The Value of Stress Testing your Business

The act of “stress testing” banks, allows regulators to understand the effect on a bank’s economics during a severely adverse scenario, i.e. what is the likelihood that the institution will continue to transact business and survive a prolonged economic downturn.  Based on the results of the testing, regulators and bankers understand if the bank has the proper capitalization or alternatively what capital cushion is required to sustain itself.  Projecting an outcome based on a potential set of circumstances is a sound risk management approach.  Slightly modified, this approach can be and should be used to assess the impact of a stress on your business.  Does your business have the proper capital reserve cushion to adjust to a shock for a prolonged period?

For example, in the next three to twelve months, it is highly likely that the Federal Reserve will increase the federal funds rate.  This tool of monetary policy has an indirect impact on the prime rate, as the rates tend to move in lock-step.  As such, borrowers with variable rate loans will find their borrowing costs increase, i.e. a shock.  Since January 2009, the prime rate has been constant at 3.25%.  Yet 24 months prior, the prime rate was 5.0 percentage points higher, i.e. 8.25% (Source: Federal Reserve Board, Proprietary Bank Surveys).  At this point it is unclear if the Federal Reserve will begin a campaign to raise rates in 2015.  But once the campaign begins, how far will rates move up is not known.

To understand the potential impact of this shock, a business may perform the following testing –

Develop a proforma model based on the cash flow of your business.  Now increase your interest expense by 50% and then by 100%.  What is the impact on profitability as interest expenses increase?  Businesses that will be most impacted directly are entities that currently utilize a high amount of leverage and/or businesses that lay money out in advance of sales, for supplies and inventory.  While a business may have control over its leverage and purchases, it cannot control the economics of its customers and clients.   As rates increase, the economics of your customers may be disrupted which will have a trickle-down effect to its suppliers, i.e. you.  The natural outcome may be payment delays and an increase in your bad debt expense.

Based on your model, understand when issues will arise.  Quantify how much additional cash is required to ensure the proper cash reserve cushion is maintained.  Next proceed with one of three options –

Option #1 Least Impactful – Do nothing.  Understand the theoretical shortfall, but only make a change when you feel it is absolutely necessary.  I have seen many businesses use this wait and see approach.  It is not recommended.  Admittedly however, sometimes doing nothing works; but, other times it is disastrous.

Option #2 Most Impactful – Understand the cash reserve shortfall and discontinue any partner/owner distributions until the desired capitalization level is achieved.  This approach is very much in line with how the bank stress tests are performed.  If the bank passes the stress test, the Federal Reserve may allow it to make dividend distributions, share repurchases and major acquisitions/divestitures.

Option #3 Recommendation – Understand the cash reserve shortfall.  Investigate ways to increase the efficiency of your business.  Logical places to begin include –

  • Remove all non-value added costs – A non-value added cost is an expense that is incurred, but does not add to the value or perceived value of your product or service.  Simply stated, it is a cost your customers will not want to pay.
  • Ensure an appropriate pricing model – Pricing is a critical task that all businesses manage.  However, there are many different ways to approach the pricing requirement.
  • Review the demand for your product offerings – Periodically every business should review its product lines and services, to understand the profitability generated.  The natural result will be an emphasis on the most profitable activities; while de-emphasizing the less profitable or money loosing activities.
  • Remove discounts offered – Discounts have their place, but more often than not, they are used incorrectly.
  • Manage the vendor expense closely – Unchecked, vendor expenses can quickly become out of control. Are you spending more than you should be with your current vendors?
  • Review the profitability of customers – Obtaining a customer that becomes unprofitable is a common situation.  It only becomes an error of management if you do not periodically review these relationships, or ignore the results.

At this early stage, take advantage of the time you have to make adjustments to your business model to help absorb the shock and continue to thrive.  If you review the six areas listed, but are unable to find cost savings and efficiencies, you may need to fall back on either Option #1 or Option #2.

 

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Business Disruption Survival Techniques

Establishing a twelve month budget/business planand a business continuity plan are still the best ways to prepare a business for the most probable known threats. But what can you do for unanticipated shocks that negatively affect your ability to achieve your profit goals? When companies are faced with unanticipated situations, that threaten their business, and they realize these disruptions are not short-term issues, they may need to employ “business disruption survival techniques.”

Examples of situations that few saw coming include – The sudden drop in the per barrel price of oil, i.e. NYMEX closing price $99.75 (6/30/2014) vs. $52.78 (02/13/2015), negatively impacting oil and gas companies, and the businesses that support them. Union disagreements and work stoppages at US ports along the West Coast, negatively impacting the inventory of many businesses that sell imported goods. This situation is believed to be resolved, after nine months. The climb in the value of the dollar against most currencies, resulting in exports becoming more expensive, while imports become cheaper.

