In the latest Batman movie, one of the villains is “Two Face” - a good guy turned bad guy who determines the fate of his victims by tossing a coin.
And some bankers today seem to be following his lead.
Bankers can be usefully divided into two categories - those in "sales", and those in “credit”. In the credit bubble environment, "sales" ruled and "credit" did what it was told. But now, what I call the "pendulum of bank benevolence" has swung from "profligacy" to "bastardry", and the credit people are back in the ascendancy.
When "sales" ruled, small business owners were seduced by their bankers to source all of their funding requirements with their bank, with offers of very low pricing, and the empty logic of “one stop shopping”. But now that "credit" is back in town, many SME's are finding themselves hog-tied and unable to restructure their business finances without refinancing every dollar of debt the business has.
An example will illustrate what I am talking about. I was asked recently to provide a debtor finance facility to an engineering business. They needed my services because they recently shifted premises. As always happens when a business shifts, they had underestimated the costs in terms of both expenses and lost sales through down time. Their bank (lets call them Big Bank) loaned the business nearly $1M to buy the new premises only months ago - the old premises had been rented. Yet Big Bank turned them down when they asked for an overdraft extension, and so their finance broker brought the matter to me.
I asked Big Bank to release the business's debtors from the debenture charge they (Big Bank) held over the business. The Relationship Manager agreed to help, but then, even though the debt was easily covered by mortgages held over the premises and two directors homes, he was over-ruled by “credit” (you can almost hear “Two Face” flipping his coin, can't you?)
The only option available to this client now is to refinance everything - the overdraft, the business loan, the equipment finance, the property loan on the new commercial premises, and the two directors home loans.
In this example, the client effectively has four classes of assets: Commercial property (the premises); personal property (the directors homes); the plant and equipment, and; the debtors of the business. I believe that each class of asset should be financed with different lenders – preferably specialists in those asset classes. That way, one asset class can be refinanced without the need of refinancing the other assets.
This client is now at the mercy of the decision processes of the bank, which frankly seem no more sophisticated than that of “Two Face”, with similarly dire consequences for the business.
Showing posts with label cash flow. Show all posts
Showing posts with label cash flow. Show all posts
Are credit insurers battening down the hatches?
Today I met with a printing business who had a cash flow problem. Printers are a little prone to cash flow glitches because of their large capital outlays (representing fixed costs) and the fact that people tend to pay printers slowly (an average of 60 days is often considered pretty good).
The thing is, I have had a number of enquiries from printers lately, so I asked this printer the question: is there something going on in the printing business to cause cash flow hiccups among printers?
The answer was quite fascinating. It seems that the paper suppliers are tightening up on their credit terms. Wait on, that's not the fascinating part. What I found fascinating was that the reason the paper suppliers are apparently giving for tightening up is that their credit insurers are apparently imposing tighter restrictions on the suppliers!
Credit insurance works like this: as a supplier, you take out insurance against your customers going broke. It is an excellent product, I think, for two reasons.
Firstly, the cost of insurance is a fixed, predetermined cost, that really is almost negligible. Compare this with the variable, unknown, and often devastating cost of bad debts.
Secondly, using a credit insurer imposes a discipline on suppliers to make sure they tick all the right boxes before extending credit to their customers. This is important, because often bad debts are really a result of slack internal processes on the part of the supplier.
My theory is that the credit insurers are watching the global credit markets, and the threat of a global economic slowdown very carefully, and that they see bad weather ahead. As a consequence, they are in effect, "battening down the hatches".
The Australian economy is showing many of the hallmarks of strength: growth, high levels of business investment, and low unemployment. On the other hand, credit markets are in crises. Talk in the paper includes previously foreign terminology such as as "credit rationing". The larger corporates (often suppliers to small business) must surely then be compelled to tap their own debtors (often small business) as sources of free cash flow, in an environment where bank credit is becoming scarcer and more expensive. And the credit insurers are also alive to the risks at play here.
My anecdote is only one tale, and one swallow does not make a summer, so I would be interested to hear more from others "on the ground".
The thing is, I have had a number of enquiries from printers lately, so I asked this printer the question: is there something going on in the printing business to cause cash flow hiccups among printers?
The answer was quite fascinating. It seems that the paper suppliers are tightening up on their credit terms. Wait on, that's not the fascinating part. What I found fascinating was that the reason the paper suppliers are apparently giving for tightening up is that their credit insurers are apparently imposing tighter restrictions on the suppliers!
Credit insurance works like this: as a supplier, you take out insurance against your customers going broke. It is an excellent product, I think, for two reasons.
Firstly, the cost of insurance is a fixed, predetermined cost, that really is almost negligible. Compare this with the variable, unknown, and often devastating cost of bad debts.
Secondly, using a credit insurer imposes a discipline on suppliers to make sure they tick all the right boxes before extending credit to their customers. This is important, because often bad debts are really a result of slack internal processes on the part of the supplier.
My theory is that the credit insurers are watching the global credit markets, and the threat of a global economic slowdown very carefully, and that they see bad weather ahead. As a consequence, they are in effect, "battening down the hatches".
