Finance Does Not Live In Isolation

Finance does not live in isolation, an interesting concept. There are two important ramifications to that concept, first, you cannot look at your company’s numbers just for now, or just for this year. As a matter of fact, not even just for this year and last (unless, of course, you just started last year). Rather, you need to look back at least three years. You do so in order to see the trend lines of how you arrived where you are now. Are you improving or declining? If for example, your cash cycle is 145 days, what was it three years ago, better or worse? If better, work to understand what you have done right. If worse, dig down to find out what is going wrong.

The second ramification of the opening statement above is a question: what is your competition or industry doing? You need to know how you compare to your competition, whether you are a local or national player, dig out information about the rest of the industry. From the example above, what if the industries cash cycle average is 95 days? Can you see how you may have trouble competing in an industry that is far more efficient than you in keeping cash flowing through your organization? A longer cash cycle will mean that you must tie up more cash in working capital, rather than investing in other ways to improve business.

There are any number of online researchers that can provide you with industry information for you to use in viewing how your business stacks up against the competition. I prefer Bizminer, an online research company, because they break down their research in ways that are very useful for a small business. For example, you can do research on a statewide basis, and many of their reports are narrowed down to a small area, such as a county. In addition, their reports are broken out into different revenue categories, allowing you to narrow down your comparative information to your industry sector.

A last word, when comparing your company to your industry, do the comparison over the same timeframe that you are using for your company review. That is, if you are going back three years to see what your trends are, it is important to look at industry trends for the same period, to see if you are trending in the same way. This can give you another important clue on how your financial picture is shaping up.

Never leave your numbers all by themselves!

Did Someone Say Competitive Advantage? A Great New Book on Strategy

Did Some Say Competitive Advantage? A Great New Book on Strategy

“Did someone say competitive advantage?” In a booming voice, Dr. Chuck Bamford started his class on strategy, a capstone piece in the Notre Dame Executive MBA program. I was fortunate to follow this class with Dr. Bamford, and it has made a big difference to me.

Now Dr. Chuck has written a book entitled, “The Strategy Mindset”. In creating this pared-down tome, Bamford has distilled his wisdom on strategy to its essence. The book is easily read, but more importantly, presents a clear, logical and winning formula for doing strategy right. I know, because I have used this formula with several companies, always to great success. I have been waiting for Dr. Chuck to create this volume for some time now.

The author is a straight talker, and begins with some myth busting. He pulls no punches when he takes issue with a number of ideas about strategy, including some of the more common myths of the day, such as trying to be the low cost leader. He not only takes issue with these myths, but cogently explains why they don’t work.

In the rest of the volume, Dr. Chuck takes you step by step though strategy, presenting an overview of the model that is both strong and easy to understand. He begins with the importance external analysis. Many a business has been started with an idea, but if that idea is not based on a sound understanding of the market, its’ players and dynamics between them, the idea will probably not come to fruition.

The author then turns to an internal analysis of the company in order to understand what about the company makes them stand out in the marketplace. This is not a “My people are my advantage exercise.” Rather he seeks an understanding of what within the company creates the advantage, in order to focus resources on those facets.

The next stage of Dr. Chuck’s process is the creation of a one-page strategy map that make crystal clear what each person in a company must do for all to achieve success. To those that protest at the simplicity, Dr. Bamford insists that with proper preparation, if the exercise of creating a strategy takes more than two days, you are doing something wrong. The elements of the strategy map are:

  • The Value Driver: what creates value for the customer.
  • Stakeholder Statements: what you want the stakeholder to say about the company.
  • Need from the company: what we need to make this happen.
  • Must do individually: what I need to do to make this happen.
  • Metrics: how we will measure success.

I don’t often make endorsements, but I cannot speak highly enough of this book. You need to acquire a copy of The Strategy Mindset by Dr. Chuck Bamford today!

