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.

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.

Diversification or Divestment – Opposite ends of the same Strategy

When an entrepreneur starts a business, there is usually one product/service in mind.  They are focused on marketing and distribution.  As they grow, they begin to think about diversifying the business mix.  But whether your business sells Real Estate, Insurance or widgets, the primary reasons for diversification are to reduce risk, stabilize cash flow, and preserve a competitive advantage.  Through diversification, you can

-Ensure sales during seasons when the demand for your primary product is low.  In this situation, a firm should sell a related product that is active during business lulls, i.e. firm sells heating systems, as well as air cooling systems;

-Satisfy customer demands for related products.  One mistake in business is to refer your client to a competitor, to satisfy a need which you cannot fill.  More than likely, once they go, they will never come back.  One stop shopping for customers is always preferable over visiting multiple vendors;

-Assume control of a supply or distribution chain, i.e. Amazon begins Sunday deliveries, to increase customer satisfaction;

-Stay competitive by exploring growth opportunities, i.e. develop new markets and/or attract new customers; and,

-Balance a business which has long periods between sales with a quick sales cycle, i.e. automotive sales which may occur every five years, offering auto service which occurs every six months.

From a purely finance perspective, when investing capital to achieve growth, only commit capital to those projects that meet your profit expectations, return on investment requirements and results in a positive free cash flow position.

Profit – Funds available after total expenses are deducted from total revenues.  The basis from which taxes are calculated.  Pre-tax profits can be calculated monthly, quarterly, annually.  This value is ideal to plan annually.

-Return on Investments (ROI) – Ratio of Income generated over dollars invested in a process or product financed, to stimulate the growth of the company.  ROI is usually tracked for three to five years.  This statistic should be used to ensure that financial resources are being allocated to growth opportunities with the highest returns.

-Free Cash Flow (FCF) – Funds available after paying expenses, adjusted for non-cash items, minus capital expenditures to maintain the firm’s current productive capacity, i.e. the amount available for distributions or future growth prospects. FCF is an annual measure.

A company that incorporates a diversification strategy should be prepared to also at times consider a divestment approach.  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.  Through this exercise, you will quickly identify problems in products and service fulfillment.

When you discover a line or business that is not performing as planned, there will be three questions that need to be asked – Is the business inefficient, but can be optimized?  Is the business being managed by the correct person?  Is the activity important to the overall strategy of your business?

If this line or business is not critical to your strategy, it may be time to divest.

It is not uncommon to read the press and see an article about a company divesting of a subsidiary.  The next day, there is another press article that the same company is acquiring an entity.  There are multiple reasons why a business may divest itself of a product line or subsidiary – the business does not meet expectations of profits, return on investment, or free cash flow targets.  These success targets may have been missed due to faulty production assumptions in the planning of the new line or subsidiary; or external factors may make the business no longer profitable.  Common external factors include unexpected regulation or taxes that make the business more expensive than previously planned; or a new competitor enters the market with a lower cost of doing business.

But the greatest reason for divesting an unsuccessful line or business is to free capital, so it may be allocated to more profitable activities.

When was the last time your business mix was reviewed?

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.

Why are so many companies announcing a Turnaround?

So far in 2014, turnarounds have been discussed domestically at Radio Shack, Yahoo, Best Buy, Lowe’s and JCPenney, to name a few.  Internationally, word of turnarounds have been reported at Sony, HTC, Carrefour…   So what has caused this trend?

Simply stated, when business is good, it is very easy to overlook inefficiency and waste.  But the macroeconomic weakness that is affecting the US is resulting in sales declines; while at the same time costs continue to rise. As a result, profits decline.  A business may find itself in need of turnaround assistance based on unforeseen external factors, i.e. a natural disaster, competition, new regulation, new taxation assessed federally or at the local level.  While internally, rapid unplanned growth can be very disruptive, if the focus turned away from profitability.  This growth may have been attributed to organic growth or a merger or acquisition.

The most detailed and transparent turnaround discussed is the turnaround at Hewlett Packard –

Meg Whitman joined HP as the President and Chief Executive Officer in September 2011.  After a year of assessing the HP situation, Ms. Whitman announced a Turnaround.  At a Security Analyst Meeting (10/03/2012), Ms. Whitman attributed the need for a turnaround to several factors, including a change in the IT industry; constant change in executive leadership of the company; decentralized marketing; integration of acquired companies; misalignment of compensation and accountability; lack of metrics and scorecards to manage the business; lack of a cost containment focus; product gaps; and ineffective sales management.  The turnaround which began in 2012 is expected to take hold by 2016.