The Australian economy is showing many of the hallmarks of strength: growth, high levels of business investment, and low unemployment. On the other hand, credit markets are in crises. Talk in the paper includes previously foreign terminology such as as "credit rationing". The larger corporates (often suppliers to small business) must surely then be compelled to tap their own debtors (often small business) as sources of free cash flow, in an environment where bank credit is becoming scarcer and more expensive. And the credit insurers are also alive to the risks at play here.
My anecdote is only one tale, and one swallow does not make a summer, so I would be interested to hear more from others "on the ground".
How much does "debtor finance" cost?
Debtor finance is a great tool for financing business growth, but how much does it cost? This is a question accountants love to ask. Before I answer it however, allow me to point out that at a very basic level there are two determinants of business profitability: income and expenditure. Accountants, by training, are expenditure focused, which is why they love to ask "how much does it cost" instead of "how much value will it create"?
So let me answer the "expenditure" question directly by saying that debtor finance will normally cost a small percentage of the value of invoices financed. However, given that debtor finance facilitates revenue growth, the revenue or "top line" impact of debtor finance should not be discounted when the "cost" of debtor finance is being assessed.
Recently I spoke with a prospective client who was a business services provider. His Gross Profit Margin was 40%. He was turning over $300,000 per month. He had very real potential to double that turnover - but needed funding to do so.
I estimated that a debtor finance facility for his business, given its circumstances and debtor collection cycle, would cost him in the vicinity of 2.5% of invoices financed. His accountant thought that this was expensive.
Lets assume that a doubling in sales is realistically achievable. The client is now trading off:
So let me answer the "expenditure" question directly by saying that debtor finance will normally cost a small percentage of the value of invoices financed. However, given that debtor finance facilitates revenue growth, the revenue or "top line" impact of debtor finance should not be discounted when the "cost" of debtor finance is being assessed.
Recently I spoke with a prospective client who was a business services provider. His Gross Profit Margin was 40%. He was turning over $300,000 per month. He had very real potential to double that turnover - but needed funding to do so.
I estimated that a debtor finance facility for his business, given its circumstances and debtor collection cycle, would cost him in the vicinity of 2.5% of invoices financed. His accountant thought that this was expensive.
Lets assume that a doubling in sales is realistically achievable. The client is now trading off:
- Using my services and having a business that grosses 37.5% per month on a turnover of $600,000 per month, or;
- "Going it alone" and maintaining his margin at 40% - but 40% of $300,000 in revenue per month.
The illustration below shows the clients existing GP, his potential additional GP (GP foregone if he decides not to grow) and the debtor finance fee. The whole "pie" represents total sales of $600,000 per month.
The chart illustrates that in the event the client takes his accountants advice, he runs the risk of missing out on $75,000 in gross profit per month!
So the cost of of debtor finance, in expenditure terms, is negligible when weighed against value creation debtor finance facilitates.
What advice would you give this prospective client if you were his advisor?
How much of the business should go to the investor?
As a cashflow lender to small business, I am occasionally asked for a large chunk of money and offered absolutely no security in return. Unfortunately (!), unsecured lending for start-up enterprises and business acquisitions does not exist in Australia. What does exist is equity finance.
So after your client comes to the realisation that they will not be able to raise the funds they need via an unsecured loan (for their business start-up/ acquisition/ expansion), how much of their business are they going to have to relinquish to an in-coming equity investor/ business partner? Say for example the client needs $500,000 to start-up a widget making business. How much of the new enterprise should the money-partner (investor) get to own?
A simple three step calculation can provide the answer to this question.
Step one is to calculate the value of the business in five years time (the normal investment horizon for equity investors). How do you calculate the valuation? See my blog posting from two weeks ago for a detailed explanation, but the short answer is that you multiply the projected EBITDA (Earnings before Interest, Tax and Depreciation Allowance) by the relevant earnings multiple. Lets say in our example the projected EBITDA will be $1M, and the multiple is five times. The business in five years will be worth $5M.
Step two is to calculate the "present value" of the projected business valuation. To do this, you will firstly need to apply a "discount rate". The riskier the business, the higher the discount rate, but lets say in our case we are going to apply a discount rate of 30%. We now divide our projected business valuation by 130% (or 1.3) five times. In our case here, that gives us $1.35M.
Step three is to calculate now how much of the business the investor should receive. In our case, the investor is putting in $500,000. This is 37% of $1.35M, so the investor should receive 37% of the shares.
The variables here - all of them open to vigorous debate in any negotiations between investor and investee, will be the projected EBITDA, the earnings multiple applicable in five years, and the discount rate.
Investors will argue to business owners that owning 63% of something is better than owning 100% of nothing!
However most small business owners are simply unwilling to sacrifice such a large stake in their business for what they believe is such a small amount of money - which is why debt finance is usually more attractive - even if it does mean that security will have to be (begrudgingly) put on the table, and regardless of interest rates (within reason). Risking the family home, and paying a premium for the money is usually seen as a reasonable trade-off for retaining 100% of the business, and 100% of the pay-off for all the hard-work!