Be Thankful for What We Have

Several days ago, my wife was sworn in as an U.S. citizen in a ceremony in Chicago. Having dealt with the government bureaucracy throughout, we did not have high hopes for the occasion, but were pleasantly surprised by the ceremony that took place. Along with the 140 other new citizens and several hundred friends and families, we sang the national anthem and recited the pledge of allegiance. We watched a video about immigrants and also a music video with the song, “Proud to be an American”. The new citizens recited the oath to their new country.

For me, the highpoint of the ceremony was when the new citizens came forward to receive their certificate of naturalization. Of course, this is the digital age, so there were several new citizens taking selfie-videos of themselves receiving the certificate.

The person that impressed me the most was a gentleman in his 60’s, who really looked the part of an immigrant; neatly dressed but somewhat grizzled, with the rough hands of one who had done manual labor for many years. When he received his certificate, he held it aloft in both hands as high as he could reach to show it to friends and family across the room, and then began jumping up and down in a dance of sheer joy, a wide smile on his face. This was an important moment in this man’s life!

Of course, bureaucracy was on display that day as well. It took longer to check in the 141 prospective citizens than the actual ceremony. The Bulldog noted several quick changes in process that could have cut the time in less than half, but I kept my peace that day.

Afterwards, my wife told me about a comment that one of the bureaucrats made during the checking in lineup. Seeing the long line waiting to check in, she asked how many were there. When she was told that it was 141, she said, “Wow, why so many? Are they giving something away for free? I want some!” My wife had the right thought, but she did not verbalize at the time. I will now, “Ma’am, you’ve already got it, and you don’t even know!”

What the bureaucrat had was the liberty and blessings of being an American citizen. Unfortunately, at least at that moment, she seemed to have forgotten that fact. Many do, including myself from time to time. The freedom to live as I would like, to be an entrepreneur and build a business that supports my family and my community. The freedom to express myself and my ideas. We often take these things for granted, and often it is immigrants who remind about these freedoms.

To quote Churchill, “”Democracy is the worst form of government, except for all those other forms that have been tried from time to time.” (From a House of Commons speech on Nov. 11, 1947).

 

Unintended Consequences

Business agility demands that a business be ready to react quickly to their environment in order to take advantage of change. However, there are times when a fast change results in unintended consequences. Many are the stories of plans gone awry, even when well researched and grounded in fact. All the more reason not to make snap decisions that can take your business in the wrong direction. Here are some questions that can help you discern the difference.

Are we equipped to handle the change? There are many companies that are the victim of their own success. Something that seems like a good idea turns out to be a great idea, to the point that the company is unable to keep up with demand. Before making a change or introducing a new product or service you need to ask several questions. The first is about volume, do you have the infrastructure to keep up demand? The second is about resources, do you have the people to keep up with the demand.

What would we do if demand was 2 times what you predict? 10 times? 100 times? Using hypothetical numbers allows you to analyze what effect different scenarios might have on your business. You may discover that up to a certain point, you can handle the new business or increased volume that a change may foster, but nothing beyond that point. If that is the case, you may want to introduce the change or new product to a smaller segment of your clients or the market.

Is the change based on fact or a hunch? It is true that there are those that can study a market and get a “gut-level” sense of what is going on. Generally speaking, I would not believe that of myself, and you should be skeptical as well. Is your hunch based on research and data, or is it based on anecdotal evidence but not supported by more extensive research? Getting to market with a new product or service includes doing a certain amount of research to back up the hunch.

Do you have a Plan B? If the new product or service does become successful beyond what you can handle, do you have a Plan B in place? Plan B can include outsourcing on a temporary basis, or using temporary staff to fill in. Be ready for success beyond what you predict.

These simple questions can help your business avoid unintended consequences on the road to success.

