Avoiding burnt fingers

 

With the plethora of companies coming to the market much focus is being placed on EBITDA– earnings before interest taxes dividends and amortisation.

EBITDA has increasingly become the key metric to show the "intrinsic operational performance" of the business, i.e., the performance when all costs that do not occur in the normal course of business (e.g., restructuring costs, ramp-up costs, consulting fees for special projects, special legal fees) are ignored. While this is helpful in general, it is often misused by declaring too many cost items as "one-offs" and thus boosting profitability.

Many of the companies have as yet only traded at a loss and based on their history, there is no basis for concluding that these unprofitable companies will ever make money.

That’s the stock in trade for a company about to float whilst losing money. If it were making a profit before its IPO, it would be harder to make bullish forecasts about how much profit the company will generate in the future.

Ironically for a company losing money, the sky’s the limit when it comes to predicting how bright its future revenues will be.

In tandem with the ability to forecast a spectacularly profitable future is the functioning of one of the market’s most basic laws: momentum. In other words powered by its own performance a stock that is gaining value up will continue to appreciate in value just because it is going up.

More specifically, when there is no real positive cash flows on which to value a stock, its price will rise because investors who do not own the shares will want to climb aboard the bandwagon rather than miss out.

This wave of “new buying” can help to drive up the shares further, which will attract a new buyers creating a dangerous bubble.

It would probably be a more prudent strategy to avoid the money-losing IPOs and invest in companies who are making a profit before they try and float their shares.

However forecasting the price of stocks remains an inexact science and unfortunately for the investor there is as yet no failsafe basis on which to explain why stocks go up and down.

Effective stock control

For suppliers and manufacturing companies alike the efficient management of stock is a vital element of their business.

In many cases business failures can be traced back to the inability of a company to turn its stock back into cash within an acceptable time frame.

It is worth noting the costs associated with carrying stock:

Holding stock ties up working capital with otherwise could be used for other purposes therefore it has an opportunity cost.

All stock being held incurs storage costs such as rent and other utilities. Insurance especially for high value goods also is an expensive add-on.

If goods are being funded via a Bank overdraft or loan this may well inhibit the company’s ability to finance other activities as Banks are reluctant to extend terms.

There is always the danger that stock can become obsolescent or in the case of perishable products deteriorate and become a write off.

The only way to ensure that a company keeps track of this area of exposure is by constant monitoring of stock levels and focussing on unusual or irregular patterns in the movement of stock.

 

Charity begins at home

 

There is a growing pressure on suppliers to accept extended payment terms if they wish to retain the business.

Companies who previously had accepted 30 day payment terms are now requesting periods of up to 90 days.

Such terms can only be served by larger organisations with adequate cash reserves. For the small to medium supplier it further ratchets up the pressure at a time when banks are unwilling to increase their credit lines.

It has been general commercial practise for companies to try to stretch the length of their payment terms by all manner of means both fair and foul.

However as profit margins are further squeezed by increased operating costs the importance of maintaining cash flow is vital.

Business is hard-won in the current climate, but above all there has to be a commercial raison d’être for any transaction.

Mutual reciprocity has to be the basis for the Customer/Supplier relationship for it to remain worthwhile.

 

Tesco - every little helps

 

The fallout from the revelation that Tesco had been overstating their profits has and will continue to be immense. Following their mea culpa on Monday the market responded with a sell-off which wiped £2 billion off of the value of the company.

The scenario has become all too familiar over recent years. Companies seemingly enjoying a never ending run of profits and nobody willing or prepared to ask the difficult some might say obvious questions.

The initial statement referred to accounting errors in the previous 6 months which then raised questions about the validity and integrity of previous results.

In the only course of action open to the management of Tesco they launched an independent enquiry. This will not only focus on the role of Tesco senior management but also their auditors of long standing Messrs PWC.

How many times has the scenario played out? Loose governance, directors preoccupied with their own bonus structure, Auditors not getting to grips with the fundamental issues of the business they are auditing.

Either the figures are wrong through incompetence or deliberate falsification it can only be one of these two issues.

In smaller companies it is not unusual for management under pressure to resort to “massaging the figures” whilst unacceptable business practice it does not have the implications that accompany the Tesco situation.