So after your client comes to the realisation that they will not be able to raise the funds they need via an unsecured loan (for their business start-up/ acquisition/ expansion), how much of their business are they going to have to relinquish to an in-coming equity investor/ business partner? Say for example the client needs $500,000 to start-up a widget making business. How much of the new enterprise should the money-partner (investor) get to own?
A simple three step calculation can provide the answer to this question.
Step one is to calculate the value of the business in five years time (the normal investment horizon for equity investors). How do you calculate the valuation? See my blog posting from two weeks ago for a detailed explanation, but the short answer is that you multiply the projected EBITDA (Earnings before Interest, Tax and Depreciation Allowance) by the relevant earnings multiple. Lets say in our example the projected EBITDA will be $1M, and the multiple is five times. The business in five years will be worth $5M.
Step two is to calculate the "present value" of the projected business valuation. To do this, you will firstly need to apply a "discount rate". The riskier the business, the higher the discount rate, but lets say in our case we are going to apply a discount rate of 30%. We now divide our projected business valuation by 130% (or 1.3) five times. In our case here, that gives us $1.35M.
Step three is to calculate now how much of the business the investor should receive. In our case, the investor is putting in $500,000. This is 37% of $1.35M, so the investor should receive 37% of the shares.
The variables here - all of them open to vigorous debate in any negotiations between investor and investee, will be the projected EBITDA, the earnings multiple applicable in five years, and the discount rate.
Investors will argue to business owners that owning 63% of something is better than owning 100% of nothing!
However most small business owners are simply unwilling to sacrifice such a large stake in their business for what they believe is such a small amount of money - which is why debt finance is usually more attractive - even if it does mean that security will have to be (begrudgingly) put on the table, and regardless of interest rates (within reason). Risking the family home, and paying a premium for the money is usually seen as a reasonable trade-off for retaining 100% of the business, and 100% of the pay-off for all the hard-work!
Market volatilty: What are the shares in your client's small business worth?
Understanding how stock markets value businesses seems to many to be a dark art. Never more so than in times such as the past few trading days when valuations (reflected in stock prices) have been alarmingly volatile. How are listed companies valued? Do similar principles apply to small businesses, and what are the implications for small business owners?
Businesses are generally valued on the basis of a multiple of earnings (see the papers for the daily price-earnings ratios implicit in publicly listed stock prices). Yes rocket scientists, its much more complex than that, but even you will concede that the NPV of future maintainable earnings can be reduced to some kind of earnings multiple.
This principle applies to large and small businesses alike.
So if a business is valued at a multiple of its earnings - what is the "multiple", and how do you define "earnings"?
The last bit first - earnings these days are generally defined as EBITDA - earnings before interest, tax and depreciation. The rationale for adding back interest is that the value of the business should not be determined by its debt structures.
As for the applicable "multiple" - that depends on the sustainability and quality of the earnings - and "volatility" in yearly earnings is a surrogate for these two factors.
How should you advise a small business owner looking to increase the value of their business so they can sell to a generous competitor and retire early?
Firstly, my bias is for business growth over cost cutting to achieve better quality earnings. Cost cutting can enhance the bottom line in the short-term, but for long term sustainable profits, the fundamentals need to be looked at.
Which leads me to my second point. A business - no matter how small - that dominates a market segment or niche, is going to enjoy greater earnings and attract higher multiples. So the small business owner should be focused on looking for market segments or niches to "own" in order to increase the value of their business.
Given that "earnings" for valuation purposes are before interest, using debt to grow the business should be seriously looked at - subject obviously to risk and the ability of the owners of the business to employ the debt funds profitably.
Are small business valuations as volatile as stock prices? Market forces still apply - supply and demand, the cost of money and the general availability of funds. Lower multiples apply when interest rates are high. And if credit tightens at the retail level, then this will impact on business valuations in the same way other asset prices are effected. What do you think?
Businesses are generally valued on the basis of a multiple of earnings (see the papers for the daily price-earnings ratios implicit in publicly listed stock prices). Yes rocket scientists, its much more complex than that, but even you will concede that the NPV of future maintainable earnings can be reduced to some kind of earnings multiple.
This principle applies to large and small businesses alike.
So if a business is valued at a multiple of its earnings - what is the "multiple", and how do you define "earnings"?
The last bit first - earnings these days are generally defined as EBITDA - earnings before interest, tax and depreciation. The rationale for adding back interest is that the value of the business should not be determined by its debt structures.
As for the applicable "multiple" - that depends on the sustainability and quality of the earnings - and "volatility" in yearly earnings is a surrogate for these two factors.
How should you advise a small business owner looking to increase the value of their business so they can sell to a generous competitor and retire early?
Firstly, my bias is for business growth over cost cutting to achieve better quality earnings. Cost cutting can enhance the bottom line in the short-term, but for long term sustainable profits, the fundamentals need to be looked at.
Which leads me to my second point. A business - no matter how small - that dominates a market segment or niche, is going to enjoy greater earnings and attract higher multiples. So the small business owner should be focused on looking for market segments or niches to "own" in order to increase the value of their business.
