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.

The Frequency of Best Practices with Small and Medium-Sized Businesses

Business failures are all too common.  You may be an excellent doctor, accountant, architect or engineer.  You may be a specialist in your field, but respectfully, it does not mean you know the nuances of running a successful business.  Sadly, mismanagement is one of the primary reasons for business failures.

“Best Practices” are techniques that businesses employ to control costs, stream-line processes and avoid disruptions.  Over the years I have worked for three very large companies; and worked with a great many small and medium sized businesses.  I have found that small and medium-sized businesses incorporate some Best Practices, but not consistently.  However each large Fortune 100 company I worked with incorporated best practices consistently.

On March 6, 2014, CFOTips published a quick 32 question survey to understand the existence of standard best practices in small and medium-sized businesses.  Questions were general, so the concepts would have applicability to all responders, regardless of the business model.  Select results were as follows –

  • To understand the success of your business, it is recommended that an annual business planning process be conducted.  But when asked, only 47% of responders had a long-term plan of where they expected to be in five years; while only 47% of responders had a documented, detailed business plan for the next 12 months.
  • A best practice for an entity is to annually set strategy for the coming year.  This activity requires external information to validate your approach and direction.  Interestingly, only 41% of responders conducted competitor surveys; while 59% conducted customer satisfaction surveys; and 41% conducted employee satisfaction surveys.  Only 59% of entities conducted an analysis of their place in the market, similar to a Strength, Weakness, Opportunity, and Threat (SWOT) analysis.
  • To ensure processes are efficient and reduce expenses, a best practice is to establish policies and procedures and document job descriptions.  Only 41% of responders have policies and procedures for most, if not all processes; and 59% of responders have job descriptions.
  • To ensure your cash flow is not disrupted, a best practice is to have a collections process and utilize it when required.  Based on our survey, only 65% of responders have an established collections process.
  • To reduce the risk, of fraud annually a segregation of duties analysis should be performed.  Yet only 47% of responders performed a segregation of duty analysis.  And to ensure an environment where all employees act on behalf of the company’s best interests, ethics policies should be established, with a system available by which employees can identify unethical behavior.  While 75% of responders have an ethics policy, only 35% of responders have a whistleblower program.
  • To control costs, periodically vendor agreements should be reviewed to understand what you are paying for and what you are receiving.  Yet, only 35% of responders review vendor agreements and company needs periodically.
  • But the most surprising results were related to the prevalence of a business continuity plan.  Only 29% of responders reported a documented business continuity plan for their business.

Note, as less than 100 responses were received, this information should be considered directional only.  How do you compare?

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 Supplier Marketing Program

There are multiple ways companies market themselves.  Each form is associated with a certain level of investment and return, within a certain timeframe.  One of the most effective approaches is “quid pro quo” marketing, i.e. marketing your products or services to your suppliers/vendors.  This approach can work as a business-to-business strategy, or a business-to-consumer strategy, or both.

As a business, you pay for multiple services from your chosen vendors, i.e. software, hardware, banking, accounting, stationary, mail delivery, office cleaning…  Does your business offer any products or services that may be purchased by these vendors or the employees of these vendors?  I worked with a company that implemented this type of Supplier Marketing Program.  The program was highly successful and easily adaptable to any business.

So how do you get started?  The implementation of any Marketing program has two main pieces, both of which are required to be successful, i.e. analytical review and marketing execution.  In situations where your Marketing department does not have the knowledge and experience to perform the financial analysis that justifies the marketing investment, that responsibility should fall on the office of the CFO.

Prior to undertaking this strategy, a Return on Marketing Investment (ROMI) should be calculated.  The formula is as follows – (Gross Profit-Marketing Investment)/Marketing Investment.

Analytical Review – Estimating Gross Profit

Identify the Opportunity – Develop a table of all company relationships. Include the supplier name; contract type; purpose; pricing; term; termination requirement.  Customers should be rank ordered, i.e. highest likelihood to use the product or service you offer.  Your focus should be on the best opportunity based on your relationship type; the location of the supplier and the employee count.