The damage to shareholder confidence and the brand itself is incalculable. It will be difficult to rebuild trust from either the market of its customers with the overhanging feeling that there may well be more skeletons lurking in the cupboard.

Don't neglect stock control

Efficient stock control can limit the effects of problems in the supply chain whilst at the same time reduce the amount of capital which is being tied up with excessive stock.

Many companies have adopted the “just in time” ordering policy and as a result have little or no buffer stock.

Whilst this does translate to a reduction in working capital and lower storage costs there are potential problems such as the inability to deal with an unexpected spike in demand.

This policy also means that the purchasing company has little control and is therefore reliant on the efficiency of its suppliers.

The other side of the coin is to maintain a relatively high level of stock holding which ensures that the company never runs out of material and may afford some economies of scale by bulk buying.

As with all things it comes down to a judgement call.

The best measure is stock turnover ratio equals cost of goods sold during a specific time frame, divided by the average stock holding during the period.

The result of this ratio gives the "number of days that on average money is tied up in stocks". The longer this is, obviously the worse this is for the business as the money is not available to be used elsewhere.

An stock turnover ratio of 20 means that the average amount of stock holding during the year has been renewed, or turned over, 20 times over the course of the year.

Dividing the number of days in the period under consideration by the turnover ratio tells you how many days it takes, on average, for the warehouse to empty and then be refilled. The number of days in a year, 365, divided by 20 is 18.25. So the entire stock is fully sold and replenished every 18.5 days, on average.

As a general rule, the higher the stock turnover ratio, the more efficient and profitable the firm. A high ratio means that the firm is holding a low level of average inventory in relation to sales.

 

Never underestimate the value of the human touch

Technology continues to revolutionise the way in which we do business. Business practises have changed markedly in recent years and will continue to do so.

Although many operations are completed electronically in this virtual world we should never forget that essentially commerce is about people trading together.

The reality of the real world is that goods need to be moved from point of production to point of consumption and obviously the diverse elements which make up this chain cannot be achieved solely via a computer terminal.

It makes sound economic sense to foster and maintain good customer relationships.

It has been determined that it costs up to five times as much to win a new customer as it does to retain one.

There is an old adage “know your customer,” this dictate has never been more important than in these competitive times.

 

Wake up call

 

The demise of the telephone company Phones 4U illustrates some harsh truths about operating in today’s business climate.

To the outside world the company appeared to be a successful entity. At the time of going into administration the company had a turnover of over £1bn, EBITDA of £105m for 2013 and significant cash in the bank.'

However a closer scrutiny of the company showed it was heavily burdened with debt and reliant on its suppliers to ensure its long term survival.

Once Phones 4U lost the support of their suppliers they were essentially finished. Without product to sell there was no business.

Although a rather extreme example it does highlight the need for companies to acknowledge that it is a two way street. Notwithstanding the importance of the buyer (end consumer) it is paramount that dealings with suppliers are maintained on a fair and equitable basis.

Many companies rely on operating on a “just in time basis” which can leave them particularly vulnerable if there is any disruption to the supply chain.

For any business relationship to grow there has to be mutual reciprocity and understanding of the other party’s situation.

Be it constant delay in payment or unreasonable requests it is not surprising that suppliers decide that some business accounts aren’t worth the candle. When a supplier decides that enough is enough there is not always a readymade alternative

Push your sales

Focus on niche markets - there is an advantage in positioning your company as a market leader in a niche market.

Target a niche market that drives the greatest sales, profitability and quickest sales cycle.

This will produce sales growth with the least amount of effort. Niche market leaders generate strong sales revenue and profit growth driving up the value of their business.

Promote your products - drive increased sales growth by offering customers bespoke packages such as volume discounts, extended contracts or product bundles.

There is no merit to be gained from discount pricing on your offerings if they truly provide the value described.

Develop your brand - unique design, functionality and technology can make your products proprietary, which can increase the desirability of your products/services and the price a buyer is willing to pay. Branded products offer protection from the competition and enabling sales of products at a higher price and profitability.

Highlight your USP - even if your company are offering products that are not proprietary, it is vital that customers recognise what makes your company different to the herd.

When you do this successfully, your company becomes the first choice and achieving sales targets will not be an issue.