Given that "earnings" for valuation purposes are before interest, using debt to grow the business should be seriously looked at - subject obviously to risk and the ability of the owners of the business to employ the debt funds profitably.
Are small business valuations as volatile as stock prices? Market forces still apply - supply and demand, the cost of money and the general availability of funds. Lower multiples apply when interest rates are high. And if credit tightens at the retail level, then this will impact on business valuations in the same way other asset prices are effected. What do you think?
Credit Crunch?
So now all the media pundits are talking about "the credit crunch" as though it is already a reality. It may be, but to what extent? And what is a "credit crunch", how has it come about, and what will it mean for small businesses looking to raise funds to grow?
A "credit crunch" happens when lenders stop lending. The banking system, and financial markets rely on lenders lending to other lenders. When lenders stop trusting their "counterparts" (what banks call other banks), the funds stop circulating at the wholesale level ("bank" to "bank" and in the capital markets), and then they dry up at the retail level. And then you have a "credit crunch".
Why is this happening? In the USA, some mortgage lenders, specialising in lending to high risk ("sub-prime") borrowers, have come unstuck as a result of declining property prices. When the property bubble burst, many of these loans sank "under water" (when the value of the debt exceeds the value of the asset). So with loan books full of loans that were "underwater" and no longer performing, the sub-prime lenders found their own cash flow streams dried up, and some of them defaulted on their own debt obligations. This becomes a "contagion" when the lenders to these lenders (superfunds and banks) have over-lent.
What happens next is that lenders stop trusting each other. Not knowing how much exposure a financial institution counterpart has to "sub-prime" loans, other financial institutions turn off the flow of funds.
In Australia, non-bank lenders have become a prominent feature of the mortgage landscape, and an important source of capital for small businesses borrowing on "low-doc" and "no-doc" terms. If the financial markets stop trusting these lenders altogether, then this flow of funds may be interrupted, causing head-aches for many small businesses.
There are mitigating factors. For years now there has been a large surplus of funds looking for investments. Here in Australia, compulsory super has contributed to very large institutional funds becoming desperate for places to park all the money. I can't see this drying up overnight.
And APRA (the regulator) in its most recent reports on the mortgage industry, says that default rates are a fraction of 1% - well under the high double digit figures experienced in the USA by sub-prime lenders.
There is a credit squeeze - whether or not its a crunch is open to debate at this point. I am not seeing banks closing their small business loan desks at the moment. But even with a credit "squeeze" interest rates will be impacted. The market for money is just like the market for bananas: when there is a shortage, the price goes up. The flow of funds to non-bank lenders will become impeded (how much so is the question), and the banks will become tougher to deal with. Without the non-bank mortgagees applying the competitive pressure we have seen in recent years, the banks will be able to increase their own margins, and to become much more choosy about who they lend money to.
The big questions are: will there be a "contagion" and if so, can it be "quarantined"? My feeling is that given the robustness of our economy, and the points made above, the answer will be "yes", but if you disagree, let me know!
A "credit crunch" happens when lenders stop lending. The banking system, and financial markets rely on lenders lending to other lenders. When lenders stop trusting their "counterparts" (what banks call other banks), the funds stop circulating at the wholesale level ("bank" to "bank" and in the capital markets), and then they dry up at the retail level. And then you have a "credit crunch".
Why is this happening? In the USA, some mortgage lenders, specialising in lending to high risk ("sub-prime") borrowers, have come unstuck as a result of declining property prices. When the property bubble burst, many of these loans sank "under water" (when the value of the debt exceeds the value of the asset). So with loan books full of loans that were "underwater" and no longer performing, the sub-prime lenders found their own cash flow streams dried up, and some of them defaulted on their own debt obligations. This becomes a "contagion" when the lenders to these lenders (superfunds and banks) have over-lent.
What happens next is that lenders stop trusting each other. Not knowing how much exposure a financial institution counterpart has to "sub-prime" loans, other financial institutions turn off the flow of funds.
In Australia, non-bank lenders have become a prominent feature of the mortgage landscape, and an important source of capital for small businesses borrowing on "low-doc" and "no-doc" terms. If the financial markets stop trusting these lenders altogether, then this flow of funds may be interrupted, causing head-aches for many small businesses.
There are mitigating factors. For years now there has been a large surplus of funds looking for investments. Here in Australia, compulsory super has contributed to very large institutional funds becoming desperate for places to park all the money. I can't see this drying up overnight.
And APRA (the regulator) in its most recent reports on the mortgage industry, says that default rates are a fraction of 1% - well under the high double digit figures experienced in the USA by sub-prime lenders.
There is a credit squeeze - whether or not its a crunch is open to debate at this point. I am not seeing banks closing their small business loan desks at the moment. But even with a credit "squeeze" interest rates will be impacted. The market for money is just like the market for bananas: when there is a shortage, the price goes up. The flow of funds to non-bank lenders will become impeded (how much so is the question), and the banks will become tougher to deal with. Without the non-bank mortgagees applying the competitive pressure we have seen in recent years, the banks will be able to increase their own margins, and to become much more choosy about who they lend money to.
