One of the very first things I review when either called into a troubled company or appointed as a receiver are a business’ discretionary expenses.
Unlike utilities, insurance, rent or mortgage payments, payroll and other fixed costs, discretionary expenses have to be paid for with left over cash.
Delivery trucks, new machinery and equipment, business (and personal) vehicles, and luxuries all fall under the heading of discretionary expenses.
Let’s take a look at a couple of these items and examine some of the ways these discretionary items can impact cash flow.
Delivery trucks are essential, but how much delivery truck is essential? Size, engine choice, transmissions are fairly simple. But the graphics package cost is discretionary and has to be weighed along with the unit value as an advertising piece, and what consequence the graphics package may have on the truck’s re-sale value.
Hypothetically let’s say the graphics package adds $2,500 to the truck’s cost. It may really be $5,000 because if it has to be applied, someone will have to remove it at sale time. While that may be OK for one new truck, suppose you are replacing a fleet?
Let’s say you want to make 15% on an investments like graphics packages and let’s say you have 10 trucks to set up. Even if you are buying used trucks there is a substantial unit cost. At $5,000 each graphics will cost you $50,000. That means the graphics have to generate $57,500 in new revenue to hit the return target.
Discretion, better use discretion.
Machinery and equipment can put a big dent in operating cash flow. Regardless of whether you buy or lease there is a continuing cost associated with having new equipment. The big question is this…do you really need it?
Over the years I’ve seen many business owners buy or lease equipment based on a perceived need. The difference between a perceived and a real need can easily be influenced by the discretionary spending profiles of others.
Let’s consider a machine shop that makes specialized parts for an (insert your own favorite) industry.
Our subject shop has adequate machinery and equipment to adequately handle current and some additional demand. All of a sudden a new gizmo takes the industry by storm.
Our shop can take its share of the new volume without adding anything, OR it can acquire more equipment to get even more of the new demand. Suppose it chooses the latter.
There will be some lag time between placing the order and taking delivery of and putting the new machine into production. More important, there will be additional expense in acquiring and bringing the new machine on line and into production.
If the new gizmo’s a fluke our shop is out a lot of money in acquisition and financing costs for a machine(s) that cannot now pay its own way. (The same holds true for adding shifts.)
Discretion, better use discretion.
Now we’re to the fun part: cars, boats, airplanes and sports tickets. All of these are paid for with discretionary money. I could do a paragraph on each but instead let me suggest that you carefully evaluate how much money these toys REALLY make your business over the course of a year.
You choose what your target return is for a discretionary expenditure. If it’s zero and your business is wallowing in cash it may not matter. But, if your business fortunes could unexpectedly turn down and you are left with a lot of expensive discretionary items life could become difficult very quickly.