The solution to counter this situation is a redesign, i.e. a focus on stream-lining processes and cost containment.  Interestingly, the method to redesign a business is the implementation of standard business management “best practices.”  But to fully implement a turnaround, innovation and growth will be required.  Customers’ needs must be placed at the center of your decision making and a focus on business development will be required.

Start by assessing and understanding the amount of change required and develop approaches that will minimize the potential for disruption.

Superior management and flawless execution will be required.  Each member of the management team should understand their responsibility and be committed to work together as a team to redesign to turnaround the underperforming business.  A commitment to financial discipline and a returns based capital allocation strategy is required.

Going forward, managing the business should be accomplished from a data based perspective.  Any decision regarding the use of funds and or the changing of strategies needs to be quantified.  Opinions should be the basis for investigation, but data should be the reason for actions.  An executive needs to be able to read financial and production numbers; as well as understand the significance of combining the data sets to grow.  If you do not understand the drivers of revenues and expenses, or the significance of production data, any decision will be a best guess on how to proceed.

If you understand the current situation with respect to the market, competitors, customers and employees, you will be better able to develop detailed strategies that allow you to minimize weakness, maximize opportunities, and mitigate threats.

Managing cash flow is critical.  The optimal approach is to employ conservative and sound financial and accounting policies; maintain a strong working capital position; and implement accurate and responsible reporting that looks at variances to established plans.

In a turnaround situation, a “best practice” is to document and review policies and procedures; to stream-line and remove inefficiencies; discontinue manual tasks through automation; and, enhance security through segregation of duties.  The outcome will naturally be cost savings.  Circumventing established policies and procedures exposes the firm to errors, unnecessary risks and costs associated with wasted time.

If you are in a business turnaround situation, it is very easy to think the proper decision is to slash the marketing budget to cut expenses.  But, it is during these tough times that marketing and sales are the most important.  As expenses keep increasing, revenues at the very least must keep pace, or profits suffer.  Annually, new customers must be sourced.

The role of your marketing department is to collaborate on strategic campaigns and point of sale initiatives; while fostering a consistent and standard sales approach across all corporate communications and marketing efforts.

The redesign steps are as follows –

  • Communicate the need to redesign to senior managers and the board of directors, to gain concurrence;
  • Select a respected executive with the authority to cross department lines to lead the project.  This individual will be the champion of the project and facilitate the integration of change;
  • Perform a key assessment of the organization to prioritize the trouble spots;
  • Set strategy and establish a cash flow plan for the next 12 months, based on the current situation;
  • Communicate the strategy companywide, as well as the intentions to redesign companywide processes, to gain employee understanding and involvement in the process;
  • Optimize support functions; and,
  • Emphasize business development to grow.

Communicate with the Board of Directors, throughout the process.

The speed at which the process can be completed will be based on the amount of redesign required and the commitment of your management and staff to make required changes.

 

In 2014, Regis published Redesign to Turnaround Underperforming Small and Medium-Sized Businesses.  To read chapter one of the manuscript, click Here.  Recommendations so far have been positive.  To order your copy, click

Redesign to Turnaround Underperforming Small and Medium-Sized Businesses

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.

2014 Concerns to the CFO

The concern of all senior finance professionals in 2014 will continue to be the proper management of cash flow in an environment of shrinking margins and soft demand.  To foster revenues, companies will need to improve responsiveness and meet customer expectations through innovation.   Productivity advancements will come from the implementation of new technology.  To contain costs, the focus will include overall spending; technology spending; and the efficient use of marketing.   All of these actions are internal in nature, i.e. the CFO will be able to exert some amount of control.

However there are three very specific issues in 2014, which will consume the thoughts of CFO’s as they potentially have a direct impact on the cost structure of the business model.  All of these activities are external in nature.  The CFO will have little control, but will be responsible for integrating change within the organization.

Data Security – Gregg Steinhafel Chairman, President and CEO, Target announced on December 19, 2013 – “We wanted to make you aware of unauthorized access to Target payment card data. The unauthorized access may impact guests who made credit or debit card purchases in our U.S. stores from Nov. 27 to Dec. 15, 2013.”  As a result of the breach, up to 40 million credit- and debit-card accounts may be compromised.  The true impact of the theft to consumers will not be known for some time; but the impact to Target will be immediate and may include a loss of confidence by its consumers with a corresponding decline in business.  It will be important to watch this situation unfold to understand what Target does correctly vs. what Target does incorrectly.  What regulatory actions will evolve out of this issue?

Tax – On January 1, 2014, the IRS’s new requirements regarding when taxpayers capitalize vs. expense for acquiring, maintaining, repairing and replacing tangible property becomes effective (T.D. 9636).  The exact impact to your organization is based on your business model.  The regulation is complex and should be reviewed early on to maximize the benefit to your organization.