The big questions are: will there be a "contagion" and if so, can it be "quarantined"? My feeling is that given the robustness of our economy, and the points made above, the answer will be "yes", but if you disagree, let me know!
Small business "crisis" and the Minneapolis bridge collapse
Apparently this Chinese character for "crisis" is a compilation of the characters for "danger" and "opportunity". A couple of weeks ago, I posted an article here called "A business in denial is a crisis already underway". In that article, I outlined a model for "the four stages of crisis". Can I use this model to make a prediction on what will be in the final report into the Minneapolis bridge collapse.Question: Why did the Minneapolis bridge collapse?
Predicted answer (using the four stage model):
- Essential data that would have otherwise presented early warning signs of danger was not being collected. This was a result of a combination of poor systems, and management decision processes heavily biased towards actions that had been successful in the past for reasons that were no longer valid (crisis stage one - "hidden crisis").
- When data was available, the early warning signs were explained away, mis-interpreted or not taken seriously enough (crisis stage two - "crisis denial").
- When the warning signs were finally recognised, only the symptoms were treated, instead of the underlying causes. As a result, the underlying causes of trouble kept on doing damage (crisis stage three - disintegration begins).
- Finally - the devastating collapse (crisis stage four - "collapse").
Why should this interest small business advisors? Because the answer appearing above could be applied to 90% of business failures. Why did XYZ Widget Importers Pty Limited collapse? Word for word, the answer above will more than likely provide the explanation. Ditto for HIH, Ansett and Westpoint. And ditto for all manner of disasters, from railway accidents, to space shuttle disasters, failed personal relationships, and boiled frogs.
This "four stages" model of business crisis has been in circulation for over twenty years. It should be a useful tool for business advisors wanting to practice "early intervention".
If you need a list of "early warning signs" of trouble, see page three of the ASIC document entitled "Insolvency: a guide for directors".
Hopefully understanding the Chinese characterisation of "crisis" gives us insight, and the impetus to help small business proprietors understand that if they respect the signs of "danger", they may then be better placed to seize the "opportunity"!
Playing the "blind side" for business growth
It is sometimes difficult for small business owners caught up in the day to day running of their business to maintain the right marketing mentality. Being switched on to the concept of the "blind side" as it is used in rugby may help!
The "blind side" is the narrow side of the ball contest on the rugby field, and by definition is usually sparsely defended, and therefore not seen as the logical side of the scrum to run the ball. (Follow the link for a three page treatise on "The Blind Side" by English Rugby legend Don Rutherford).
What does this have to do with marketing? Recently I have come across three excellent examples of "blind side thinking" that may help you make the connection.
The first is this ad for the iconic Mars Bar. The obvious space for Mars to contest is the confectionery market, right? In this ad, Mars takes a run straight into the "energy drink" space that is uncontested by other confectionery bars. It is taking on sports drinks, whilst at the same time positioning itself as an energy bar. Very clever.
The second is the internet search engine globalspec.com. Everyone knows that Google has won the search engine wars, right? Not quite. Topic-specific search engines are now beginning to emerge and these businesses are re-positioning Google as a "generalist"search engine. Globalspec is for engineers. Other "vertical" search engines exist specialising in the medical field (such as healthline). The point is, that even in a market space seemingly heavily defended by a giant such as Google, "blind side" opportunities exist.
The third example is Smintair (Smokers International Airlines) - a new German airline providing business-class-only travel for smokers (see the SMH article). Even the crew can smoke on this new airline! This is another great example of thinking laterally to find an un-serviced market segment.
The blind side has to be the natural option for small businesses who are not usually able to take on the heavy defenses of their larger competitors. It is also the natural play for Cash Flow Ninjas!
The secret to "blind side" rugby, according to Don Rutherford, is to be a "head up" as opposed to "head down or blinkered" player. The head up player has a "head up" mentality. Always looking for blind side opportunities, and making assessments of the risks attached to pursuing those opportunities before the ball is in their hands - that is before the heat of the next contest can cloud their judgement.
To maximise blind side opportunities, Rutherford's advice is to "take the ball as flat as possible [ie sprinting, not standing], aim for space, pin your ears back and go". What are the blind side opportunities in your market place?
The "blind side" is the narrow side of the ball contest on the rugby field, and by definition is usually sparsely defended, and therefore not seen as the logical side of the scrum to run the ball. (Follow the link for a three page treatise on "The Blind Side" by English Rugby legend Don Rutherford).
What does this have to do with marketing? Recently I have come across three excellent examples of "blind side thinking" that may help you make the connection.
The first is this ad for the iconic Mars Bar. The obvious space for Mars to contest is the confectionery market, right? In this ad, Mars takes a run straight into the "energy drink" space that is uncontested by other confectionery bars. It is taking on sports drinks, whilst at the same time positioning itself as an energy bar. Very clever.