Great Customer Service is No Accident

Nothing brings out the bulldog in me more quickly than poor customer service. Recently, the bulldog has had too many occasions to come out! In one case, a company website where I was trying to pay a bill was not working. The site was quite rudimentary for a $6 billion dollar company, with no help function at all. When I called the only number listed on the site, I went through the “pass you on” routine, with lots of hold time during which I was told how important I was to their company.  Finally, I reached the office of the right person to talk to, but she was on vacation. I sincerely hoped that she would make it back from vacation else I might never be able to pay my bill online (or anyone else, for that matter).

In another instance, a well-known delivery company left me a form to sign to have a package delivered on the second attempt. I even called the company to let them know that they could leave the package in the foyer and that I would sign the form. The next day, I found a second form next to the first. When I called this time, the customer service person could not tell me what happened and passed me on to the local terminal.

After a couple of tries, and more messages about how important I was, I reached the terminal manager. The manager explained to me that company regulations did not allow them to leave the package in the foyer of my condo. To put a quick end to the story, about fifteen minutes later when I removed my teeth from his leg (figuratively, of course), he agreed to have the package left as I had requested.

Customer service should be in the DNA of every company, and it does not happen by accident. Based on my experience, both as a customer and as a service provider, here are some guidelines to great customer service:

  1. Every employee of a company is potentially a customer service agent. Even amid the myriad choices in a company’s voice response system many people get through to one employee or another. Therefore, all employees must be trained and ready to handle customer service at a triage level, that is, be able to understand the problem and get the customer to the right place the first time.
  2. There should never be a circumstance where the only person who can solve the problem is not there. When there is a technical problem, multiple experts must be on hand. For a small company, this may mean having experts on call. With today’s technology, reaching a person who can solve a problem should not be a problem.
  3. Customer service representatives must be given reasonable authority to solve a problem. Repeating company policy is not a solution. Nor is saying, “My supervisor is not here right now, he will call you back.”
  4. At the very least, customer service representatives, supervisors and managers must learn how to ask questions and listen, not only to understand the problem, but ascertain what the solution is that the customer wants.

Finally, a suggestion to all companies: please stop using the “your call is important to us” routine!

DuPont Analysis: The Numbers Don’t Lie

Over the years that I have been working with small businesses and entrepreneurs, I have discovered that there is no better way to judge the health of your company than through financial analysis. As the title of this blog states, the numbers don’t lie. A good financial analysis can lead you directly to the source of any problems within your business. Yet, many small business owners and entrepreneurs don’t spend a lot of time on financial analysis, or only do so superficially.

In my experience, one of the best ways to analyze you business’ financials is based on a method developed early in the 20th century, the DuPont Method of ratio analysis. The method was created by F Donaldson Brown, an employee of the DuPont Company, as a way to manage General Motors . The DuPont Method was considered the standard until the 70’s, although I still find it a very useful tool.

The DuPont Method introduces a pyramid of ratios with Return on Equity at the apex (click here to download a file). At each level of the pyramid, the method deconstructs ratios into their constituent parts. For example, Return on Equity is composed of Return on Capital multiplied by Leverage. Return on Capital and Leverage are then decomposed into their constituent parts and so on.

The key highlight on financial ratio analysis is to see how financial operations drive value. Some finance people refer to this model as the value drivers model; others, as the financial levers model. The former see value drivers as the explanation of how an entity makes money and increases its value, hence the term “value driver.” The latter view financial ratio analysis as the method for identifying the triggers of financial results, hence the term “financial levers.”

There are three different types of ratios within a DuPont analysis: profitability ratios, activity ratios and solvency ratios. Profitability ratios analyze whether or not you are making money, and why. The question why is the most important part of that inquiry. Many are the occasions when an entrepreneur or small business owner will say to me, “According to my Profit and Loss statement, I am making money. Why is my bank account empty?” Profitability ratios will help to answer that question.

Activity ratios will help you understand how efficiently your business is operating. For example, if your business turns over its capital 3 times a year, but your competition does so 5 times a year, you could be at a competitive disadvantage. In other words you will find it harder to compete because the competition used its capital more efficiently.

