Everybody loves a winner

One recurring theme from the analysis of losses made in the financial sector is that in many instances 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 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.

 

Beware of Greeks bearing debts

 

“If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem” the famous quotation from JP Getty neatly sums up the dilemma faced by the international community in dealing with the Greek debt problem.

 

Following Sunday’s election in Greece the stock market in Athens has suffered a fall of10%.The biggest losers were bank shares with Piraeus Bank down more than 20%.

In the two sessions following the election, banks have seen 23% of their value wiped off, with investors fretting that the possibility of Greece leaving the euro would see bank accounts converted back into a new Greek national currency.

The sharp movements came after new Greek Prime Minister Alexis Tsipras said in his first cabinet meeting that he planned to negotiate with creditors over the €240bn (£179bn; $270bn) bailout.

In spite of the hard line talk it will be no surprise to see realpolitik coming into play and a fresh compromise being offered to the Greeks, in effect kicking the problem further down the road.

 

The fact is the international community will have to learn to accommodate the spectre of countries failing to grapple effectively with their debt burdens. In turn this will inhibit growth and impact upon the speed and strength of global economic recovery.

 

It will be an uncertain time but one undisputable outcome of the above will be the hard ball attitude of banks towards companies seeking funding.

 

It will become ever more necessary to demonstrate effective control over all areas of cost and exposure as the banks will undoubtedly remain cautious providers of finance.

The bullies are in evidence again

 

During recent years many companies focussed on the element of supplier’s credit as they sought to improve their own bottom lines.

 

By virtue of their purchasing power large corporations such as the supermarkets are able to squeeze their suppliers.

 

It is the SME’s who are feeling the pressure most acutely. The average small business is owed £31,000 in overdue payments, amounting to over £30 billion across the UK economy.

 

The UK has late-payment laws that give small businesses the right to charge interest, but many avoid doing so for fear of upsetting customers.

 

The EU issued a directive in 2013 which aimed to enforce similar measures across the union, with public bodies given 30 days to pay and businesses 60.

 

Cash flow is a vital element for any business and timely payments are crucial for small businesses trying to grow.

 

Over the past couple of years many companies have lengthened payment terms seeing the suppliers as a soft target. As many as 17% of suppliers claim that they have been subject to intimidation over payment terms by their buyers.

 

There is evidence that the bigger the company, the harsher the terms. For example chocolate manufacturers Cadbury and Mars are now seeking payment terms of 120 days from their suppliers.

 

With suppliers consistently facing a declining return it should come as no surprise when they conclude that the game is not worth the candle.

 

The dragon pauses to catch its breath

Since 1978, China's economy has doubled every eight years. Today, the average Chinese person has some ten times the purchasing power they had just a quarter century ago.



China was the engine room powering the global boom of the early 21^st century.

However there are signs now that the Dragon is catching its breath.

 

Growth in the world’s second largest economy in 2014 missed its official  annual growth target of 7.5% for the first time in 15 years albeit that the actual figure of 7.2% was higher than most analysts had forecast.

 

European markets are crucially important to China but with European economies in a fragile state the implication for exports is obvious and the continuing pressure on the euro could result in a decline in export growth in the months ahead.

 

Caveat emptor

After a process lasting two years the Serious Fraud Office has closed its investigation into alleged wrongdoing following the 2011 takeover of UK technology firm Automony by Hewlett-Packard.

 

The SFO has concluded that based on information available there is insufficient evidence for a successful conviction.

 

A year after the takeover HP were forced to write down the value of Autonomy by $8.8bn (£5.9bn), having bought it for more than $10bn in summer 2011.

 

Meg Whitman, the chief executive who took over as the acquisition was being completed, blamed a "wilful effort" to inflate the company's figures, and that they "severely impacted HP management's ability to fairly value Autonomy at the time of the deal".

 

The numbers are truly eye watering and begs the question that during the due diligence process how many auditors examined the validity of the reported accounts?

 

Despite the decision by the SFO Hewlett-Packard continue to pursue the legal battle in the US as they attempt to “hold the architects of the Automony fraud accountable”.

 

How well do you know your customers

 

In just a few short years, rapid advances in technology have transformed the way we all conduct business.



Much of business is today conducted in the so-called virtual world of paperless trading. However, we should never forget that essentially commerce is about people trading together.



Whilst computer “stop loss” mechanisms are the order of the day for “paper trading” the reality of the real world is that goods need to be moved from point of production to point of consumption and obviously this cannot be achieved via a computer terminal.



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

 

One of the biggest problems associated with the rise of e-commerce has been the accompanying lack of personal contact between a company and its customers.



Obviously this is not an issue for an online retailers selling products over the net and being paid via a Debit Card or Pay Pal etc.



However, there is an increasing tendency for B2B sales to be concluded by email or even SMS. The personal element has been lost and so has the identity and customer relationship.

 

The surest way to avoid problems is by knowing your customer and understanding their business.