Jettison underperformers - the best way to dramatically lower your costs and improve profitability is to shed underperformers. Evaluate all of your products and services and delist them if they are not profitable or helping to drive sales of your other products.

Ensure that marketing is delivering a positive return on investment. Less easy is the evaluation of the sales team but in reality underperformers are a luxury no organisation can afford.

 

Fraud - don't be a victim

One of the lessons of the recent economic downturn was the need for all businesses and organisations to remain alert to the potential for fraud.

Entrepreneurial owners of SME’s are a prime target for fraud as overseeing finances doesn’t always come naturally to them. If a founder is focusing mainly on the product or service being sold, and only minimally on administration, it leaves a business vulnerable to fraud.

In smaller organisations fraud can take many forms e.g. invoice scams, to suppliers providing kickbacks for inflated purchases, theft of stock, fictitious expenses etc.

For larger organisations the potential for various fraud activities exists but the numbers involved are far greater.

It is vital that all organisations have systems in place to monitor all of the company’s finances and commitments in a clear and concise format.

Simple but effective systems of checks and balances can go a long way to limiting if not removing the risks.

It is all but impossible to ensure that any organisation is “fraud proof” but by establishing robust and efficient systems some measures of comfort can be introduced.

Competition is hard enough without having to face another drain on your company’s resources.

Go East young man

In the 1860’s the American author Horace Greeley adised “Go West young man”. Today he would undoubtedly change his advice to go East.

Chinese GDP is surging on the back of consumer spending. Within the next decade China’s GDP is set to exceed US$28.3 trillion versus a forecast for the US US$27.4 trillion.

The ability of the Chinese to play the long-game has never been in more evidence.

In a single decade from 2001 up to 2010 Chinese trade with the rest of the world increased from£325 billion to £1.9 trillion.

Since 2005 China has invested £320 billion across the globe with 75% of this in developing countries.

There is an insatiable demand for raw materials to fuel the economic growth in China and commodities such as Oil, Minerals, Precious Metals and Fuel are the prizes for these investments.

The ongoing crisis in Western economies has provided ample opportunity for China to assert its economic strength and China has now usurped the US as the largest foreign investor in Germany.

Chinese companies are investing in such diverse areas as the French Wine industry or making acquisitions in the US/European Food Industry and this will undoubtedly continue as China accelerates its move into Western markets.

China says it wants to back major UK infrastructure projects and has recently signed £14bn in trade deals.

The projects the state-owned China Development Bank (CDB) wants to invest in include High Speed 2 and the next generation of nuclear power stations.

A major deal between BP and China National Offshore Oil Corporation is worth about $20bn (£11.8bn).

At the same time China has continued to extend its influence in Africa. In the latest development China has agreed to give Nigeria a $1.1bn (£700m) low-interest loan to build much-needed infrastructure.

The money will help build roads, airport terminals in four cities, and a light-rail line for Nigeria's capital.

China will continue to invest heavily in Africa at it relies on it for oil and other natural resources.

The growth of China will continue to stimulate Asian economies .Similar rapid growth is expected in India where its consumer market is predicted to overtake that of Japan by 2024.

 

Better late than never

Following the scandal in 2013 where horsemeat was passed off a beef the UK government commissioned a report whose findings will now lead to a Food Crime Unit especially set up to investigate fraudulent trading in foodstuffs.

At the time of the so called “horse gate scandal” the Chartered Institute of Purchase and Supply reported that almost half of supply chain managers “do not have a means of monitoring their entire supply chain”.

Even more damaging was their comment that “how few chief executives and boards take supply chain issues seriously”.

Initially the effects of the horsemeat scandal were dramatic. In the first two months following the reports of horsemeat being found in ready meals sales of these products were down 5% year-on-year, frozen food sales dropped 13% and there was a fall of 3% in chilled ready meal value sales.

One of today’s buzzwords is “traceability” – it being incumbent on companies to monitor all aspects of their supplier’s performance with failure to do so having far reaching and damaging consequences.

In the eye of the storm it appeared that the days of a “cosy” relationship between Buyer and Supplier, the archetypal nod and a wink would have been consigned to history.

Nobody faced any penalties or sanctions for what was described as the worst scandal in the history of the UK supermarkets.

