Limit Your Business Risk & Prepare for the Unexpected

No matter the size of your business – sole proprietor, partnership, LLC, or corporation – you daily face decisions and opportunities that affect your business risk. Many of the choices due to these circumstances are obvious and you will make good decisions guiding your future business operation toward safe territory. However, other choices may appear to be innocuous in their affect on your business but under dynamic market and business conditions can have a significant impact on your business, increasing your risk to grow and perpetuate the business.

At the beginning of the recent recession I was amazed at the number of companies that did not have sufficient cash reserves or line of credit to last more than a few weeks when sales dropped. They did not have enough freeboard in their business to withstand the economic storm and take corrective action to survive. Do you have enough freeboard to deal with the unexpected in your business?

Here are some positive steps that you can take to reduce the impact and risk in dealing with the unexpected?

1. Managing Cash Reserves: Accruing cash to offset unexpected cash (either due to controllable events such as unplanned/ unforecasted expenditures or uncontrollable crisis) demand is difficult to do when you think you are in control. Putting cash on the sidelines may appear to be betting against yourself, that you have a good handle on the future, or that you are convinced that spending the money now versus putting it into an “idle” position is a better business decision. Remember once spent it is not easy to recreate cash when business tightens, squeezing your cash flow from positive to negative. Get counsel from your accountant or trusted advisors on what level of cash to keep in reserve. Rely on outside or objective perspective as your emotional commitment to the business may blur your objectivity.
2. Employee Competence: The competence of key employees or contractors may not be a glaring problem during boom times but can become a critical factor when you least expect or can afford it – particularly during a down market. This may be expressed in what you hear from customers that your employees are promising or how they are servicing the account, which may be retarding additional sales. Employee loyalty is a diminishing characteristic in the work force today, which can result in unexpected turnover, loss of an account relationship or worse loss of a customer if they go with the employee. Choose employees wisely and review their performance regularly to make sure their performance and attitude is consistent with the needs of your business. Owners can become so focused on the tasks of managing the company that they take relationships with key employees for granted and overlook their shortcomings and miss signals indicting their dissatisfaction and potential for leaving.
3. Customers: Customers are obviously important but what risk do they present to your business. Do you have good business agreements in force in case payments are stretched out? Does one customer have more than 10% of your business or margin? Do you have regular contact with customers to measure what is happening to their business and how it will affect your forecast? Good customers can adversely affect your business when you least expect it. Do you have the reserves to see through what ever interruption in normal business occurs, possibly even replacing them, until you are able to recover the loss? If you have customers that represent a significant part of your revenue or margin then you are well served to develop other clients to reduce the potential impact on your business by any unexpected loss of business from major accounts.
4. Key Suppliers: A supplier of critical components or services can also have an adverse impact on your business. Remember you are not just buying a product or service to a specification but you are also dependant upon the quality of the management process to perform sufficiently to protect your interests with timely delivery, at the contracted price, and meeting or exceeding quality expectations. Do you have a strategy to use alternate sources of supply to preserve your ability to deliver to your customers reliably?

Will I avoid all risk if I invest in the areas cited above? No! But it will set a tone for how you and your organization manage the business. It is not a matter of making a mistake but how you respond to those mistakes and reduce them over time, Developing sound business practices and a balanced business strategy that is not only focused at developing the business but also addressing those issues that will impair your ability to deal with the unexpected – and the unexpected will occur!

When to Say No to Business!

In a recent article on the Five Principles to Managing Cash Flow Successfully I received a number of comments on the third principle – Importance of No.  As business people we strive for the yes from the customer/account/client, which means an order or a commitment for an engagement.  However, in our drive toward closing the order we can overlook critical signals about the customer or become too aggressive in negotiating away our value that often results in business we wish we had said No to and walked away.

Why is it so hard to say “No?”  We have all been there –more than one, two or three times.  The experience is the same.  We make less money.  We regret the customer relationship.  We loose face or feel people will think less of us if we back away.  We are less motivated and we struggle to deliver a good quality experience despite the circumstances.  Our internal drive to win any and all business is a strong one and difficult to manage.  It becomes personal when we should be objective and recognize that we should let the opportunity pass to someone else who may be a better fit or willing to take the risk with this particular piece of business.

We need to manage and control the fear of loosing business or an account and stand firm on the success principles of our businesses. It doesn’t make sense to compromise your business principles only to put the customer relationship at risk.  If you roll over and walk away from your principles you will move from a position that you can defend to your customer to the slippery slope of compromise that once you start it is difficult to know where to stop.  Some customers (under the guise of good negotiating) will take advantage of you once you start down this path.