It is simply not possible to nurture this relationship and mutual understanding thru a key pad and email ordering system.

 

 

The real cost of cheap food

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.

The latest casualty is the UK dairy industry. Global milk prices have fallen 50% in the past year to an 8 year low. The NFU said in December that the number of UK dairy farmers had dipped below 10,000 for the first time - a 50% fall since 2001.This reflects the worsening conditions for producers some of whom are currently faced with accepting a price of 22 pence per litre of milk versus a production cost of 28 pence.

Looking back 25 years ago, British people spent about 22% of their disposable income on food .In 2015 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.

 

 

Biting the hand that feeds you

 

The old adage the customer is always right has come in for a fair amount of scrutiny recently and there are many times when plainly the customer is in the wrong.

Notwithstanding it is of paramount importance to the sustained growth of any business that the customer is kept onside.

The key requirement that any customer wants is to feel that his/her business is valued and appreciated.

In business securing the deal is only the start of the process and the repeat order very often stands or falls with the after sales service (or lack thereof).

 

Simple but effective measures such as ensuring all contracts are performed efficiently and within due time and that any complaints are handled promptly and with courtesy will go a long way to building and maintaining long lasting relationships.

There will always be the difficult customer with whom it would be easier not to deal. However, in these difficult times there are many who would willingly take this “problem” and revenue off of your hands.

 

 

Keeping costs in check

 

 

As operating margins continue to be squeezed it is imperative that all costs are rigorously monitored. Left unchecked escalating operating costs have been the death knell of many businesses.

 

Every commercial sector is seeing the impact. A prime example is the area of transportation. Wherever possible exporters are moving business from air to slower and less expensive forms of transport.

 

Manufacturers of electronics and mobile phones are now shipping cargo by sea because competition was eating into their profit margins meaning they needed to cut delivery costs.

 

Exporters of perishable goods such as fruit, vegetables and flowers have little choice and as such face a diminishing return.

 

Non-perishable goods will continue to be shipped on water as the cost of moving by air is very energy-intensive and despite the recent falls in jet fuel, the costs of air freight remain high.

 

Facing marked resistance from consumers to price increases and a greater level of competition those companies who are unable to exert a firm control over their costs face a difficult future.

 

 

Commercial realism

 

There is a growing trend for companies to bully their suppliers over the question of payment terms. It is not unusual for buyers who hitherto had paid on the basis of 30 days to now demand switching their suppliers to 90 day payment terms.  The food processors Heinz have informed their suppliers of a “switch” in payment terms from the previous 45 days to an extended 90 day cycle.

Such terms can only be served by larger organisation with adequate cash reserves.

For the small to medium supplier it further ratchets up the pressure as banks are unwilling to increase their credit lines.

This is not a new phenomenon. For some time companies have sought to stretch the length of their payment terms by all manner of means both fair and foul.

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.

Ignore the warning signs and they will bite you

 

The hackneyed response from recalcitrant debtors used to be that “the cheque is in the post”. This generally bought some time as generally suppliers met this response with a weary resignation.

Times have moved on and the latest mantra is “its set up for next week’s payment run”.

Basically the name of the game remains the same, buy some time - achieve a payment extension thereby effectively squeezing the supplier’s margin.

 

Obviously it is a difficult balancing act between keeping the customer happy and managing your own company’s cash-flow.

However, we are all operating in difficult times and it is vital to keep full control of receivables.

Delays in payment will impact on the bottom line; however the worst scenario is that neglecting to strictly monitor a failing company could result in a total write off.

 

Shining a light

One of the conclusions arising from the foreign-exchange rigging scandal was that the regulators such as the Financial Conduct Authority were blind to institutional wrong doing.



This was not the case of an isolated “rogue trader” but was corruption on an industrial scale as witnessed by RBS who in addition to having paid fines to the regulatory body are now investigating up to 50 members of the staff for their part in the market rate rigging between 2008 and 2013.

The integrity and reliability of any organisation’s reporting structure are vital to its long term survival. All too often risk controls are lax or can even be ignored in the pursuit of profits.

 

It can also prove a false comfort to rely on the findings of the auditors.

As we have seen some of the financial instruments employed by the banks were so complex that even their own architects could not fully understand the full implications.



Even with the most rigorous reporting procedures any company is still heavily reliant on the calibre of the people operating the business and recording each and every transaction diligently.



A prudent exercise for any organisation is to regularly assess and test the systems in place for monitoring risk both transactional and counter party to judge that they are fit for purpose. At long last both the banks and the regulatory authorities are waking up to this.

 

 

Driving sales

 

The only way to grow your business is by increasing sales and revenue.



The following are some suggestions for achieving improved sales growth:



Concentrate efforts on broadening the customer base. If you are not adding customers then your business will stagnate.



Increase sales turnover by persuading buyers to purchase more. It will also benefit sales by increasing the frequency of transactions per customer.



Be alive to market trends and spikes in demand which will allow for an increase in the sales price.



Always concentrate your efforts on serving your premium customers i.e. those who are loyal and regular buyers.



