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.

 

 

Speak softly and carry a big stick

 

Funding issues continue to impact on businesses with more and more customers actively employing various tactics to delay payment to suppliers.

 

Credit control and the monitoring of payments is an increasingly critical element of every business.

 

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

 

This situation if left unchecked can spiral out of control. As the situation deteriorates the supplier can find themselves in the invidious position whereby they are forced to keep “trading” with the errant customer for fear of realising a bad debt.

 

Think of the parallel to the Euro zone bail out situations – it is a slippery path.

 

Slack policing of accounts receivable will have serious consequences. At best tardy payments damage cash-flow and at worst can often be the precursor of a company failing with the end result of a total write off.

 

Take a long hard look at your accounts receivable. Undoubtedly there will be examples of aged invoices where 30 day terms have drifted into 60 and beyond.

 

Consider the damage that is being done to your company’s financial position and ask the question “who is taking advantage of us?”

A rewarding 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.

 

 

Cyber crime the new growth industry

 

Cyber-crime is growing at an alarming rate. A particular area of fraudulent activity is linked to stolen passwords.

 

Latest estimates indicate that online fraud hits one in eight UK businesses each year and costs a staggering £20 billion.

 

Despite storing critical information on mobile devices and computers some 82% of SME’s are unprepared for an IT security breach.

 

Entrepreneurial owners of SME’s are a prime target for fraud as overseeing finances doesn’t always come naturally to them.

 

 If an owner 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 essential 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.

 

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.

 

 

Policing 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.

 

 

Who checks the bean counters?

 

The majority of the flak following the failures in the global financial system was largely directed at one sector i.e. the banking industry.

 

One group of participants remained largely unscathed for their part in the train wreck, the auditors. It has taken time to percolate through but now the auditors are coming under closer scrutiny.



Tesco who recently reported a £6.4 billion loss advised that accounting irregularities were in excess of £326 million in its accounts signed off by auditors PWC. It is hardly surprising that Tesco as it tries to repair its reputation and image has sacked PWC.

 

Auditors are in a very privileged position and their integrity is paramount.

In the US authorities have brought criminal and civil charges against former senior partners at accountancy giants KPMG and Deloitte Touche over alleged insider trading.

 

However it is not just about negligence or illegal activity, there are many instances of conflict of interest such as taking on consultancy work for clients and becoming too cosy with management teams.

 

At the lower end of the scale 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.

 

There are many instances when faced with a strong (bullying) senior management of the company being audited that the auditors end up signing off on a “nod and a wink”.

 

The validity of a company's accounts reflects both the integrity of the company which is being audited and that of its auditors.

 

Revving up the bottom line

When attempting to boost the bottom line there are two obvious courses of action, cut operating costs and generate additional revenue.

Many organisations opt to reduce staffing numbers as a quick fix but there is a danger that in line with reduced personnel there is an accompanying decline in operating standards. In such circumstances customers often choose to vote with their feet.

The sales director only has one shot in his/her armoury namely increase sales. Sales targets can always be raised but a sense of commercial realism also needs to be applied.

If you are marketing a totally unique product or service the task is easier but for the most part there are many companies offering a similar range of products in a broadly similar price range.

In many instances companies would be advised to make customer service their USP but this requires the commitment of a dedicated work force not one that is pre-occupied with the spectre of further redundancies.

Learning from the past

 

Rarely in life either in a private situation or in a commercial environment do we come across an entirely unique or new situation.


History provides many examples of financial crises such as the 18th century South Sea Bubble, the Victorian Banking crisis of Overend & Gurney, the Great Depression which followed the 1929 Wall St Crash, and the Dot Com Crash.

 

In all of these episodes the common denominators were reckless pursuit of profit whilst fundamentals were ignored, the so called “get rich quick” school of business.

 

Following each of these debacles there was a collective reigning in and return to the principles of sound business.



However memories are short and it is not long before the blurring starts again and risky practices again become more and more the norm.


Complacency has resulted in the demise of numerous organisations. As George Santayana commented “those who cannot remember the past are condemned to repeat it”.

Spotting the early warning signals

 

It is unusual for a company to implode like a supernova. In the majority of cases the distress signals are visible for some time before the flame out.

Any analysis of a company’s published accounts or even monthly management accounts are by definition “out of date”.

It is vitally important that all counter parties are monitored closely and “real time”.

In the case of customers look out for unusual ordering patterns, repeated delays in payments – these are early indicators of more serious problems ahead.

For any organisation facing mounting problems it is obvious that the solutions will of necessity be painful. However, radical and decisive surgery is often the only way to ensure a patient’s survival.

Many companies adopt the Mr Micawber attitude that “something will turn up”. In the overwhelming majority of such cases the only people likely to turn up are the administrators/liquidators.



Be it merely inertia or fear of addressing the issue, the outcome will remain the same.

 

 

Developing and sustaining relationships

 

Business practises have changed markedly in recent years.

 

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.

 

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.

 

 

It makes sound economic sense to foster and maintain good customer relationships as 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 maxim has never been more relevant than in these uncertain and challenging times.

 

 

Blueprint for sales growth

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.

 

Keeping your eye on the ball

Despite many warnings and scares many companies are still failing to adopt a robust approach to their financial controls.



These companies fail to recognise the need for strict discipline in respect of stock turn and control but what is even more disturbing is the reaction to the debtors’ book.



As more and more customers seek actively to delay payment this element of business policing is even more critical.



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



If left unchecked this situation can spiral out of control. In a worst case scenario the supplier is forced to keep “supporting” the errant customer for fear of realising a bad debt.

 

Think of the parallel to the Greek debt crisis – it is a slippery path.

Without a vigilant approach it will not be unusual for payment terms of 30 days drifting into 60 and beyond. The implications for your company’s financial position are all too obvious.

 

 

The measure of trust

 

The most important component in any business relationship is the question of trust.

 

The ultimate demonstration of trust and good faith is when a supplier delivers goods to a customer on credit terms.

 

It therefore is incumbent on the buyer that they acknowledge this act of trust and observe the agreed payment terms.

 

With the current pressures it is easy to understand the temptation of  delaying payment, thereby “pinching” a few days extra credit but this type of behaviour soon begins to pall.

 

Once a supplier feels that their buyer is taking undue advantage the relationship is damaged sometimes irreparably.

 

For any relationship to be sustained there has to be mutual benefit.

 

When a buyer gains a reputation for persistently crossing the line the merit in maintaining the account is called into question.

 

It is a very short sighted business tactic.

 

 

Getting your fingers burnt

Prior to companies coming to the market much focus 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.

It is always worth asking the difficult question

One recurring theme from the analysis of any company reporting losses 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 corporate culture is dominated by fear and greed and these together make for a toxic combination.

 

When strategies fail and businesses lose their way 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.

 

The old adage that if something looks too good to be true it invariably is still rings true.