Here are key indicators that you should look for that will put you in a “No” position.

1. Balanced agreement/contract – You should have a sound business contract/engagement agreement that protects you and looks out for the interests of the buyer.  Use legal counsel and an insurance professional to look it over to make sure it is sound.  The key terms of the agreement should be reinforced during the sales development process.  If the customer is hesitant to sign the agreement wanting to do a handshake or refers it to his attorney and it comes back with language that clearly favors the buyer – say “No!”
2. Moving goal posts – Too often a customer will want, or appear to want, infinite idea flexibility and each time you meet with them the story changes.  Your job is to contain scope creep and avoid pressure on what you have proposed and what will be agreed to in the beginning but seems to continue to evolve.  Another factor is vagueness or difficulty in agreeing to details that are critical to your performance.
3. Working relationship – If you do not have a reasonable working relationship – keeping scheduled meetings, providing necessary details, reasonable access (returns e-mails, phone calls, etc.), demonstrates appropriate follow up on activities they are responsible for – then you are witnessing what your under-contract working relationship will be like.
4. Outside your core competency – You get jazzed about a great opportunity and then realize that the scope of the work requires experience and competency that is too far from what you are capable of doing.  In this case the opportunity is not a good match for you and you should withdraw gracefully.  Most customers will respect your decision and will consider you for future opportunities due to your honesty.
5. Contact with the key decision maker – Where your success is dependant upon organization cooperation but you do not have access to the decision maker that is responsible to deliver that cooperation then you are at risk. You need to have access to the senior manager that can make things happen if they are not occurring on their own or you will find that you are working uphill, against the flow, and at risk.
6. Absence of commitment – If the customer is unwilling or finds it difficult to commit time or reasonable resources in the development of the project then, like 3 above, the customer is not engaged or committed to not only to their success but yours as well.

Saying “No” should occur as soon as you cross one of the thresholds above where you know it is not going to be a good deal.  Communicating your decision should be in person if possible and also in writing describing the important business factors that you feel need to be present for success.  Do not highlight what you feel are the customer’s shortcomings, as you will want to be considered for future work.  The “No” statement should be used to strengthen the customer’s impression of you and not a basis for breaking a relationship.

So what do I do if I am always saying No?  You will find yourself doing a better job of qualifying customers and investing in those that do not have the characteristics above.  They are out there and as you raise your standards you will find them.  Why are there so many “No” opportunities – possibly because the better companies and professionals have already turned them down! 

Make sure you invest in opportunities where there is a high probability you will want to say, “Yes!”

5 Principles to Managing Cash Flow Successfully

Managing cash flow is a simple concept – but hard to do it successfully in practice. Why? Business is dynamic and balancing the timing of unpredictable revenue against the predictable consumption of cash by fixed expenses coupled with unpredictable variable expenses can create a cash flow crisis. An easy solution is to just borrow more money (sound familiar – US Gov?) but that only provides a short-term solution to what might be a chronic problem of reigning in expenses to the revenue that your business is producing.

I have outlined 5 basic principles that can help you establish good business practices that will allow you to keep abreast of your cash flow position and enable you to take necessary action and managed your cash successfully.

