How to burn your fingers

Ahead of a company being floated on the market  emphasis is 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.

 

 

Prioritise cash collection

 

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.

 

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.

 

Evaluate the efficiency of the Credit Control function, the best measure is Days Sales Outstanding (D.S.O).

 

DSO is important because the speed at which a company collects cash is important to its efficiency and overall profitability. The faster a company collects cash, the faster it can reinvest that cash to make more sales.

 

A relatively low DSO indicates that a company collects its receivables quickly, and a high DSO indicates the opposite.

 

Here is an example:

 

Total receivables - £4,600,000

Total Credit Sales - £9,000,000

Number of days in period 90

(4,600,000/ 9,000,000) x 90 = 46 days

In this example it takes 46 days (on the average) to collect the receivables.

 

The industry standard is for DSO to be no more than 10-15 days longer than the company’s standard terms of sale. So, if the standard terms are net 30 then the target for DSO is approx. 45 days or less.

 

The heavy cost of complacency

 

It is all too easy to become complacent particularly when a business relationship is long established.

 

Accordingly when companies fail the usual reaction is one of surprise.

 

However very few companies fail overnight and in the majority of instances there are numerous warning signals of a company’s demise.

 

When dealing with any company always rate their efficiency levels. If your dealings leave you with the impression that the company is muddled in its thinking or lethargic in its dealings then these are early indicators that the company is languishing.

 

If the staff shows a marked lack of commitment this is also an indication of a demotivated workforce who clearly sees the writing on the wall.

 

A company who is failing in its obligations to either suppliers or customers will lose business to competitors. A declining market share can rapidly become a slippery path.

 

Companies that ignore changing market trends and technical innovations are doomed to fail. Companies need to be responsive to market developments and changing patterns.

 

Be alive to high levels of staff turnover, a continuous exodus of staff is a sure indicator that all is not well and normally a precursor of a more substantial problem surfacing.

 

“Show rooming” a growing problem for retailers

 

With the rise of online shopping retail chains do not need as many stores as they did in the past, a trend that looks set to accelerate.

 

Customers are becoming ever more savvy in looking for value for money, employment is tight and also we've seen a massive growth in the supermarkets in terms of non-food retail.

 

Now further adding to the problems of the “bricks and mortar retailers” is the rise of “show rooming.”

 

Essentially this is customers going into a shop to browse but in reality an exercise to check out goods and then search on line for a more competitive deal.

 

The growth of online shopping is a juggernaut now accounting for 12% of retail sales - and forecast to be at least 30% by 2020.

 

Those retailers who fail to exploit all areas of multi channel marketing whilst finding themselves saddled with the burgeoning costs of maintaining retail outlets will continue to suffer.

 

The weakest go to the wall (mart)

 

ASDA has come in for criticism after sending out a letter to its suppliers that appeared to change their payment terms for the worse. This is not a new phenomenon; credit checker Experian recently published a report which showed than on average the supermarkets took a month longer to pay than their contractual terms stipulated

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.

 

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