Quantify the Potential – Following is the standard opportunity waterfall, which changes based on factors specific to your business –

Category Factor Opportunity 1 Opportunity 2 Opportunity 3
Total Employees (Leads) 100% 100,000 250,000 500,000
Employees that are Consumers of Product/Service 50% 50,000 125,000 250,000
Current Shoppers 25% 12,500 31,250 62,500
Capture Rate 5% 625 1,563 3,125
  • Total Employees (Leads) – total number of the employees, of your suppliers, as a group.
  • Employee Consumers – employees that would use the product or service you offer.
  • Current Shoppers – consumers that are in the market today for your product or service.
  • Capture Rate – consumers that are willing to purchase from you today.

An additional category that can be added is frequency of purchase based on your business model, i.e. tax services are needed annually, mobile phone every two years, home purchase every seven years.

Marketing Execution – Estimating Marketing Investment

The marketing process has three distinct steps –

Relationship Development – Contact the gatekeeper of the Supplier account.  Present product or service benefits.  Focus on value to the company and employee retention.

Endorsement – Develop marketing plan in conjunction with the gatekeeper.  Determine how you will reach out to the employee base and the way you will reach them.  Leave behind the appropriate marketing materials.

Account Management – Execute the marketing plan.  Activities may include desk drops, attending sales meetings/events, lunch-in-learns, etc.  Maintain ongoing contact with the employee base.  Add value by offering personal touch services.  Market directly to consumers whenever possible.

At this stage you have all of the factors needed to create a ROMI.  Use this information going forward and review the actual results to plan results, to understand if this program is a success and should be continued.

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.

Tips to Mitigate Technology Implementation Challenges

Companies continually look for ways to reduce costs, facilitate sales, and increase customer satisfaction.  While there are a multitude of specific approaches that could be utilized to address each issue, all three of these objectives could be achieved at the same time through automation.  Production systems serve to increase sales efficiency and introduce cross-sell opportunities; while the implementation of back office systems serve to drive support efficiencies and remove non-value added costs.  Efficiencies that improve the sales process and/or the customer service process will result in increased customer satisfaction.

But, prior to searching for the best enterprise system solution for your business needs, establish your preliminary budget.  Consider licensing fees, development costs (external and internal), as well as the conversion costs.  Compute your expected Return on Investments (ROI), which is the ratio of income generated less dollars invested, over dollars invested in a process or product financed, to stimulate the growth of the company.  This statistic should be used to ensure that your financial resources are being allocated to growth opportunities with the highest returns.  As you get closer to selecting the new technology, these numbers should be revised.

Just keep in mind, any change in your business model will cause a certain level of disruption, regardless of the size of the system to be implemented.  If not executed correctly, the new system may cost you more than you expected, both today and in the future.  Proper planning is critical.  In my experience, the top issues which raise the cost of the development are consistent across different platforms, and not specific to the size of the company.  These are common issues associated with all technology implementations.

Issue #1 – Customization – When an off the shelf enterprise system is purchased or leased, a certain amount of customization will be required.  This customization serves to ensure a clear identification of features for the users, within the application, in the terms common to the business.  Another area that requires customization is the development of reports specific to managing the business or responding to client needs.  But all customization requires development time, that quickly raises the price of the new technology.  Be sure that the requested customizations are required.  Differentiate “nice to have” from “need to have.”  Negotiate and budget for this start-up expense.

Issue #2 – Integration – It is not uncommon for a business to be composed of a few systems with no integration.  This situation occurs when a business is growing and different departments purchase technology for their own areas, not considering the greater business.  This situation also is common for larger companies that recently experienced a merger.  It becomes obvious quickly, that different departments of the new business cannot communicate clearly with each other, as they are not all on the same platform.  Ensure that any new system is integrated within the company, satisfying the needs of a few departments.  At the very least, there should be integration between your productions system and financial system.  Integration requires development time and quickly raises the price of the new technology.

Issue #3 – Data Quality – When introducing new systems or upgrades, information maintained in either a legacy system or a homegrown database may be incomplete and inconsistent.  Information clean-up is time consuming and has an internal cost.  But correcting deficiencies today is a worthwhile project, vs. perpetuating issues in your new technology application.

Following are “best practices” to avoid these issues or at least reduce the negative impacts associated with implementing and managing new technology within your business –

Understand your Technology Needs – Assess the current needs of your customers (internal or external); while also considering their future needs.  This step may include surveys and focus groups with the users.  Flowchart the process today and identify what happens when things occur without issue.  Analyze the flow.  Are processes as efficient as they could be?  Now consider the experience when breakage(s) occur.  At what point in the flow does it happen?  How can this situation be avoided?