1. Revenue/Expense Budget: Develop a budget that time phases your cash (expense) needs. This may need to be down to the day (i.e. cash for payroll) and not just bucketed by month. This then helps you determine how much revenue you need to sell and then collect payment on in time to make payments. Review your budget with other business professionals to get their feedback as to its believability. Their initial comments may hurt but your still working on paper and not spending money. Stress your plan for corner conditions (low sales, unexpected expenses, delays in receivables) and understand how your budget may or may not respond under those conditions.
2. Collection of Receivables: The critical element in managing cash is to understand what collection obstacles may occur that would delay the arrival of cash to pay for necessary expenses. A common mistake is not recognizing that a (valuable) client may choose at their discretion to extend and delay payment. Having an effective collection process that is prepared to contact clients “prior” to the payment date to make sure that the client organization is scheduled to make payment and that nothing is amiss. Do not let this become a conflict avoidance issue. Remember you are in business and the collection process, done professionally, can be painless – most of the time!
3. Importance of No: Too often we are hungry for business or excited about a new client and make allowances, become too aggressive in pricing or scheduling a project, or committing to a poorly defined project. The end result is that you devalue the value that you offer the customer. What you rationalize as a good concession at the time to get the order makes it a costly product/project to deliver. Because of the over commitment you consume opportunity and delivery time on a low margin piece of business that may end up becoming a collection problem when other business was available that would have come in with full margin and paid on time.
4. Negotiate Expenses: A number one priority is to minimize your expenses by effective purchasing. When you need something in your business remember that there are all kinds of ways of purchasing it – at different prices. Online auction sites can be very effective in reducing the cost of a business item by over half the local street price. Used equipment is also a great way to conserve cash. That approach may be a problem for you or a few of your employees using something that is refurbished or shows signs of wear but still has a useful life left but it protects cash. Tough negotiating on recurring costs (rent, advertising, etc.) is basic to containing cost and relieving pressure on cash flow.
5. Cash Flow Dashboard: Doing all of the above does not get you to a point where you are through. Managing cash flow is a daily discipline. How severe your cash flow situation is determines the intensity in which you monitor key performance indicators (KPI’s) or metrics. If you are in good shape then it may be as simple as monitoring incoming orders, shipments and deposits. If you are on a roller coaster then you may need to include watching each receivable, bank balance, when you pay payroll (even yourself), what your payable situation is, etc. Keep a dashboard active so that you can always dial it up or down when you need it. Creating it during a crisis is not easy to do.

I have listed 5 principles to managing cash flow successfully. These steps are tactical measures that require solid execution. Bottom line is your basic cash attitude toward managing your business.

• Good attitude: Keep your spending inline with your actual revenue and don’t spend assuming you will get the revenue.
• Dangerous attitude: Convincing yourself that by spending more the revenue will come.

You may feel “crippled” by a tight spend/cash policy but that is an easier problem to handle than when you are over extended with no way to meet your financial obligations. Many successful individuals and companies started out using an austere money management approach and made it work for them. Make it work for you!

The Best Read: Reading Your Financials!

For many people the most boring aspect of running a business is reading their financials. For some it is so onerous they try to avoid the experience every month and only want to know the bottom number - profit or loss! However, your P/L, Balance Sheet and Cash Flow statements are the cardiogram of your business. To maintain our personal good health we get physicals on a regular basis and for many that means a cardiogram and even a stress test to make sure all pumps and valves are working properly. For good health and longevity we would not go without one.

Your financial statements, on a monthly basis (minimum), are the cardiogram of your company. Properly designed financial statements provide insight on how the key elements of your company are performing. While significant focus is put on how much profit (hopefully) you made. Profit will take care of itself if the key profit performance factors of your business are under control. Financial ratios help you quickly get the feel of where the pain might be if profit is less than expected. The value for each ratio may be measured against historical averages or market benchmarks. Obviously performance factors that have current values on the wrong side of the desired value deserve your first attention. There is always a story behind each number so it is necessary to uncover the facts that influenced the outcome in order to take effect give action. It is in this process that you can learn a lot about your company.

• Are unusual numbers the result of data collected incorrectly (wrong coding)?
• Is it a one-time anomaly which will correct itself in successive periods(3 versus 2 payroll periods)?
• Were all of the closing cutoffs made on time so that all revenue and all expenses for the period are included?
• Is your Cost of Goods sold - material, labor, contracted services - consistent for the revenue recorded?
• Are you absorbing too much labor that is nonproductive?
• Are you buying from the best price/quality/delivery source?
• Is there a mix shift in the products delivered that resulted in less margin than what was expected?
• Are your overhead expenses inline?
• Salaries are often fixed for the period but variable expenses such as marketing, expense accounts, travel, entertainment, etc. may get out of line.
• Are your commission payments consistent with revenue and discounts?
• Does your balance sheet show any surprises?
• Is your inventory level consistent with the production demand?
• Are customer deposits collected and in reserve for the product or service ordered and not consumed by other operations?
• Is debt service under control and do you have adequate operating reserves in the event of an unexpected change in business?
• How healthy is your cash-flow?
• Do you have sufficient cash to ride out the normal flow of high expenses and valleys of revenue?
• Do you have the cash to afford the capital improvements that you are planning?
• Using a conservative revenue forecast how strong is your cash position two to three months out?