The second is the internet search engine globalspec.com. Everyone knows that Google has won the search engine wars, right? Not quite. Topic-specific search engines are now beginning to emerge and these businesses are re-positioning Google as a "generalist"search engine. Globalspec is for engineers. Other "vertical" search engines exist specialising in the medical field (such as healthline). The point is, that even in a market space seemingly heavily defended by a giant such as Google, "blind side" opportunities exist.
The third example is Smintair (Smokers International Airlines) - a new German airline providing business-class-only travel for smokers (see the SMH article). Even the crew can smoke on this new airline! This is another great example of thinking laterally to find an un-serviced market segment.
The blind side has to be the natural option for small businesses who are not usually able to take on the heavy defenses of their larger competitors. It is also the natural play for Cash Flow Ninjas!
The secret to "blind side" rugby, according to Don Rutherford, is to be a "head up" as opposed to "head down or blinkered" player. The head up player has a "head up" mentality. Always looking for blind side opportunities, and making assessments of the risks attached to pursuing those opportunities before the ball is in their hands - that is before the heat of the next contest can cloud their judgement.
To maximise blind side opportunities, Rutherford's advice is to "take the ball as flat as possible [ie sprinting, not standing], aim for space, pin your ears back and go". What are the blind side opportunities in your market place?
A business in "denial" is a crisis already underway
"If only they'd come to us sooner". I have often heard these words from accountants, lawyers and insolvency professionals when talking about a hopeless business case. A business crisis rarely evolves overnight. But most business owners usually "stick their heads in the sand" rather than take heed of the warning symptoms that always present early on, and are always obvious in hindsight.
In this post I am going to cite a very recent example, plus give some theory around "business crisis" that might help the business advisor deal with clients approaching crisis.
Last week I met with the owner of a business who had a large cash flow crisis indeed. He owes his bank around $1,700,000 - a number that exceeds the value of his securities by at least $300,000. His securities include his home, plus stock and debtors in the business.
His problems became serious when he approached his bank for an additional $200,000 to "land" a shipment of stock. His bankers, having taken the opportunity to review his business and their risk position, responded by calling up his loans (to be fair to the bank, this is the very simple version of a slightly more complicated story). As at last Tuesday, he had until the end of this week to refinance (pay them out in full). Or else. They are likely to appoint receivers and he is likely to end up personally bankrupt.
The bank (one of the majors) is upset because their lending ratios are way out of kilter (loan to asset value). Further, the business has been growing very rapidly, but it is yet to hit monthly "break even volumes" with consistency - so its other financial ratios (profitability, gearing, debt servicing etc) raised red flags on the banks financial analysis software.
How could have this crisis been avoided? According to Stuart Slatter*, the business crisis has four stages of development. A look at these will help answer that question.
Stage 1 is "the hidden crisis". Early warning signs are simply not detected due to poor administration and record keeping, and poor management processes. Business advisors need to help their clients establish systems that ensure that the clients accounting system produces meaningful information (reports etc) and that this information is regularly reviewed with a critical eye.
Stage 2 is "crisis denial". This is where crisis symptoms are explained away. "Its because of the low/ high Australian dollar", "its the economy", "all our competitors are having the same problem", "its anything/ anyone we can blame but ourselves". Hockey-stick forecasts are made (the ones forecasting a slight dip before a huge turnaround). This is where the advisor needs a solid relationship with the client built on honesty and trust so that the advisor can hold up the mirror to the client and make the client see the true situation and the true causes of the problem. A tip here is that if you ever catch yourself or your client blaming externalities for poor performance, the client is/ you are probably "in denial".
Stage 3 is "disintegration begins". The business starts to fall apart and too little is done too late. Drastic action is required here, more than just the papering over of cracks. Often a refinance is called for to raise additional capital, but it should always be used to fund a well thought out turnaround action plan, not simply to delay the inevitable.
Stage 4 is "organisation collapse". The administrator/ receiver is appointed, and only a formal restructure will breath life back into the business - but only after creditors have been compromised and the personal wealth of the owners (usually) seriously diminished.
What does this mean for the business owner I met last week? My guess is that the crisis was "hidden" during the early stage of rapid expansion and he has been "in denial" for some time.
I love the old saying "the difficult we do immediately, but the impossible takes a little longer". But the only response I had for the referring broker in this case I am afraid was "if only he had come to me sooner!" Often (in concert with brokers and advisors) we are able to perform miracles, but this one was beyond help.
Small business owners have heavy emotional investments in their businesses, which is why they often overlook the early stages of crisis. Its up to their advisors to be courageous and and point out the early symptoms as they arise.
As always, I look forward to any thoughts or feedback.
*Corporate Recovery: A Guide to Turnaround Management by Stuart Slatter. Published by Penguin, 1984.
In this post I am going to cite a very recent example, plus give some theory around "business crisis" that might help the business advisor deal with clients approaching crisis.
Last week I met with the owner of a business who had a large cash flow crisis indeed. He owes his bank around $1,700,000 - a number that exceeds the value of his securities by at least $300,000. His securities include his home, plus stock and debtors in the business.