Finally, solvency ratios will tell you whether or not you have the financial wherewithal to stay in business. There are many businesses that are the victim of their own success. A business that has a great product or service that others want to buy may expand so rapidly that they don’t have the capital resources (money) to keep up with the expansion. Solvency ratios will help you understand where you are in terms of capital resources and how fast you can grow.

So, tune in for the next three weeks as we take on the DuPont Method.

i Project Management Accounting, Callahan, Stetz & Brooks, John Wiley and Sons, Hoboken New Jersey, 2007
ii Ibid.

It’s Cash That Counts

Next week I will begin a series about a financial anlysis tool known as the Dupont Analysis. To set the foundation, I am repeating this Blog about cashflow, because it introduces the capital blance sheet, which is integral to a Dupont Analysis.

I was working with an entrepreneur in startup mode, and was once again reminded of the difference between profits and cash. Particularly in startups, but also in more mature companies that achieve a breakthrough of some sort, mistaking profits reported on an income and expense statement with cash in the bank could be a crucial error. How do people make this mistake?

They do so by not taking into account the timing of cash flows. Remember, an income and expense sheet is reporting sales and expenses as they are booked for accounting reasons, but the cash flows that accompany the sales often do not happen at the same time.

For example, unless they are in retail, most companies do work on a credit basis (when retail accepts a credit card payment, they deposit slips like cash, so there is no extended term). You may not think about that way, but terms like Net 30 or Net 60 are nothing more than extending credit to your clients. In other words, your company is financing your customers’ purchases. The longer that it takes to be paid by your customer, the larger the debt that you finance.

Every company has a cash cycle, and depending on the business that you are in, there are more or less components to that cash cycle. Let’s take a company that distributes materials to other businesses. Here is a view of their cash cycle:

1. Purchase materials on credit terms (Net 30, 60, etc.) from suppliers
2. Hold in inventory
3.Repackage and sell to customers on credit terms (Net, 30, 60, etc)
4. Paid by customers
5. Pay suppliers

Now, this is a simplified cash cycle, but you get the idea. Obviously, if your customers are slow to pay you and you must pay your suppliers, you could be in for a shortfall of cash. Actually, one of the greatest risks to a startup or small company that is trying to grow is running out of cash while the business is expanding quickly. We should also note that there are other expenses (salaries, benefits, office space or utilities) that must be paid even if your customers are not quick paying you.

That brings us to the concept of Working Capital. Working Capital is the amount of cash that your company needs to have available in order to keep the cash cycle going or better put, to keep the company going. Working Capital is usually tracked in a type of spreadsheet known as a Capital Balance Sheet (which is a bit different than a Balance Sheet).

In a regular balance sheet, capital is kept above and debt below. In a capital balance sheet, a certain portion of debt is brought above. Here is the outline of a how to calculate Working Capital in a simple capital balance sheet:

Receivables (what your customers owe you)
+ Inventory
+ Current Assets
– Payables (what you owe your suppliers)
= Working Capital

Working capital represents the cash that a company needs to keep on hand to operate with receivables, inventory and payables. Receivables represent the cash that you have invested in materials and financing your clients. Payables are what your suppliers have invested in your company.

If the company sells $10,000 worth of materials in a month, 50% at Net 30 and 50% at Net 60, it means that they will not collect any cash for at least 30 days (if the customer pays on time!), and some of it not for 60. Even so, after expenses they might show a net profit of $1,500. There’s the rub, the net profit is not cash in the bank! If the company has bills to pay this month (or salaries) they must use the cash flow from previous sales to pay.

A startup company, in particular, will have problems if as they grow they do not have adequate cash in the bank to pay for expenses while waiting for cash to flow from sales. Often, a portion of the original investment capital in a new company is put aside for Working Capital; other means of having working capital at the ready could include a line of credit.

This is precisely what is meant by being adequately capitalized. Working with investors, bankers and others, the company’s executives must ensure that they have the cash in the bank to operate or they will literally be “out of business”!