There is no benefit to be gained from dealing with customers who show no loyalty and abuse payment terms.



Time spent on these accounts could be more profitably utilised in dealing with worthwhile accounts.



Essentially the more ideal customers the better your business.

 

Spotting the fault line

The overriding lesson from the calamities in the global financial mess was that monitoring systems were inherently flawed.

 

Exotic trading products and programmes were created which like the Frankenstein monster quickly became uncontrollable. Risks were taken on an unprecedented scale and those supposedly monitoring risk were “asleep at the wheel”.

 

Recklessness was encouraged and became the default position. There were no checks and balances – it became for the participants in the so-called casino bankers a safe bet.

 

What’s the worst that could happen following a spectacular flame out? Maybe you lost your job and had to move to another bank or institution. Get it “right” and the rewards were sky high.

 

Whenever there is a bonus culture unless the supervisory systems are rigorous there will be potential for abuse.

Apart from the self-inflicted wounds the general public also paid the price for this flawed culture.

 

One whistle-blower at Barclays was quoted as saying “It's a very high-pressure environment. The way we are paid means there is a lot of emphasis on getting people to invest more of their savings in the stock market than they should.' He added “Some of the things we sell —such as structured products — are rubbish.”

A little like bolting the stable door after the horse has bolted the regulatory authorities have now decided it is time for a closer scrutiny on bank, building society an insurance company staff being paid commission on sales.

 

This follows years of obvious laissez faire when for example it was quite normal for people to borrow based on self-certification of earnings, a recipe for disaster if ever there was one.

 

Whether through greed or stupidity there will always be people willing to take potentially catastrophic chances.

 

 

Avoiding burning your 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.

 

Reviewing your business plan a worthwhile 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.



An analysis of the current inventory levels and receivables will provide the answer to the future growth and capital requirements of the business.

Danger signals

 

Very few companies explode like a super-nova the warning signs are usually visible for some time ahead.



The following is a basic check list which should help to determine whether the problems are of a temporary nature or have more serious implications for the future of the company:



The most important element in any business is maintaining a healthy cash flow. It is imperative that a strict control is maintained on all outstanding invoiced amounts.



The value of an efficient credit control system cannot be over emphasised.



Do not focus on generating sales with little margin in the belief that over time things will improve. Being the “cheapest supplier” will not provide an automatic route to more satisfactory profits in the long term. It is often better to keep your powder dry.



If you are constantly in danger of breaching your credit arrangements with the banks or suppliers this is a clear indication that the company is not trading satisfactorily.



As conditions deteriorate more and more time is spent focussing on the problems and not enough on to how to position the business for the future.



Particularly for owners of SME’s it is not easy to take the necessary remedial actions and very often this is where an outsider can be of assistance in repositioning the business before it is too late.

 

Fraud the ever present danger

 

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.

 

Cash-flow the life blood of a company

Credit control has never been more vital. It must be a priority that all businesses ensure that their customers are settling invoices on time.

 

With slim operating margins the norm, very few companies can afford the spectre of significant bad debts.

 

Small businesses in the UK are owed billions of pounds in late payments, but new research has shown that a third are reluctant to chase slow-paying customers because they are worried about upsetting them or feel embarrassed.

 

Four in five, SME’s say they avoid chasing debtors because they find the process 'uncomfortable', while the remaining 20% are afraid of antagonising customers.

 

This is a dangerous approach resulting in more than a third of UK SMEs reportedly writing off thousands of pounds of bad debt every year.

 

The following are some procedures which companies can employ to increase the efficiency of credit control.

 

Set credit limits for each customer and review these regularly.

 

Be concise in trading terms for example it is better to specify 30 days from date of invoice rather than 30 days from end of month.

 

Issue monthly statements detailing invoices paid and those outstanding.

 

Score your customers and set a collection policy accordingly.

 

Do not let overdue payments go unchallenged.

 

Evaluate aged debtors on a weekly basis.

 

Prioritise collections and press for settlement of the highest values first.

 

Have a plan of action if payment is not forthcoming within a set date.

 

Despite the vital importance of maintaining a healthy cash flow three quarters of SME’s do not have a person or a procedure in place for chasing bad debt and a vast majority have no established escalation process for late payments. This is a recipe for disaster.  

 

Efficient control of stock turnover

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.

 

Carrying stock ties up money. This money is either borrowed and carries an interest charge, or represents funds that could otherwise be better used in servicing other elements of the business.

 

There are additional costs in holding stocks such as storage and the risk of getting spoiled, breaking, being stolen, or simply going out of style.

 

Wherever possible companies need to reduce stock holdings and there are various means by which to achieve this aim:

 

Liquidate slow-moving or obsolete stocks.

 

Introduce more efficient production techniques to reduce stock holdings.

 

Rationalise the product range weeding out the under performers and thereby reduce stock carried.

 

Negotiate sale or return with suppliers in order to avoid being stuck with unwanted product.