SETTING THE COURSE
review your business model
Why is a business successful? Let’s introduce the concept of the Valuable Formulae which helps explain why any given business is successful. The success of a business is dependent on its business model and good business models have a Valuable Formulae. A Business model will answer the following questions:
• WHAT products or services you sell?
• WHO buys them?
• WHY they buy them?
• HOW you make a Profit out of the transaction?
There are two specific aspects of the business model that we really need to understand. Firstly, HOW does your business make its money, and secondly, WHY do customers buy from you. If you clearly understand these two things you have identified your Valuable Formulae. Your customers come to you because… convenience, location, after sales service, you are the only real choice, you have a unique understanding of their business, your product/service is the best value for money and no one else can supply it and so on. There is always at least one reason why a customer will buy from you, and these reasons vary over different market segments. In relation to how you make a profit, what is it you do that allows you to generate a margin over your costs? Do you have lower costs, and if so, why? Can you command a price premium, and if so, why? It is hard to go into business and generate revenues, but what is it about your business that makes these revenues profitable? Both of the above add up to your Valuable Formulae.
And here is the real rub. In good times many businesses take their Valuable Formulae for granted — or even worse, they are not really aware of just why they are successful. However, when the external environment is changing, the dynamics of your Valuable Formulae can change and adverse outcomes can emerge. Those businesses with a “weak” Valuable Formulae are going to feel the pain quickly, and those with a strong Valuable Formulae may find this could erode due to the changing circumstances and the business will come under pressure. Your grip on the market will slip and this will manifest itself in reduced margins, loss of market share and declining profitability.
The key point is this. You must re-examine your Valuable Formulae and make sure what you are doing is relevant to the current market place, because if you are not doing the right things strategically, the right things will not happen in the rest of your business. Working harder and harder is not going to overcome a broken Valuable Formulae.
GETTING THINGS SHIP SHAPE
Modify Operations
Once you are sure your strategy is valid, consideration needs to be given to certain operating parameters to cope with the economic crisis. The key ones are highlighted below:
Impact on products and services
• Careful management of inventory levels will be needed as demand for your products may decline and you could end up holding excess inventory with this tying up much needed working capital.
• A close look is also needed at research and development and product development activities. If a project is not going to provide a short term return, you should seriously look at deferring it.
• Become best friends with your suppliers and communicate with them regularly. These are the people who become first port of call if things get a bit tight, and they react better if they know what might be coming rather than finding out when the problem has reached a critical point.
• Remember your customers may also be struggling. Focusing on their customer service needs during rough times can put you a boat-length ahead of your competition.
Impact on marketing and sales
• Review marketing expenditures closely but avoid the temptation to just cut this back. Be selective and consider using on-line marketing as a substitute for traditional channels. It is a lot cheaper and very effective.
• Avoid the temptation to cut prices to get the sale. Cutting prices cuts Profits and you need Profits to generate cash. The only circumstance when discounting is justified is if you have a serious cash crisis and you need to liquidate inventory simply to get cash flow in. Look at offering payment terms, bundling in other products, extending warranties and other price maintenance measures. It is easy to drop prices and hard to get them back up again.
Impact on systems and processes
• There are many reasons businesses spend on IT. For some, it is when an item is so old that it has rusted, others have a rotation based replacement policy (e.g. three years for a desk top), others have a policy about following a new software release (e.g. they upgrade to the latest version of Windows within 12 months of its release). At the end of the day investment in IT should increase revenues, reduce costs, and increase customer service or increase productivity. In the current climate take a hard look at IT spending. Do not cut expenditures on core systems, redundancy or disaster recovery. Murphy’s Law will get you and this will be very costly. But have a close look at trying to get another year out of existing equipment. Okay, you will not get the efficiency gain or even the customer service increase, but in the short term will this make that much of a difference?
• Look for increased internal efficiencies. There is always a smarter way to do something and necessity is the mother of invention. Now is a great time to identify the wastes in your processes and eliminate them.
Impact on your crew
• Communication with the team becomes more important now than ever. People are fearful for both personal and professional reasons. Fear results in speculation and conjecture and these are your enemies. Let your team know what’s going on honestly and openly. When people know the goal and the clear action plan to deal with the situation, they feel better about participating in the changes that are necessary and will contribute innovative ideas to support the ongoing success of the business. This may be an excellent time to introduce team advisory boards.
• Consider your recruitment activities and possibly look at contract or part time solutions. This may not be the best long term solution but it gives you flexibility, which is a major weapon in tough times.
• Salary increases are always a contentious issue. We are probably going to see an increase in inflation (with governments putting all this money into the system), and there will be growing expectations of increases at least to offset inflation. People are working hard but it is more important you protect the business so that they have jobs in the long term. Consider one-off bonuses instead of pay increases and other non-monetary rewards for the hard work and dedication of your team.
• We’re all motivated in different ways, knowing what makes your team tick will help you determine the best rewards for your team. Introducing flexibility in working hours, working from home, changes in benefit programs or a simple "Thank You" may be what your team is looking for.
BATTENING DOWN THE HATCHES
(Manage For Cash)
At the sharp end of things is the need to manage for cash. If you can’t pay your bills, no matter how profitable you are, you will crash and burn. There are many tactics that can improve cash flow. Some of these are short term and one-off measures. However to resolve any cash crisis you must have the right Valuable Formulae and you must operate the business sensibly. You can only squeeze the lemon once, but if you work on growing a healthy lemon tree there is a sustainable availability of lemon juice, hence the need for the right strategy and operations.