In reacting to these shocks, businesses implement three main types of cuts, for the sake of temporary relief, i.e. expense personnel, expense non-personnel and investments. If not done correctly, these approaches may do more long-term harm, than good. Activities are as follows –

Slash budgets (Personnel Expenses) – As personnel expenses are the largest cost associated with every business, targeting this expense is usually the first move. This tactic includes implementing hiring freezes and job eliminations.

Additional approaches include salary freezes; bonus reductions; and reducing or eliminating the company investment in the employee, i.e. usually related to education subsidies. More often than not these approaches will leave you with a large exodus from among the high performing dis-satisfied employees that can move to your competitors.

A popular technique which I believe is a big mistake is to provide a stay bonus to a select few. The message relayed with this last strategy, “If you did not receive a bonus, you are not considered critical to the organization.”

Slash budgets (Non-Personnel Expenses) – In the short-run, fixed expenses cannot be slashed, i.e. rent, insurance… The target of this tactic is usually variable expenses, i.e. marketing. But during this time of a disruption, marketing is very important to bring in new sources of revenues.

Delay Investments (Revenues) – To preserve cash during tough times, companies may place a hold on investments until the difficulties pass. But why would you wish to delay the opportunity for revenues, associated with a new product or service?

To avoid the slash and burn mentality, establish an environment of constant review and analysis. Do not wait until you are forced to make a large correction. Make small adjustments to your business, continually along the way. Suggested areas to monitor include –

Review Client Arrangements – Obtaining a customer that becomes unprofitable is a common situation. It only becomes an error of management if you do not constantly review the situation to understand the returns.

Review Products or Services – Periodically every business should review its product lines and services, to understand the profitability generated. The natural result will be an emphasis on the most profitable activities; while de-emphasizing the less profitable or money loosing activities.

Review Accounts Receivables – If you extend credit to your customers, which is required for almost all businesses, a certain amount of bad debt will result. At a certain point, you will need to ask for what you are owed. Resolving this bad debt efficiently and quickly, while not disrupting the possibility of future business from the customer takes tact and experience.

Understand Variable Expenses – Review your needs – Contracts represent your needs at a point in time, i.e. when they were executed. It makes sense that a contract will include items you no longer need – understand needs; understand pricing alternatives; seek opportunities to bundle; and avoid the warranty trap with new technology.

Consider Business Management Practices – The solution to counter an underperforming small or medium-sized business is a redesign. Interestingly, the method to redesign a business is the implementation of standard business management “best practices.”

Continue to Review Investment Opportunities – A company should only allocate cash to the most profitable uses, with the highest return on investment, which will provide potential distributable benefits to its investors, within the shortest amount of time.

Survival will be based on your ability to shift quickly, but strategically.

You can never plan for external disruptions, but you can prepare. Do the analysis today.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

CFO Concerns 2015

In 2015, the CFO will continue to be tested in a challenging market.  After the Great Recession, growth has not returned to pre-recession levels.  The macro-economic environment is anything but stable.  In addition to individual concerns that are industry or market specific, following is a selection of issues that face all CFO’s regardless of the organization industry, size or geography.

Brand Protection – A new area of concern and focus will be brand protection.  Not the brand protection associated with intellectual property.  While that concern does exist with the growth of on-line market places, the brand protection in this context relates to avoiding blemishes to your brand associated with vendor mis-management.

In the normal course of business, companies purchase inputs for their products or services from external vendors.  Interacting with vendors is critical for all businesses.  However, third party vendors create a certain level of risk that should be controlled and managed.  What would be the impact on your organization if your vendor fails?

Consider the following – Defective air bags from a vendor are causing recalls to be issued for Honda, Toyota, Nissan and General Motors Co.; faulty ignition-switches are central to General Motors recalls and  a lawsuit.  One year after the announcement of a strategic partnership, an Apple vendor filed for bankruptcy.  Hackers breached the systems of both Target and Home Depot by going through vendors of the respective companies.

Update – Apple Watch: Faulty Taptic Engine Slows Rollout, WSJ (4/29/2015) – “A key component of the Apple Watch made by one of two suppliers was found to be defective, prompting Apple Inc. to limit the availability of the highly anticipated new product, according to people familiar with the matter.”

Vendor Management should be a part of your Business Continuity Plan.

Regulation and Taxation – The adoption of increased regulation is associated with increased costs.  With every change an organization is required to analyze the new regulation, develop a plan to implement the regulation, develop training for current staff, potentially be required to hire new staff, and monitor implementation.  It is for this reason that time is a very important element when adopting new regulations.