This new unit operating under the umbrella of the Food Standards’ agency will have the power to ensure that the safety of the UK food supply chain is not compromised.

 

Who’s getting a free ride?

 

In this current climate more and more customers are actively delaying payment to suppliers. Slow payers monopolise profits and starve creditors of much needed cash.

Accordingly policing of receivables is critical.

When a customer exceeds the agreed payment terms, they are in reality using the supplier as an alternate (unsecured overdraft).

Left unchecked this situation can easily spiral out of control so that in a worst case scenario the supplier is forced to keep “supporting” the errant customer for fear of realising a bad debt.

Take a long hard look at your accounts receivable – are you happy to see 30 days drift into 60 and beyond?

Not only is the profit margin eroded but the risk to the company is severely heightened. Sound companies do not need the financial support that comes from pinching credit.

Evaluate your customer’s performance and then ask “who is getting a free ride?”

 

The danger of short termism

 

The pressure to deliver quick results to the potential detriment of the longer-term development of a company has become an entrenched feature of the UK business environment.

It has become a very damaging business approach.

Short-termism curtails ambition, inhibits long-term thinking and provides a disincentive to invest in research, new capabilities, products, training, recruitment and skills.

There is no doubt that the main reason which precipitated the financial meltdown was the slavish following of short terms goals which hitherto had been labelled “get rich quick” schemes but have been shown to be the very opposite.

The problem facing the business community now is as companies struggle with funding issues and the spectre of more corporate failures it becomes increasingly difficult to focus on long term objectives as opposed to satisfying the immediate requirements of the shareholders.

 

Don’t shoot the messenger

 

One recurring theme from the analysis of losses made in the financial sector is that the management were totally unaware of the risks which their institutions were running.

To be effective, risk management and risk controls rely on the people operating them.

As has been well documented all too often the corporate culture is dominated by fear and greed and these together make for a toxic combination.

When strategies fail and trading positions spiral out of control these two elements come very much to the fore. Fear can often lead to individuals embarking on an even more reckless course of action in the misguided belief that it will all come right – the gambler’s doubling up mentality.

At the same time recklessness is often driven by greed; the larger the risk the greater the reward should it prove to be a successful course of action.

Against this background it is incumbent on the management to ask the uncomfortable questions and not merely rely on the assurance that all is well and going to plan.

It is always worth remembering that if something looks too good to be true it invariably is.

 

Time for housekeeping

 

The ongoing debate about the timing of higher interest rates will inevitably result in consumers reigning in their spending. Accordingly many businesses not least the leading supermarkets will face a difficult time.

Without doubt now is the time to tackle potential problem areas with some effective housekeeping.

One of the first areas for scrutiny is the level of inventory which the company is carrying. It is imperative to ensure that the best level of Stock Turn is achieved and the company and that you are not carrying any obsolete stock. Rather than face a “fire sale” it may well be prudent to lighten up now with some innovative marketing strategies.

How is the company’s cash position? With the backdrop surrounding financial institutions and Governments alike, the banks will not readily provide additional finance- it is an absolute priority to maintain positive cash-flow and this can only be achieved by keeping debtors under control.

Those organisations that fail to maintain strict controls will fail and now is the time to do everything you can to ensure your company doesn’t become one of the casualties.

Engaging the workforce

Working with companies over the past months there is a noticeable sense of demoralisation amongst many sectors of the work force.

The causes for this are readily identifiable, many people are struggling with their own domestic finances whilst at the same time the need for increased levels of performance and efficiencies at work have rarely been as intense.

It is the responsibility of management to ensure that during these times staff members are encouraged to give of their best.

Too many managers are remote from the day to day activities of their staff and appear to have the attitude that the people who report to them are lucky to have a job.

This mentality is counterproductive. Staff need motivating and incentives do not necessarily have to come solely in the form of financial rewards.

Some of the best run and therefore by definition most successful commercial entities are those where the workforce is engaged and feels part and parcel of the organisation rather than merely there to make up the numbers.

 

Trust - the overriding business requisite

With fiercely competitive trading conditions the question of trust is of paramount importance.

Operating margins are being squeezed and people are looking for ways to protect their bottom lines.