Getting Your Balance Sheet Right
Many businesses have a poorly structured balance sheet and pay the price for it. Assets are financed from both debt and equity and the right balance is needed. As things get tight, try and move your balance sheet to having more equity and less debt, as this reduces risk, and also reduces the servicing costs. Equity is more expensive as it carries a risk and hence demands a higher return but it is more forgiving in terms of servicing in the short term.
Financing Capital Expenditure
Assets should be funded within the lifespan of the asset, in particular those with short life spans. There is nothing worse than still paying off a loan relating to an asset that has worn out. It is important to match the asset life to the funding cycle. Conversely paying off assets quickly may draw too much from free cash flow and restrict other business development activities. A lot of businesses pay for assets out of cash flow, e.g. computers, and over time there can be a lot of working capital tied up in capital assets.
Manage Sales Lead-To-Cash Cycle Time
Sales lead-to-cash cycle is the time it takes from marketing a product to receipt of cash. Put simply, it’s the number of days from initial investment (marketing) to payment in full. This is often quite a long time, much longer than you realize. Consider carefully launching a marketing campaign that will take a long time to have cash deposited into your bank account. It might be better from a cash flow point of view to do something with an existing campaign.
The part of this cycle that is usually a focus is credit management, and in tougher times, a review of your credit policy and how this is followed is vital. Look for signs that customers are in trouble. You should review the accounts of slower payers to see if you should be tightening the terms and maybe going “cash on delivery”. If they were having difficulty paying you in good times, they are more likely to become a bad debt risk in bad times. Also, watch for customers who don’t comply with payment terms they have agreed to.
Implement Supply Chain Management
Improvement in cash flow management can be achieved by reviewing your supply chain management. There are three primary areas where you can find improvements:
- Supplier management, i.e. your relationship and terms of trade with suppliers
- Inventory management, i.e. look closely at inventory turnover by product lines, consignment stock, Just-in-Time ordering systems
- Workflow management, i.e. bringing greater efficiency into your production processes
Know what is going on with your key suppliers. If they get into trouble do you have a backup to ensure that there is no interruption in receiving the goods and services you need?
Other ways to Manage Cash
Implement spending policies and controls by setting authority levels and making it clear who can order items
Lower operating expenses by reviewing suppliers e.g. power, telecoms, freight, travel. (Remember these businesses will also be hurting and will really want your business.)
Adopt a culture of cash preservation and cost control and as a fish smells from the top down, this has to start with the boss i.e., you must lead by example.
STRENGTHEN YOUR RELATIONSHIP WITH YOUR BANK
Know your bank covenants and understand what you need to do so that your company will be able to meet these covenants. Complying with your bank covenants and debt obligations is the best way to stay on the good side of your bank. However, this may not be possible during a downturn, especially if your business has seen a drop off in revenue. If your business will not be able to meet its bank’s covenants and/or you are going to need their help, it is important that you sit down with your bank manager as soon as possible. When you do this, have a viable plan ready setting out how you are going to get the business back on track. Do not go to your bank with your hand out and no plan for how the business is going to move itself forward! Your bank manager doesn’t like surprises. Also, if you leave your bank manager out of the loop too long, it may be too late for your bank to help you when it does find out about your company’s current situation. As a result, your bank may take aggressive action to recover their current loans. Be proactive, your bank is an important partner in helping your company be successful.
REVIEW YOUR FINANCING OPTIONS
If your company requires financing in the next year or two, you will probably find it will be more difficult to obtain and more expensive. Lending institutions are working to get their balance sheets in better shape so any new loans will come with stricter covenants. A company’s existing credit facility may even be reduced when it comes up for renewal. You should be looking at options now rather than waiting until you may need the financing. As discussed previously, there are strategies that you can undertake to reduce financing requirements? E.g. the sale of redundant assets, speed up collection of accounts receivable or reduce discretionary spending to name a few. Review your current financing agreements to see if any assets pledged as security can be freed up to be used as collateral at a later date. Given the current loan balances outstanding, your financial institution may not require as much security. As mentioned previously, build your company’s equity. This will provide a buffer against declining revenues since available credit may be limited.
THE WIND IN YOUR SAIL
(POSITION YOUR BUSINESS TO TAKE ADVANTAGE OF NEW OPPORTUNITIES)
It may not be all bad news. In any business environment there are opportunities and businesses should not lose sight of this. In economic downturns there may be more opportunities available to your business than in normal times. These will be available to those companies that are well positioned to take advantage of them. Oppor tunities may include purchasing a business at a discounted price that will complement your existing business. Competitors may become unable to service your market providing an opportunity to expand your customer base. Property and equipment that will enhance your business may become available at discounted prices. There may be an improved climate for recruiting quality people. These are some of the opportunities that may make themselves available in the next twelve to eighteen months. Companies able to take advantage of these opportunities can enter the next upturn in the economy in a stronger position than they entered the current slowdown. However, don't lose focus on what you need to do to manage your company through these times and don't over-leverage your business.
IN CONCLUSION
Be prepared! There are a wide range of predictions of how long this slowdown will last and how deep it will get. The only thing we can say at this point is there is no clear picture of when the economy will turn around. We do know that it will. Credit will become easier. Pent up demand will drive an increase in the appetite for goods and services. Businesses need to be cautious during these times, but also need to be aware of the opportunities that come available. With proper planning and execution, businesses can weather this economic storm and be stronger once it ends.