Patient Protection and Affordable Care Act

Healthcare is now moving into the next phase as penalties for not covering employees are set to take effect.    With respect to ensuring compliance with the law, employers must comply with certain IRS reporting and disclosure requirements, which are important for the administration of the individual and employer mandates.  This reporting will be required beginning in 2016 for coverage provided during the 2015 calendar year.  By January 31, 2016, you must provide a notice called the 1095 to everyone who was on payroll in 2015; as well as file a form called the 1094 with the IRS.

To alleviate the burden in 2016, it is recommended that the following steps be adopted – Review IRS Reporting requirements under Sections 6055 and 6056; determine what applies to your organization; determine the information that must be gathered; develop an approach; and establish a procedure to collect and maintain the data.  It will be far easier to collect data going forward then to scramble in January 2016 to complete a form.

Taxation

In 2013, 55 tax provisions expired, of which 24 would be categorized as business provisions.  In 2014, 6 tax provisions are slated for expiration.  Of the six, three provisions relate to Alternative vehicle/fuel; while three provisions relate to defined benefit pensions.

It may make sense to review the 61 provisions, as Congress can extend them retroactively for 2014.

Debt Collection

The Consumer Financial Protection Bureau (CFPB) filed a lawsuit against a firm for its debt collection tactics ((http://files.consumerfinance.gov/f/201407_cfpb_complaint_hanna.pdf).  As stated in the law suit – “…the Firm operates less like a law firm than a factory. It relies on an automated system and non-attorney support staff to determine which consumers to sue. The non-attorney support staff produce the lawsuits and place them into mail buckets, which are then delivered to attorneys essentially waiting at the end of an assembly line. The Firm’s attorneys are expected to spend less than a minute reviewing and approving each suit.”

You cannot help but see the parallels between this situation and the robo-signing scandal relating to foreclosures which took off in 2010.  As a result of that scandal, in February 2013, a settlement deal was entered into with 13 banks over foreclosure abuses.  The cost of the settlement – $9.3 billion.

If you extend credit to your customers, which is required for almost all businesses, a certain amount of bad debt will result.  Now with the potential of legal action, it is more important to develop a strategy to efficiently and legally assert your rights of collection.

Optimizing the Business – When business is good, it is very easy to overlook inefficiency.  But if sales decline or stay static and costs continue to rise, profits must decline.  To thrive, a business must evolve and stay focused on optimizing business processes by removing inefficiencies and waste, to contain costs.

  • Focus on Cash Flow. Poor cash flow management will impact a business by constraining its ability to fill orders timely if inputs and/or inventory purchases are delayed; replacing outdated equipment; and, implementing process improvement which historically has upfront costs, prior to the savings.
  • Review product lines and services, to understand the profitability generated. The natural result will be an emphasis on the most profitable activities; while de-emphasizing the less profitable or money loosing activities.
  • Review customer/client relationships,to understand the relationship value. Obtaining a customer that becomes unprofitable is a common situation. It only becomes an error of management if you do not review the economics of each client periodically, or ignore the results after the review. If you discover that a client is unprofitable, try to correct the situation or walk away from the client.
  • Review and Improve Business Management and Production Processes. Process improvement is undertaken for a multitude of reasons which include – improve customer satisfaction, improve employee satisfaction, eliminate/contain non-value added costs.  Several back-office tasks should be consistently managed closely. More than likely these areas represent straight expense, but are critical to the successful management of any business, i.e. Accounting, Finance, Administration.

No doubt 2015 will be a challenging year.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

The Company Lifecycle

The classic lifecycle is used to describe the phases that most products go through, i.e. Introduction, Growth, Maturity, Decline. Products move from one phase to the next phase in succession. The most successful products move slowly through each phase.

Similar to a product that has a lifecycle, companies have a lifecycle.  The company lifecycle includes Introduction, Growth, Redesign, Maturity, and Merger & Acquisition. The goal of any business is to completely avoid the decline phase. During the decline phase it is not uncommon for a successful business to be acquired by a larger entity. But companies do not move from one phase to the next phase in sequence. The most successful companies will constantly shift back and forth between the growth to redesign to the maturity phase.

For a company, the phases are as follows –

Introductory Phase

This period is characterized by a heavy marketing focus. The company consumes cash to establish and build a brand. It is possible to lose the profit focus and instead be driven by revenues and customer acquisition counts. Pricing is set to promote client purchase. Within the business itself, staffing is low. Multiple tasks are being performed by a few individuals. These individuals may be required to manage different aspects of the business, which are not representative of their primary skill set. It is in this phase where a large number of start-up entities perish.

Growth Phase

A victim of its own success, a company grows production and distribution rapidly. The company reacts to the sudden increase in business and creates processes that are inefficient; contracts are signed quickly, increasing the potential for error; employee overhead rises through increased overtime or additional headcount; and cash outlays jump to manage the increased business.

Redesign Phase

In this phase the focus turns to stream-lining processes and cost containment. Interestingly, the method to redesign a business is the implementation of standard business management “best practices.”

