair in southeast Wisconsin and president of Thorsten Consulting Group, Inc. He is an award-winning speaker and best-selling author.

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