As we saw last year with the meat contamination in “Beef products” there will always be those who disregard regulations or flout the law in the belief that they will get away with it.

Consumers should have absolute confidence in what they are buying. The responsibility for that lies with the retailers, who need to be absolutely sure that what they're selling is what they think it is.

It boils down to the integrity of the supplier, no matter how many factory audits are conducted or how many QA questionnaires are completed it is essentially an issue of trust and reliability.

The same can be said of the buyer, if goods are delivered on a credit basis this should mean that the supplier has every right to expect that the agreed settlement terms are adhered to.

Any good relationship takes time and effort to build and sustain, once the question of trust is damaged it is hard, sometimes impossible to restore.

 

A benefical exercise

 

As business practices change and external factors come into play a regular review of the company’s business plan will ensure that the company stays ahead of the game.

The review if done correctly should result a realistic, objective and clinical appraisal of the business.

Following an analysis of the business plan it should be easier to communicate objectives and strategies to those funding the operation and also to the company’s employees.

The review will serve as a reference point when determining the effects of alternative courses of action on business operations.

A clear assessment of current working practices should highlight areas where the company may require outside assistance.

At the same time an analysis of the current inventory levels and receivables will provide the answer to the future growth and capital requirements of the business.

 

Hard sledging for SME's

Latest figures show that bank lending to small and medium enterprises fell by another £435 million in the second quarter of 2014.

This further underscores that although banks are willing to lend more the situation for SME’s remains difficult.

The Bank of England recently commented that lending to “small businesses remains constrained with little change in banks risk attitude”.

Having suffered the consequences of their previous reckless attitude to lending the banks remain cautious in their dealing particularly in respect of lending to small and medium size businesses.

After the spectacular failure of their previous policies, there was always likely to be an excessive over reaction on the part of lenders.

The tragedy for many small businesses is that they are being strung along whilst banks prevaricate about increasing facilities and in the meantime much damage ensues.

Now more than ever any application for funding must be accompanied with a stand-up strategy together with evidence of strict control over all elements such as cash-flow, debtors and stock turn/ inventories.

In this current climate, the banks will look to any shortcomings and or operating deficiencies as justification to turn down increased funding and or to reduce or even call in previous agreed facilities.

 

A true and fair representation?

The fall out arising from Hewlett Packard’s disastrous £7.10 billion acquisition of Autonomy gathers pace. HP is now set to sue the accounting firm Deloitte on the basis of flawed accounts for 2 years prior to the takeover.

HP claims that there was a widespread fraud which saw them suffer a £3 billion loss. In this instance the numbers are huge and allegations of criminality.

However in respect of company’s audits there are many instances of conflict of interest such as taking on consultancy work for clients and becoming too cosy with management teams.

It is all too easy for companies to bully the young staffers sent in to do the grunt work.

For example what chance has a newly appointed auditor walking around a factory warehouse to adequate value stock? In reality they have to rely on the company for “valuations” and this can result in a totally inaccurate picture being presented.

The validity of a company’s accounts reflects the integrity of the company which is being audited.

As was demonstrated with the banking crisis in Spain an unrealistic valuation of the property portfolio either through deviousness or sheer incompetence will ultimately have disastrous consequences.

 

Cheap food who subsidises the bill?

In a market where prices are squeezed to the absolute and in order to protect margins suspect practices and questionable ethics will inevitably come to the fore.

The current economic reality will continue to underpin the demand for cheap food but in satisfying this demand there is a price to pay.

The combined effect of the recession, the growth in online retailing and the increased market share of discounters such as LIDL and ALDI has shaken the likes of Tesco, Sainsbury and Morrison’s. For supermarkets focussing on market share food prices must be kept down, at all costs. But in the case of farming it is such a long cycle and there is little account taken of retrospective costs for the producer.

Looking back 25 years ago, British people probably spent about 22% of their disposable income on food.

In 2014 the spend is roughly between 4 and 8%, so food has actually become cheaper.

The reality is that the 'bog-offs' - the buy-one-get-one-free deals are not actually sponsored by supermarkets. They are paid for by the producer who has to agree to them under tight terms and conditions.

As the margins of the big supermarkets fall from 5% to nearer 3% producers will be expected to absorb more of the pain.