These are just a few of the questions that need to be considered as you examine your financial feedback on your business. In too many cases I have observed owners/CEO's taking a complacent attitude toward their basic financial reports "since they were profitable." However, when an unprofitable period arrived they then had plenty of time to dive into the details only to find out that the "unprofitable" signals began several periods earlier. Timely action would have avoided the profit problem or reduced it significantly through proactive measures instead of reactively applying CPR to the business.

Experienced owners/CEO's take advantage of interim metrics that track key performance factors that influence their financials so that on a daily/weekly basis they get snapshots of what is going on without waiting until the next month to discover a problem. This serves as a pace maker to make sure that the pulse of the business is appropriate and if not - inject their attention and leadership to get things back on track.

Read your financials and develop a good feel for how your business operates so that you can enjoy good business health!

Is Your Line of Business Profitable?

Anyone who owns or runs a business knows if they are profitable or not. They look at the P/L at the end of the month and to see if the bean counters show that all revenue exceeds all expenses for the period producing "earnings". This may not be the true profitability of your "line of business" or LOB. The question is compounded if you happen to have more than one LOB.

I have often come across companies that report profits but upon closer examination the profits reported differ from what the LOB's produce. Measuring the profitability of a LOB aligns all of the products, services and overhead for related products that serve a particular industry or customer base. Provided the accounting esteem collects the appropriate data on material, labor and overhead cost it is then possible to measure the LOB profitability.

In a single LOB company it is not uncommon for administrative overhead or corporate overhead to include more cost than is really used by the LOB. This may be due to general inefficiency or intentional misuse by senior leadership or owner for services that are not really related to the LOB. Consequently the company may be profitable with the LOB bearing a heavy overhead allocation or worse the company may be unprofitable when the LOB is profitable. The risk here is that the LOB may be starved of critical resources so that overhead services can be continued.

An extreme example of this was a multi LOB business model where two of the lines were producing LOB profit in excess of 10% while the third and most capital intensive had a loss of 15%. The consolidated profit was 5% and termed "a good profit" by the ownership. Upon further examination the third, capital intensive, LOB had significant issues without he pricing model of work performed, an understanding of what the loading factor of the equipment should be to be profitable, and when it was "profitable" to add additional equipment to the business. These "weaknesses" would not have been revealed had the LOB profitability of a profitable company's not investigated.

Make sure your LOB's are profitable and that your consolidated profit is the accumulated totals of those profits!!

Personal Guarantees and Your Business

Operating and growing a business often requires injections of cash to provide the working capital for expansion in staff, equipment, and market promotion campaign or to just get through a tight business climate and preserve essential resources. Depending upon your source for credit you may be asked to make a personal guarantee. Despite your confidence and enthusiasm in the ability of the business to bear the repayment of the loan and associated debt service consider the following 5 tips (see 5 Steps: A Personal Guarantee and Your Business (and Future ) to protect your self and your business. Know the risks. Understand what you will risk in the personal guarantee. For business partners, a new meaning to "one for all." Make sure that all partners share the same liability if the debt cannot be repaid. Beware the "clause" & effect. Know what the impact of changes or "flexible" alternatives to loan elements as such as determining interest rate over the term of the loan can have to you. Don't gloss over the fine print. Understand what the fine print says. Use a lawyer to interpret the legalize. You do not want a surprise if things go bad. You can't run. You can't hide. So don't! Bankers do not like surprises. Don't let them learn of a problem from someone else other than you. Don't let your bravado hide the true condition of your business. Be transparent on what you are doing if a problem situation and build their confidence in you. Borrow wisely and take the time to exhaustively determine what range of liabilities you are obligated to in your loan agreement.

The Benefits of Revenue Linearity

"Through improved revenue linearity and strong working capital management, we improved DSO, decreased inventories and, as a result, generated $46.8 million in positive operating cash flow, our 46th consecutive quarter of positive operating cash flow."

Chairman and CEO Robert Hagerty, Polycom Inc.

Many companies measure revenue on a monthly basis and overlook the "flow" of revenue during the month. In some cases companies are captives of their customers as it relates to the demand curve that they place on them. We often receive promotion offers to order by . . . which are designed to improve the linear flow of revenue for the company. In other instances, companies do not apply sufficient planning(forecasting)/control to the manufacturing process which can result in a hockey stick flow of revenue at the end of the month. This can be particularly true for build to order products versus those that are more commodity oriented. Insufficient order backlog can also produced a non-linear revenue flow as manufacturing will produce products for potential orders that do not arrive until late in the month placing extreme demands on operations as they do final assembly, configuration and test to ship by the end of the month.