With respect to state tax, twenty-three states have either expanded or proposed sales tax nexus expansion laws, i.e. click-through nexus for internet sales.  A firm without physical presence within a state, but sells goods and services, may be required to pay sales tax to the state.  This trend is expected to continue to evolve.  Check with the tax body in the states where you operate to understand if you will be newly impacted.

Compensation – Various unrelated actions are occurring in the compensation space, which will result in this area as a main focal point in 2014 –

  • CEO Compensation Ratio – On October 1, 2013, the SEC Pay Ratio Disclosure proposal was published in the Federal Register for a 60 day comment period.  “As required by the Dodd-Frank Act, the proposal would amend existing executive compensation disclosure rules to require companies to disclose: the median of the annual total compensation of all its employees except the CEO; the annual total compensation of its CEO; and the ratio of the two amounts.  [SEC Proposes Rules for Pay Ratio Disclosure, Press Release 2013-186] From October 1 through December 2nd – 493 comments were received.  Expect the SEC to publish its analysis during 1Q2014 with a final rule published soon after.
  •  Minimum Wage Changes – Thirteen states will have minimum wage increases effective January 1, 2014 – Arizona;  Colorado; Connecticut; Florida; Missouri; Montana; New Jersey; New York; Ohio; Oregon; Rhode Island; Vermont; and Washington.  The smallest increase is $0.10/hour; with the largest increase $1.00/hour.
  • Cost of Healthcare Benefits – The cost of health insurance is evolving and should be closely watched.

The success of your business is directly related to your ability to execute on your plans, i.e. internal factors where you have some control.  However, it is important to understand external actions that may impact your business in the future, to allow for their future integration, if required.

What issues are of concern to you?

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 Three Financial Metrics Every Business Should Track

There are 100’s of ratios used to analyze financial statements if you are an investor.  Some of these ratios are specific to industries and business models, i.e. manufacturing vs. service.  Regardless, if you are the owner or a partner in an entity, there are three primary metrics that measure the financial health of your company, that should be reviewed periodically –

Profit – Funds available after total expenses are deducted from total revenues.  The basis from which taxes are calculated.  Pre-tax profits can be calculated monthly, quarterly, annually.  This value is ideal to plan annually.

Return on Investments (ROI) –  Ratio of Income generated over dollars invested in a process or product financed, to stimulate the growth of the company.  ROI is usually tracked for three to five years.  This statistic should be used to ensure that financial resources are being allocated to growth opportunities with the highest returns.

Free Cash Flow (FCF) – Funds available after paying expenses, adjusted for non-cash items, minus capital expenditures to maintain the firm’s current productive capacity, i.e. the amount available for distributions or future growth prospects. FCF is an annual measure.

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.

The preferable way to present this data is via a Scorecard that highlights Key Performance Indicators (KPI’s) that the company deems appropriate to gauge success at achieving strategic goals.  These reports are metric centric and show results over time.   As a general rule, KPI’s provide information which gives the reader a quick glance of success from a financial, operational, and risk perspective.  A successful scorecard will assist the company drive profitability, reduce costs and provide insight into risk.

What ratio do you use to track your success?

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.

Periodic Self-Assessment to Free-up Capital to Grow

“The strategic CFO and finance organization must spend considerable time and effort understanding the company’s markets and customers, competitors and suppliers. Which markets and customers represent the greatest value-creating potential? What are competitors doing, and likely to do, relative to the company’s customer base?” (CFOs: Not Just for Finance Anymore by Robert A . Howell, Wall Street Journal 11/12/2012)

Potential outcomes in response to this intelligence gathering will be as follows –

1) Do nothing, as your business perfectly aligns with the market and customer’s needs;

2) Modify the order fulfillment process;

3) Alter products and services offered; or,

4) Combination of 2 and 3.

As most businesses have a limit on financial resources available, a product or process investment will require an adjustment or elimination in the current offerings of your company, i.e. a reallocation of your working capital.

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.  Through this exercise, you will quickly identify problems in products and service fulfillment.  You will also begin to analyze the value of your largest customers.  You may notice that certain customers are not as profitable as others, potentially requiring you to change pricing.

For example – In an organization where I was employed, we reviewed credit products every other year.  How were these products performing?  Was usage as expected?  What were competitors offering?  These products were portfolio products, and a certain allocation of the portfolio was held exclusively for the product being reviewed.  If we found that the product was no longer in demand, it would be canceled, to free up capital within the portfolio for new credit products.

This strategy will help you understand if funds are being allocated properly to support the most profitable endeavors.