During this process, continue to consider user acceptance. If your system is not intuitive, external users may not wish to use it; and internal users may not transition to the new platform quickly, making conversion a long and drawn out process.

The output of this analysis should be reviewed with key stakeholders to gather their thoughts and views.  The result of this task will be a clear understanding of the business needs.  Document this information.

Next, issue a Request for Proposal (RFP) to service providers.  There are very few processes where there is not more than one supplier.  Send the RFP to at least three providers.

Develop a relationship that compliments your business – When considering a technology solution; the vendor relationship is as important as the technology being purchased/leased.  Prior to entering into any relationship, keep in mind, that there are common risks inherent with all vendors –

  • Employee quality – vendor employees requiring special knowledge, licensing, certification;
  • Privacy policy – sharing information regarding your processes and procedures, as well as customer information;
  • Business continuity – impact of a disruption in your vendor’s business on you; and,
  • Service quality – impact on your internal and external customers.

Establishing your requirements and how you will work with the vendor, prior to entering into a relationship, would be time well spent.

If the technology fits your needs; if the vendor will be a good partner for your business; and if the final budget and ROI are acceptable – it is time to draft the contract and statement of work.

As stated previously, proper planning associated with the integration of a new enterprise solution will ensure your selection satisfies the process improvement and cost containment needs of your business within the established budget, while achieving the required ROI.

I wrote this article for CIO Review Magazine-Corporate Finance Technology Special 2014 (April 2014)  The story can be found on page 50.

 

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 New Cash Management Approach – Pay Slower

Could you continue unscathed, if your customers stopped paying you for two to three months and instead paid within 60 and 100 days? On April 16, 2013 an article was published in the Wall Street Journal, “P&G, Big Companies Pinch Suppliers on Payments.” The WSJ article discussed a trend among large companies to push payments out.

If you do not have any large clients, you may not be immune to this trend.  If you provide materials to suppliers of large clients, these clients will attempt to delay payments to you, i.e. attempting to push the payment issue down-stream.

The immediate impact to your business will be the evaporation of your free cash flow.  Your ability to develop new products, make acquisitions, pay dividends, reduce debt, and hire will be greatly reduced.

So what can you do?

I recommend you anticipate the issue.  The following tactics are simply “best practices.”  If you are not affected by this trend, none of these tips will harm you.

– Increase required down payments/retainers. A non-paying customer may be worse than no customer at all, if you incur costs to obtain the business or advance funds to complete the business.

– Tie sales compensation in some form to payments received, i.e. commissions tiering and/or quarterly bonuses.  This tactic will ensure your Sales force is providing quality customers that pay on-time and they stay engaged in the collection process.

– Document and distribute payment terms that provide discounts for early payments; but late fees if payments exceed established timing.

– Stay engaged.  If you are owed, ask for payments.

Doing nothing is ill-advised, as the message relayed to your customers will be, “its ok to pay me late.”

However, if you implement the above recommendations without success, you may need to consider the following two options to address an expected cash crunch –

– Establish a short-term borrowing facility – Short-term financing based on your credit worthiness through a bank.  This option will have a cost which you may not be able to pass to your customer, i.e. negatively impacting your margins; or,

– Consider factoring – Receive an advance against accounts receivables from an asset based lender called a factor.  This option may be required if you don’t quite qualify for a traditional loan.   This option will have a cost which you may not be able to pass to your customer, i.e. negatively impacting your margins.

It will be interesting to see how the credit agencies handle these situations, as a lack of timely payments should impact the credit quality of the delinquent payers, i.e. D&B, S&P, Moody’s…

It will also be interesting to see investors’ perceptions of this change.  There are several financial ratios calculated by investors and analysts that use Current Liabilities as the denominator.  It makes sense that if payments are put-off, Current Liabilities will increase which will impact – Working Capital (Total Current Assets – Total Current Liabilities); Current Ratio (Total Current Assets / Total Current Liabilities); and Quick Ratio (Cash + Accounts Receivable) / Total Current Liabilities).

What are you seeing?

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.