Why is linear flow necessary and valuable to the financial performance of the company?

Revenue Linearity Example: Ideally if you have a monthly revenue budget set at $1.2M and there are 20 working days in the month then a linear flow would be to deliver to finish goods and ship $60K per working day.

This example assumes that there are sufficient orders and customer approved ship dates to ship available inventory each day at a $60K rate. This linear flow allows the collection process to begin earlier than if the bulk of the $1.2M is shipped the last week of the month. Also, inventories and work-in-process can be optimized to support a $60K/day flow instead of a large "burp" the last week of the month (in some cases this could occur over a few days).

By the end of the first month or by the 15th of the next or second month a good portion of the cash from the first part of the month would be received or on its way. A non-liner flow would push many receivables out into the third month putting pressure on working capital and credit lines.

The graphic below highlights the difference in collection is a linear and non-linear revenue pattern. In the Linear example the first collections are on their way by the middle of next month and would continue to increase as the each receivable aged. In the non-Linear example we see a substantial portion of the receivables delayed and additional 15 days or more depending upon the severity of the non-linearity. The cash is delayed but demands for cash regular wages, utilities, inventory for the current month revenue still exist and would have to be paid by reserves or a draw on the credit line.

When build-to-order products are involved the scheduling and production performance are critical to produce the linear flow. Lean manufacturing methods have improved the ability of manufacturing operations to meet scheduled delivery dates that also support linear revenue flow.

In the case of Polycom above, it improved revenue linearity along with strong working capital management and produced an attractive positive operating cash flow.

What is your linear revenue strategy? Are you taking advantage of revenue linearity to improve cash flow in your company?

Cash Flow Planning and Profits

Cash Flow Planning is something that many companies do not integrate with the normal budgeting and profit forecast process. For some companies this is not a serious problem in a "normal" economy as they have sufficient cash reserves or credit line that can absorb the normal ebbs and flows of cash demands of the company. In todays economy where cash reserves have been depleted or credit lines tightened or "lost" raises a new demand for "accurate" cash flow planning.

If I make a profit then whats the big deal about cash flow? Profits on most company financials do not represent cash but a sale that is a liability on the customer to pay at some time in the future. Until the customer pays the company uses working capital to pay for inventory, employee wages, heat, lights and other expenses. It is the management of customer payments and company obligations that results in either positive or negative cash flow.

Isn't it just a matter of making sure receivables are greater than payables - right? This would be a simplistic view of managing cash flow as this attitude would most likely not recognize factors that influence the changes in Days Sales Outstanding (DSO) or balancing non-uniform demands for cash such as new products, tax payments. capital expenditures or debt reduction.

DSO is a measure of the number of days that a company takes to collect revenue after a sale has been made. Why would DSO vary?

1. Products that have quality issues and do not operate properly will cause payments to be delayed until the products perform.
2. The customer mix changes where the majority of customers paying in 45 days days may transition to customers who push payments out to 60 days - or more.
3. Customer cash flow problems can filter down to you where they may delay payments to improve their own cash flow situation.

So if I do a good job on collections cash flow can be managed? Managing the inflow of cash is important but it is also critical that you look what expense and asset strategies you are using in the company. Such as:

1. Carrying inventory that is not being used consumes cash making it unavailable for other purposes such as paying wages, lease payments, etc. Excess inventory can even result in lost cash if the inventory becomes absolute and is written off - thrown away.
2. Capital expenditures such as equipment or buildings consume cash prior to getting a return on the investment. Timing of investing in capital expenditures can put positive cash flow at risk.
3. Factory cost or the cost of goods sold - labor and material - will put pressure on cash if productivity and quality objectives are not kept to insure that a dollar of sales will yield a predictable gross margin. Loss of control in labor cost, productivity, quality or material cost can create products that cost more than expected and/ or delivered later that expected resulting in a cash flow crisis.
4. Vendor financial stability can become a problem where they may need to tighten their collection policies which may require you to pay early if there are not otters sources for the same product or service that will let you pay on the same schedule you have planned into your cash flow plan.

Summary

Good cash flow management is not an accident. Intentional action is required on a regular basis to make sure that all of the factors that support your cash flow plan are in order. Cash is king - but you have to take a proactive role with your organization to make sure you achieve your cash flow objectives. Integrated cash flow planning is essential. Developing cash models of your business will help you and your team understand the sensitivity of your specific business model to factors that can cripple or impede good cash flow management.