The Division That Looked Profitable But Wasn't

The Situation

$80M industrial distribution company (US-based, family-owned, 50 years old). Three divisions:

• East Coast: 18% EBITDA margin
• Midwest: 22% EBITDA margin
• West Coast: 12% EBITDA margin

Board discussion: "West Coast is low. Shut it down or invest?"

But the owner had a gut feeling: "West Coast always needs cash. Every quarter I'm wiring $200-300K. If it's profitable, where's the cash going?"

What Most Would Do

Review P&L allocations. Check corporate overhead distribution. Assume it's a working capital issue.

The Unfolding Values Analysis

If a division P&L shows profit but consumes cash, one of three things is happening:

• The P&L allocation is wrong
• Working capital is consuming cash
• Something is missing from the analysis entirely

What was missing:

• West Coast warehouse bought for $2.8M (debt service $180K/year at corporate level, NOT allocated to the division)
• West Coast had 6 delivery trucks purchased ($400K), while East/Midwest leased trucks (in divisional P&L)

The real math:

• West Coast "profit": $1.2M (12% on $10M)
• Capital deployed: $3.2M
• Return on capital: 37%
• East Coast return on capital: 85%

West Coast wasn't unprofitable. It was capital-inefficient.

The Decision Tree

Option A: Shut down West Coast. Stops cash consumption but loses $10M revenue and customer relationships.

Option B: Fix the capital structure. Sell the building, lease instead. Frees capital but carries transaction costs.

Option C: Fix capital and reprice (Recommended). Sale-leaseback on the warehouse, lease the trucks, increase pricing 8%, optimize working capital.

The Outcome

Results after 12 months:

• Sale-leaseback freed $2.4M cash
• Pricing increased 8% (lost only 2 of 35 customers)
• New EBITDA margin: 18% (from 12%)
• Working capital: freed $250K
• Division return on capital: 72% (from 37%)
• Cash consumption: $0 (self-sustaining)

Key Principles

1. Division P&L is accounting. Division cash flow is reality. Track both.
2. Capital intensity matters. A 12% margin on $10M with $1M capital is better than 18% on $10M with $5M capital.
3. "Profitable" is not binary. It's profitable relative to capital deployed and opportunity cost.