Interestingly, based on a recent survey conducted by American Express and CFO Research, working capital for mid-size businesses will be obtained through an emphasis on receivables – “In a survey of 275 senior finance executives at companies with $4 million to $2 billion in annual revenue, 38% said that receivables performance would be their top priority for working-capital improvement over the next year, compared to 34% who cited inventory management, and 7% who pointed to payables performance. Another 20% said that all three categories would be a top priority.” (CFOs at Mid-Size Firms Target Working-Capital Improvements: Survey by James Willhite, Wall Street Journal 5/21/2013)

These survey responses from the CFO’s are counter to what has been disclosed in the press.  Large customers have recently adopted a strategy of paying vendors within 90 to 120 days, benefiting from the use of the vendor’s cash.  Note my recent blog posting – The New Cash Management Approach – Pay Slower (http://cfotips.com/?p=513)

Alternatively, if re-allocating cash resources are not an option, you may need to consider factoring receivables, acquiring a bank loan, issuing a debt offering or issuing an equity offering, to finance your growth.

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.

Marketing Economics

The marketing department is a service that supports the Sales efforts of the organization, by providing tools to foster lead generation and customer retention. Regardless of the geographic reach, a centralized marketing department ensures consistent messaging across the organization. Additional activities should focus on identifying low cost, highly targeted approaches to messaging.

 
But this department should not be a financial drag. Most Marketing Managers create a Marketing Plan/Budget which includes a list of activities and the associated costs. This document is submitted to Executive Staff and approved. However, the lack of program justification makes it very easy to slash the Marketing budget during tough times. But interestingly, it is during these tough times that Marketing is critical.

An alternate approach is to project ROMI (Return on Marketing Investment) for every proposed activity. ROMI is simply a derivative of Return on Investment (ROI). The formula is as follows – (Gross Profit-Marketing Investment)/Marketing Investment. An example is as follows –

$600,000 Revenue from Marketing Program
$120,000 Gross Margin @ 20%
$100,000 Marketing Investment
20.00% ROMI

Programs should only be considered if they generate a positive ROMI or exceed a pre-established level. In this situation, a 20% ROMI would justify proceeding with the Marketing Investment. Now imagine all of your programs with an associated projected ROMI. Clearly the priority would include executing programs with the highest ROMI first.

Now let’s look at activities where a ROMI measure could be calculated —
• Lead Marketing – Programs that support Personal Sales efforts. For this area, a selection of brochures and materials that discuss the services you offer should be available for sales force use.

• Lead Source Management – Any sales organization should have the capability to track lead contacts centrally; as well as current customers. This database becomes the main source listing of Customers and is a focus of Retention efforts.

• Customer Retention – Programs to strengthen new and past relationships, i.e. thereby minimizing missed opportunities. ROMI should be calculated for all activities to justify their use. Sample activities include –

1. Monthly e-mail announcements with links to marketing flyers;
2. Direct Mail, i.e. targeted campaigns to leads retained in your Contact Management system; and,
3. Website / Social Media activities – please note an earlier blog post – “Is Your Company Maximizing Social Media”

Critical to the roll-out of any program, is the ability to collect pertinent data and accurately track results, to refine the process or adjust projection variables.

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.

For a Business – Cash Flow is King

Cash Flow can be considered a barometer of the financial health of any business.  An effective cash flow policy includes planning and management.  In a perfect world, your monthly revenues cover your monthly expenses and leave a surplus, i.e. a profit that increases cash reserves.  But the perfect world is a theoretical place.

In reality, businesses have cycles.  Retailers that survive lean months are able to benefit from the peak shopping season that occurs from the end of November through the early part of January.  Drug companies invest large sums of money today in research and development, to offer a medicine in the future for a finite time period, prior to patent expiration.  These are examples of industries that excel at the planning and management of cash flow.

But the benefits of proper cash flow management or the penalties of poor planning can affect companies of all sizes.  Drains on a company’s cash flow fall into two categories –

  • Controllable – expenses where management has a potential impact, which include – salaries, rent, advertising and marketing, travel & entertainment expenses.  This impact can be defined as controlling the amount of the expense or the timing of the expense.
  • Uncontrollable – expenses where management has little or no ability to impact, which include delayed payments from individuals or companies where you extended credit i.e. customers 60, 90, 120 days past due.

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.  As a result of these issues, a business may be forced to seek financing from a lender; and/or, seek outside investors.   If unsuccessful at these activities, the business may need to close its doors or sell to a competitor.

In my experience, the best way to avoid these business constraining impacts is to ensure an annual budget is established.  Subsequently, monitor actual results to understand if these results are in line with your expectations.  Monitoring should occur monthly with the results reviewed with senior management.   If needed, expectations should be adjusted to account for any unanticipated business change.

Even after all the planning, it is prudent to maintain a cash reserve cushion.  The proper size of this cushion is dependent on the business.

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.