Cash Flow Lessons from The Profit: Pacific Hospitality Design

cash flow lessons from the profit

The Profit TV show airs on Tuesday nights, 10 pm on CNBC. Last night’s episode featured PH Design (Pacific Hospitality Design Inc), a manufacturer of furniture for commercial spaces such as hotel rooms and restaurants.

Watch the video of me reading this blog post and crunching Pacific Design's numbers in Excel, or read for yourself below!

The Facts

  • Pacific Hospitality Design was founded by Gilbert Martinez 40 years ago.
  • The business is located in Los Angeles and is run by Gilbert, and his daughter Anna.
  • PH Design designs and manufactures furniture for restaurants and hotels. Some of their clients are The Coffee Bean, MGM, Planet Hollywood and Caesars Entertainment.
  • This year they will gross $2.8M in revenue and just break even.
  • They lost $46K last year.
  • In Feb/Mar/Apr they could not make payroll.
  • Anna put in $75K of her and her husband's savings to keep the business afloat this year.
  • Profit margins are around 28%, and Marcus says this is a "paper thin" margin. He says a furniture manufacturing company's profit margins have to be north of 50% in order to survive.
  • Gilbert says, "Yes" to many orders that are not profitable. Anna also undersells orders.
  • Anna's talent and passion is design, but many of the other business functions have become her responsibility due to her father's deteriorating health.
  • The product and people are great, but the process is broken.
  • There is also waste and damage, or what Marcus calls "margin leakage."
  • Marcus said, "You can see why Anna and her Dad are feeling the real pressure when it comes to cash flow - low margins, poor efficiency. When those things exist and business is great, you can just skim by. But when business drops, it’s like putting a noose around your neck. There is no chance of survival.”
  • They gave just a few Balance Sheet liability numbers:
    • $288K in payables, of which $106K are past due
    • $300K in family loans

Analysis

  • Current profit margin of 28% leaves only $784K to cover overhead and profit. ($2.8M x 28% = $784K)
  • A 28% profit margin equals 72% COGS. (100 - 72 = 28)
  • Marcus says profit margin must be north of 50% and believes he can achieve a 57% profit margin for PH Design. A 57% profit margin equals 43% COGS. (100 - 43 = 57)
  • A 57% profit margin on $2.8M equals $1.6M. ($2.8 x 57% = $1.596M)
  • $1.6M seems like a lot of money, but it's not in this type business.
    • First, a business wants 20% profit at the end of the year, so that's $560K. ($2.8M x 20% = $560K)
    • Just because a business has a net profit of $560K at the end of the year, does not mean the company's owners take this home.
    • It's nice if owners could take out 10% of this profit and invest 10% back into the business. We are also assuming owners were able to take reasonable salaries and still make the 20% profit.
    • Net profit has to be used to invest back into the business (or pay for previous investments in the business) if you want your business to grow. The the cash flow from net profit is used for
      • debt repayment
      • equipment upgrades
      • principal repayment to owners and investors (this is different than a "return" on investment)
      • investment back into business for expansion ("chicken before the egg" labor costs, marketing ramp up, more space, etc.)
      • Debt repayment, equipment purchases and repayments to owners/investors are not reported on the Profit & Loss. These activities use up the cash generated by P&L net profit.
    • So, $1.6M in gross profit less 20% net profit goal of $560K, leaves $1.04M to cover overhead, which is only $86K/month. That has to cover rent, payroll taxes, work comp insurance (which is probably expensive in this industry), utilities, general business insurance, management and admin salaries, marketing, sales commissions, etc.

Lessons Learned

  • The business has been around for 40 years, and the processes and profit margins that worked in the past are not working in our current economy and manufacturing environment.
  • Businesses that have been around for over a decade will have to continue to change their processes, and often their products, to remain current and competitive.
  • In most of the episodes of The Profit, I blame the owners for living in denial and not making changes they know they need to make. I don't see this in PH Design's case. I don't think the owners could have turned the business around without outside help.
    • Gilbert created and ran a successful business for 40 years. But due to his deteriorating health and the ever-changing modern business environment, he does not possess the skills needed to keep the company afloat.
    • Anna, his daughter, is smart and hardworking, but her talents are in design.
    • A lot of Anna's energy was used in worrying about her father. Her father would not take days off or rest because he felt responsible to be there every day during the hard times and not have Anna carry the weight all by herself.
    • There was no money to hire an "expert" to come in and help with the processes. And you can't just take on any equity investor. You have to trust your investor and the investor needs to know your industry.
    • If Anna had not been able to bring in Marcus, she could have shut down the manufacturing part of the business and try to make it as a design-only business. But I don't think Anna had the confidence that she had enough talent to do this.

This episode was a tear-jerker for me because Marcus saw Gilbert and Anna as successful. He never made a negative comment on their character or efforts. He knew it was time for Gilbert to slow down, and he recognized the incredible work-ethic and talent in Anna.

Before Marcus made Gilbert and Anna an investment offer, he praised them for their success.

Marcus: “I’m very impressed.”

Gilbert: “Why?”

Marcus: "Because anytime one person, over 40 years, can build a business in America and have it stay open and last is a big accomplishment. You fed a lot of people over the years, and you have a lot to be proud of.”

Gilbert: “I never think about that. Sometimes I’m thinking with my heart, not with my brains."

Marcus : "Well that’s why you’re successful."

Gilbert: "You think so?"

Marcus: "Yes, because business isn’t about just thinking with your checkbook."

This episode had a happy ending.

Marcus gave Anna a chance to bid on the design of one of his restaurant franchises. Her designs were a hit with him and with the franchise's VP. Marcus also let her design the overhaul of PH Design's manufacturing space and show room. He was very happy with her designs (which doesn't happen often) and used them. Marcus recognized Anna's design talent and made her "in charge" of the interior designs of all his businesses.

In the follow-up segment, we see that Gilbert took a week off, and I think he looked rested and happy!

Join me next Wednesday for another blog post of The Profit.

Please note: The assumptions and opinions here are for teaching purposes only. I in no way mean to insult or throw shadow on anyone’s character or business acumen. I understand that very limited facts are presented in the TV show, and I’m aware that there’s always more to the story.


Older Post Newer Post