  • Focus on Cash Flow. Poor cash flow management will impact a business by constraining its ability to fill orders timely if inputs and/or inventory purchases are delayed; replacing outdated equipment; and, implementing process improvement which historically has upfront costs, prior to the savings.
  • Review product lines and services, to understand the profitability generated. The natural result will be an emphasis on the most profitable activities; while de-emphasizing the less profitable or money loosing activities.
  • Review customer/client relationships, to understand the relationship value. Obtaining a customer that becomes unprofitable is a common situation. It only becomes an error of management if you do not review the economics of each client periodically, or ignore the results after the review. If you discover that a client is unprofitable, try to correct the situation or walk away from the client.
  • Review and Improve Production/Service Processes. Process improvement is undertaken for a multitude of reasons which include – improve customer satisfaction, improve employee satisfaction, eliminate/contain non-value added costs. A non-value added cost is an expense that is incurred, but does not add to the value or perceived value of your product or service. Simply stated, it is a cost your customers will not want to pay. Instead you will assume the cost out of your profits. Company owners should attempt to protect their profit margins by eliminating or containing non-value added costs.
  • Review and Improve Back-Office Processes. Several back-office tasks should be consistently managed closely. While more than likely these areas represent straight expense, all are critical to the successful management of any business.
  1. Accounting Management tasks include – Processing accurate state and federal filings; producing timely monthly financial statements; managing cash flow, i.e. receivables and payables; and responding to senior managers’ ad hoc questions.
  2. Financial Management – Providing critical financial and operational information to partners, with actionable recommendations on both strategy and operations, will allow your business to maximize profits: developing budgets/plans and analyzing financial variances to plan; installing a system of activity-based financial analysis; and managing vendor relationships to control expenses.
  3. Risk Management – A solid risk management program will reduce the probability of business disruptions, i.e. ensuring maintenance of appropriate internal controls and financial procedures; implementing financial and accounting “Best Practices;” and establishing metric(s) for each risk with corresponding tolerance range(s); and implementing a process of the timely distribution of critical success measures via a scorecard.
  4. Strategy Development – Analyzing business initiatives to determine expected cash flow, i.e. opening/closing offices, asset acquisition, new service launches; projecting impact of relationship pricing over time; and implementing processes that may open up new sources of business, i.e. sustainability, business continuity, engaging past customers.

Maturity Phase

In situations where offerings are similar, differentiation must be established at the company level. Why would consumers buy from me vs. my competitors, if I offer similar products? In this situation the company must adjust the value it delivers to customers, i.e. its value proposition. The answer to the question – you should buy from me because my product/service is superior and my knowledge, experience and customer service expertise will provide you with enhanced benefits.

As mentioned previously, the most successful companies will constantly shift back and forth between the growth to redesign to the maturity phase.

What phase is your company in?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Expense Control through Vendor Management

A primary role of a Chief Financial Officer is to oversee long-term budgetary planning and cost management; as well as oversee cash flow.  It stands to reason that if an expense does not add value to a firm, it should be eliminated.  Unchecked, vendor expenses can quickly become out of control. Are you spending more than you should be with your current vendors?

At different points in my career I have been asked to review the expense side of the company’s Income Statement, specifically vendor costs.  The following approach has been utilized successfully many times over to achieve real savings, from vendors of all sizes –

  • Analyze Vendor expenses – understand the flow, i.e. fixed, variable, and seasonal. 
  • Review the contracts – Are you receiving all services and/or features that you were expecting?  It is not uncommon for technology agreements and/or data agreements to promise everything, but fall short of expectations. 
  • Review your needs – Contracts represent your needs at a point in time, i.e. when they were executed.  It makes sense that an expiring three year contract will include items you no longer need. 
  • Understand pricing – Is pricing today different from when the agreement was established?  What is the pricing from your vendors’ competitors, for new accounts?  Consider in your analysis the cost of conversion, i.e. cost to substitute one vendor for another. 
  • Seek opportunities to bundle – At times a vendor will seek more revenue opportunities by migrating to related services.  Are there cost savings for bundling, that you may benefit from?

Avoid the warranty trap with new technology.  Every new piece of equipment starts with a two year warranty.  When the warranty is close to expiring, you will be offered a warranty extension.  Depending on the price of the equipment, extended warranties may not make sense.  Consider replacement costs.

Decide based on the data you have collected what the proper fee is, for the service or product in question.  Contact your Vendor’s Sales representative and request a concession/discount to obtain your target price.  Do not threaten to leave or reference your data.  A good sales person already knows what competitors offer.  Be prepared to negotiate.

As a policy, review agreements at the time of renewal, at least every three years.  Prior to signing any agreement, be sure you discuss service expectations.  Require that all automatic renewal language, be removed from your agreements.

What is your experience?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.