His problems became serious when he approached his bank for an additional $200,000 to "land" a shipment of stock. His bankers, having taken the opportunity to review his business and their risk position, responded by calling up his loans (to be fair to the bank, this is the very simple version of a slightly more complicated story). As at last Tuesday, he had until the end of this week to refinance (pay them out in full). Or else. They are likely to appoint receivers and he is likely to end up personally bankrupt.
The bank (one of the majors) is upset because their lending ratios are way out of kilter (loan to asset value). Further, the business has been growing very rapidly, but it is yet to hit monthly "break even volumes" with consistency - so its other financial ratios (profitability, gearing, debt servicing etc) raised red flags on the banks financial analysis software.
How could have this crisis been avoided? According to Stuart Slatter*, the business crisis has four stages of development. A look at these will help answer that question.
Stage 1 is "the hidden crisis". Early warning signs are simply not detected due to poor administration and record keeping, and poor management processes. Business advisors need to help their clients establish systems that ensure that the clients accounting system produces meaningful information (reports etc) and that this information is regularly reviewed with a critical eye.
Stage 2 is "crisis denial". This is where crisis symptoms are explained away. "Its because of the low/ high Australian dollar", "its the economy", "all our competitors are having the same problem", "its anything/ anyone we can blame but ourselves". Hockey-stick forecasts are made (the ones forecasting a slight dip before a huge turnaround). This is where the advisor needs a solid relationship with the client built on honesty and trust so that the advisor can hold up the mirror to the client and make the client see the true situation and the true causes of the problem. A tip here is that if you ever catch yourself or your client blaming externalities for poor performance, the client is/ you are probably "in denial".
Stage 3 is "disintegration begins". The business starts to fall apart and too little is done too late. Drastic action is required here, more than just the papering over of cracks. Often a refinance is called for to raise additional capital, but it should always be used to fund a well thought out turnaround action plan, not simply to delay the inevitable.
Stage 4 is "organisation collapse". The administrator/ receiver is appointed, and only a formal restructure will breath life back into the business - but only after creditors have been compromised and the personal wealth of the owners (usually) seriously diminished.
What does this mean for the business owner I met last week? My guess is that the crisis was "hidden" during the early stage of rapid expansion and he has been "in denial" for some time.
I love the old saying "the difficult we do immediately, but the impossible takes a little longer". But the only response I had for the referring broker in this case I am afraid was "if only he had come to me sooner!" Often (in concert with brokers and advisors) we are able to perform miracles, but this one was beyond help.
Small business owners have heavy emotional investments in their businesses, which is why they often overlook the early stages of crisis. Its up to their advisors to be courageous and and point out the early symptoms as they arise.
As always, I look forward to any thoughts or feedback.
*Corporate Recovery: A Guide to Turnaround Management by Stuart Slatter. Published by Penguin, 1984.
The Coles Turnaround: A lesson begins!!
Anyone interested in receiving a lesson in how to, or how not to turnaround a struggling business should pay close attention to Richard Goyder (the MD of Wesfarmers) as he embarks upon the turnaround of Coles.
I do not know many people who don't dream of buying a struggling business, turning it around and then selling it for a fortune. Those following the Coles saga will know that this is not a "private equity play", so its not about making a fast fortune. Its about creating value "to keep" long term (or so says Goyder). That is why this is going to be such an instructive case. A private equity buyer may have looked to create wealth through financial engineering. But Wesfarmers seem to want to create value by repairing the business.
Two possible factors lie at the heart of any business distress. Either poor strategy or poor operations (or a combination of both).
If your business strategy is wrong, then no matter how efficiently you execute it through your operations, you are in trouble. Similarly, the right strategy inefficiently executed will be a problem.
By "efficiency" I mean the cost effective use of assets (hard and soft) and the minimisation of unnecessary costs.
By "strategy" I mean the basis upon which the business chooses to compete: which markets it will compete in, what the value proposition (product offering) will be, and how it will deliver the value proposition to the chosen markets.
A business can be made more efficient by either cutting costs, cutting under performing assets, or a combination of both. But more often than not efficiency is not the problem, it is strategy.
If you are a plastic bottle manufacturer competing with Chinese imports, no amount of cost cutting or asset reduction is going to save you. A new strategy might (such as leading product innovation and outsourcing manufacturing). If you are a small printer competing against large printers, efficiency won't be a big help. A strategic niche offering to a targeted segment of the market might be.
And what about Coles? Listening to an interview this morning with Richard Goyder on the ABC (http://www.abc.net.au/rn/breakfast/stories/2007/1968360.htm) it sounds like the solutions Wesfarmers are going to pursue are going to be more about "strategy" and less about "efficiency". Coles operates in several different markets, and how "New Coles" goes about defining what it stands for, and how it will deliver value to its various markets will prove instructive. Small business owners and advisors should observe carefully and learn.
As I said at the top, it will be a live lesson in either how to, or how not to, but either way it will be very interesting to watch.
