Keeping ahead of the game

 
Running a business in today’s environment is a complex affair – it has been likened to 3 D gaming.

Particularly for the owners of SME’s it has never been harder to keep track of the various elements which are buffeting the business.

Now might be an appropriate time to run a check over those areas of the business most likely to cause problems in the coming months.

It is a self evident truth that many a crisis could have been averted by timely intervention.

This is where an independent appraisal can not only identify areas of potential concern but more importantly the ways and means by which to address them.

The question that needs to be answered initially is – are we positioned securely?

 

Taking the long view or emperor’s new clothes?

 

In the US Twitter the micro blogging site has reported losses of £395 million in 2013 compared to losses of £49 million in 2012.

It has been estimated that 68 percent of last year’s IPOs were also losing money.

In the UK there is a similar example, Ocado the on-line grocery delivery service saw sales up by 17% with losses to December £12.5 million compared to £600,000 year before. Correspondingly the share price in past year rose from 102p to 522.p.

 

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.

The New World Order

One of the staples of the Hollywood B movie was the Mad Scientist working away in his laboratory desperately trying to engineer a monster or come up with a powerful formula which would lead to world domination. Inevitably all these grandiose plans ended in failure and the world carried on as before.


Fast forward to today’s world and the threat originates from a different source, best described as the Mad Banker. Working away not in laboratories but behind banks of computer screens these would be Masters of the Universe were also trying to control the world through their own form of financial engineering.

By developing trading instruments and programmes of ever increasing complexity they created monsters which just like Dr Frankenstein they could not control.


The results of these spectacularly flawed experiments are now clearly visible. Last week the boss of RBS advised shareholders that problems are still emerging from the financial crisis leading to further write off in the coming months.


The greatest irony of all is that despite all the evidence of their incompetence and sheer recklessness any business seeking additional funding to expand their business finds that they are in thrall to the very architects of the disaster – the Bankers.

 

Diversification – not always the golden path

 

One of the most difficult challenges a business faces is diversification.

Very often a company is faced with the dilemma of diminishing revenue returns and a tired business model which is either irrelevant or obsolete.

Diversification is seen as the solution to this problem. However, the mechanism for achieving this objective can be particularly difficult.

The first step is examining why the current business model is not working. This requires an honest appraisal from the Management in respect of their own performance.

Then the areas of diversification have to be closely considered, very often people plunge into businesses in which they have little knowledge or experience and the results pretty quickly show up these deficiencies.

Thirdly one should always respect geography it may be very tempting to consider that there are opportunities just waiting to be picked up but to underestimate the advantage of local knowledge and conditions can again prove costly.

In essence diversification can provide the answer to a company’s need for increased revenue but without a clearly defined strategy it can equally provide another drain on an already embattled balance sheet.

Today’s watchword – focus on cutting costs

 

With operating margins being continually squeezed it is imperative that costs are rigorously controlled. 

 

Every business sector is seeing the impact of spiralling costs  e.g. FedEx the world's second largest package Delivery Company have seen their customers moving business from air to slower and less expensive routes. 

 

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.

 

Traffic will continue to moving onto the water because moving goods by air is very energy-intensive and the high cost of jet fuel was making air freight too pricey.

 

Facing marked resistance from consumers to price increases and a greater level of competition, those companies who are unable to control costs face an uphill struggle to maintain their position in today’s market place.

 

Lessons from history

  

Rarely in life either privately or in a commercial environment do we come across a unique or totally new situation.

History provides us with 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, 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.

We may well be witnessing the start of a new “bubble” in the UK housing market where house prices on average have risen by 6.3% in the past year the biggest annual increase since the start of the financial crisis in November 2007.

As George Santayana commented “those who cannot remember the past are condemned to repeat it”.

 

Making the best use of your cash flow means scrutinising 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.