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How to maintain and grow profitability in a high borrowing cost environment

How to maintain and grow profitability in a high borrowing cost environment

Synopsis
4 Minute Read

A profitability strategy is essential to help your business remain competitive in the current high borrowing cost environment. Get started on your plan by evaluating your business and asking yourself how to:

  • Reduce wasteful expenditures
  • Lean into your supply chain
  • Focus on the right customers
  • Control your cash flow

Each of these factors will help your business maintain and grow its profitability, pay down its debt, and remain competitive in an uncertain economic landscape.

Senior Manager, Consulting - Performance Improvement & Operational Excellence

The economic landscape has shifted considerably in 2023 — with far-reaching consequences for business owners. Statistics Canada reports that rampant inflation has impacted the ability of almost 75 percent of Canadians to meet their daily expenses, forcing them to adjust their spending habits and reducing the demand for products across all industries.

Additionally, the Bank of Canada has raised the interest rate in an attempt to clamp down on inflation. Many companies took on short-term debt while borrowing costs were at or near record lows between 2008 and 2022. Now many are wondering how to pay down that debt as customer demand dwindles and renewal rates rise, eroding already slim profit margins.

Businesses must focus on strategies to maintain and grow profitability as demand decreases and the cost of debt goes up. No two businesses are the same, and there’s no single correct way to execute your profitability strategy. However, reducing wasteful expenditures, auditing your supply chain, prioritizing the right customers, and controlling your cash flow are good starting points.

Why a profitability strategy matters in today’s marketplace

RBC economists predict record-high inflation and higher debt servicing costs will shave nearly $3,000 from average household purchasing power in 2023. Additionally, high borrowing costs are decreasing the ability of businesses to raise capital or leverage debt.

Almost 75 percent of businesses reported that rising interest rates are having unfavourable effects on their operations and decisions according to results from the Bank of Canada’s fourth-quarter 2022 Business Outlook Survey.

Many companies are taking a proactive approach to reduce expenses to offset high borrowing costs. Some are reducing excess labour and others are increasing the prices on goods and services to account for interest rates. Other companies in the real estate sector have defaulted on properties due to the impact of interest rate hikes on mortgages.

You may have noticed the impact on your own business as rising interest rates directly reduce your overall profitability, net profit, and indirectly impact the cost of doing business through the rising cost of materials. Many suppliers have raised their prices to accommodate rising costs, therefore increasing your input costs, and reducing the overall profitability of your business.

It is essential to remove discretionary spending and investigate all opportunities to maintain and grow your profitability in today’s economic landscape. A profitability strategy will help you identify where you currently stand in the marketplace and reveal the path you can take to improve the position of your business.

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How to maintain and grow your organization’s profitability

Increasing your profitability is closely tied to improving resiliency by ensuring your business has the available funds to react quickly and adapt course in an uncertain marketplace.

While we have touched upon a few of the subjects below in our previous article, here we expand on them to give you a firm foundation to maintain and grow the profitability of your business:

Reduce wasteful expenditures

Identifying or reducing wasteful expenditures will help to increase the profitability of your business. Take a deeper look into your expenditures to identify areas where you can reduce costs without negatively impacting productivity or business operations. 

Consider exploring zero budgeting — or starting your budgeting base from zero and justifying every expense rather than basing it on the previous year’s budget. Zero budgeting often helps expose optional spending in your business and reveals areas where you may be able to improve profitability.

Additionally, you can consider cutting or reducing your production expenditures on products that do not meet the minimum cost of doing business. Review the product segments that your business operates in. Focus on the profitability of each segment and its value to your business — as well as the amount of debt that is needed to produce or deliver each segment.

If there are segments that have high costs of production and do not sell well — or have longer cash cycles — consider cutting or downsizing those segments to reduce your cost of production and debt servicing rather than continuing to produce it for minimal returns.

Lean into your supply chain

Economic challenges have shifted the supply chain from demand-constrained to supply-constrained due to declining volumes, freight bottlenecks, swinging market demand and other factors. Your supply chain may be experiencing many challenges — however, there are also opportunities to lean into your supply chain to improve the profitability of your business.

Start by auditing your supply chain to review your number of vendors, supply chain visibility, and geographic concentration. This can help reveal potential opportunities and risks — such as whether you get your materials from suppliers concentrated in one geographic area.

If your business uses multiple vendors, consider vendor consolidation to give you economies of scale — an opportunity to renegotiate for better terms or credit prices. Prioritize suppliers that don’t incur frequent significant price changes and who are willing to take more risk in holding inventory or modifying your minimum order quantity to help better manage your warehousing and cash flow.

Additionally, prioritize suppliers who can provide visibility on the availability of materials and are willing to partner with you to forecast availability for the products and services your business needs. That will enable you to schedule your production, procurement, and inventory levels accordingly and improve the profitability of your business.

Focus on the right customers

Review your customer base to identify those customers who bring the most value to your business. Prioritize customers who pay on time and are willing to pay premium prices for the service you provide by offering incentives such as fixed contracts to improve the quality of your gross profitability.

Additionally, ensure you focus on retaining customers who are willing to provide visibility so that your business can hold the right stock levels in your inventory, reducing the risk of excessive stock. Such customers may also be willing to share their market trend forecasting to help you predict shifts in demand.

It is important to keep in mind that customers may adjust their buying behaviour to adapt to the changing marketplace. At times, the market for certain products or materials may become inelastic — where customers may no longer be willing to absorb increased costs and will instead substitute your products for other lower-priced products.

Monitor current trends to anticipate when the market for your products or materials may become inelastic. Communicate with your customers to determine the impact of rising costs and how you may adjust your buying behaviour to preserve your business’ profitability.

Control your cash flow

Evaluate your operating cash flow to better understand the position of cash in your business. You must focus on having a positive cash flow from month to month to lower your reliance on debt to run operations.

A key step is to review your working capital needs. First, focus on ensuring all invoices are collected on time to manage your credit exposure with customers — therefore limiting credit risk. Businesses often rely on financing due to a lack of cash inflow when invoices are overdue. Ensure you follow up with your customers in a timely manner to collect any payments owed to redirect cash from your aging accounts receivable into your business. 

Next, manage your cash outflow to reduce dependence on debt to meet your supplier payments. Ensure you pay your suppliers on the due date or renegotiate credit terms — paying earlier reduces the amount of cash available to cover your fixed expenses.

Finally, reduce your inventory age. Complete an ABC analysis to identify inventories that do not generate enough cash flow or profitability — acting as cash holds in your cash cycle. Reducing your slow-moving inventory and inventory with low profitability can significantly improve the cash cycle in your business.

Controlling your cash flow will enable you to hold more cash, ensure you are cash positive each month, and increase the overall profitability of your business.

Take the next steps toward success

While the current economic landscape poses many challenges for business owners, you can increase the profitability of your business by identifying and reducing wasteful expenditures, leaning into your supply chain, focusing on your most profitable customers, and controlling your cash flow. These four steps can help you improve the profitability of your business, pay down your debt, and remain competitive in a high borrowing cost environment.

Contact us

To learn more, contact: 

Nakul Gupta, Senior Manager, Consulting - Performance Improvement & Operational Excellence
[email protected]
416.596.1711

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