I do not know many people who don't dream of buying a struggling business, turning it around and then selling it for a fortune. Those following the Coles saga will know that this is not a "private equity play", so its not about making a fast fortune. Its about creating value "to keep" long term (or so says Goyder). That is why this is going to be such an instructive case. A private equity buyer may have looked to create wealth through financial engineering. But Wesfarmers seem to want to create value by repairing the business.
Two possible factors lie at the heart of any business distress. Either poor strategy or poor operations (or a combination of both).
If your business strategy is wrong, then no matter how efficiently you execute it through your operations, you are in trouble. Similarly, the right strategy inefficiently executed will be a problem.
By "efficiency" I mean the cost effective use of assets (hard and soft) and the minimisation of unnecessary costs.
By "strategy" I mean the basis upon which the business chooses to compete: which markets it will compete in, what the value proposition (product offering) will be, and how it will deliver the value proposition to the chosen markets.
A business can be made more efficient by either cutting costs, cutting under performing assets, or a combination of both. But more often than not efficiency is not the problem, it is strategy.
If you are a plastic bottle manufacturer competing with Chinese imports, no amount of cost cutting or asset reduction is going to save you. A new strategy might (such as leading product innovation and outsourcing manufacturing). If you are a small printer competing against large printers, efficiency won't be a big help. A strategic niche offering to a targeted segment of the market might be.
And what about Coles? Listening to an interview this morning with Richard Goyder on the ABC (http://www.abc.net.au/rn/breakfast/stories/2007/1968360.htm) it sounds like the solutions Wesfarmers are going to pursue are going to be more about "strategy" and less about "efficiency". Coles operates in several different markets, and how "New Coles" goes about defining what it stands for, and how it will deliver value to its various markets will prove instructive. Small business owners and advisors should observe carefully and learn.
As I said at the top, it will be a live lesson in either how to, or how not to, but either way it will be very interesting to watch.
A simple tool for diagnosing cash flow problems
We have developed a simple tool - "The Cash Flow Diagnostic" to help the business owner consider which aspects of the business should be worked on to deliver a more robust cash flow. It is outlined briefly here, and in subsequent posts we will go into detail for each of the five alternative points of action suggested.
In the first instance, a poor cash flow can be attributed to either the timing of payments and receipts or on the actual level of cash generated by the business. Cash timing issues can be relieved by either extending terms with suppliers, reviewing and enforcing customer payment terms, tight cash budgeting and through the use of debtor finance to accelerate cash receipts.
If the timing of cash flows is acceptable but the business is failing to generate sufficient cash, this can be attributed either to a lack of revenue or high cost levels. Revenue growth is constrained by either marketing factors or the amount of working capital available to the business. A refinance may be needed if working capital is your constraint. If your growth issues are more marketing related, review your “four p’s” of marketing (pricing, product, place and promotion). Many good blogs and web-sites offer helpful marketing hints. You could start by visiting Microsoft - http://office.microsoft.com/templates/ - here you will find marketing plan templates that will help you step through the marketing planning process.
High costs also fall into two categories – high fixed costs (overheads) or high input/ variable costs that result in resulting in low margins. A third party cash injection can improve your bargaining power with your suppliers to drive down the cost of your purchases, thereby improving your margins. If fixed costs are an issue, you made need to consider restructuring your business – and again, you may need funding to help you through that process. But additional finance or formal restructures do not by themselves solve problems – they are simply mechanisms for buying time and negotiation leverage.
All of the above is fairly intuitive – but even the simplest of tools are often effective in helping business managers to prioritise their actions and thereby maximize the effectiveness of their efforts.Stay tuned in upcoming weeks when we tackle the detail.
Feel free to comment!
In the first instance, a poor cash flow can be attributed to either the timing of payments and receipts or on the actual level of cash generated by the business. Cash timing issues can be relieved by either extending terms with suppliers, reviewing and enforcing customer payment terms, tight cash budgeting and through the use of debtor finance to accelerate cash receipts.
If the timing of cash flows is acceptable but the business is failing to generate sufficient cash, this can be attributed either to a lack of revenue or high cost levels. Revenue growth is constrained by either marketing factors or the amount of working capital available to the business. A refinance may be needed if working capital is your constraint. If your growth issues are more marketing related, review your “four p’s” of marketing (pricing, product, place and promotion). Many good blogs and web-sites offer helpful marketing hints. You could start by visiting Microsoft - http://office.microsoft.com/templates/ - here you will find marketing plan templates that will help you step through the marketing planning process.
High costs also fall into two categories – high fixed costs (overheads) or high input/ variable costs that result in resulting in low margins. A third party cash injection can improve your bargaining power with your suppliers to drive down the cost of your purchases, thereby improving your margins. If fixed costs are an issue, you made need to consider restructuring your business – and again, you may need funding to help you through that process. But additional finance or formal restructures do not by themselves solve problems – they are simply mechanisms for buying time and negotiation leverage.
All of the above is fairly intuitive – but even the simplest of tools are often effective in helping business managers to prioritise their actions and thereby maximize the effectiveness of their efforts.Stay tuned in upcoming weeks when we tackle the detail.
Feel free to comment!
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