J Nicholls & Associates

Category: Blog Posts

  • “Why isn’t there more money in my bank account?”

    cash flows like water
    cash and water both flow. You need to control it.

    This is one of the most common questions business owners ask when we first meet. Their business is successful but it doesn’t seem to be reflected in their bank balance. Or if the business is doing less well “why am I putting all this effort in for so little money?”

     
    It seems a simple question. The answer is less simple because your cash depends on the following:
     
    • how much profit you have made,
    • changes in level of working captial,
    • new investments (fixed assets) made,
    • Increases in financing (loans, overdrafts etc) and
    • dividends or drawings you’ve taken out.
     
    For those who like equations:
    Cash = P – ∆WC – I +∆F – D
     
    For those who are more visual: It may help to think of cash as a stream. It flows into your business as profit from operations. It flows into pools and ponds (working capital), some of these pools are stagnant. It may leak away or evaporate (inefficiencies, bad investments) before finally making into the lake you want it in (your bank account). From there you take what you need (dividends/drawings).
     
    So there is a lot to go wrong before the cash reaches you.
     
    Looking at these factors one by one and in reverse order:

    Dividends/Drawings 

    We all know how much money we’ve taken out, don’t we?
    Surprisingly the answer is generally “no”. And when you do find out it can be a shock.
    It is difficult to really know everything you are taking out of the business. The information is hidden in lots of places. Dividends are not shown on the Income Statement. Salaries and benefits (health care, car …) are often mixed with those of staff etc…. It is very rare for a business to have a report showing exactly how much you have extracted.
    And that means that owners often underestimate this. So it should be one of the first things to look at.

    Financing 

    This can be either in the form of loans or as new investment. Both increase cash in the bank. Both come with strings attached. Loans need to be paid off, come with covenants and you have to pay interest. Investments put other pressures on your business – different owners may have different priorities, new investors get a share of all future profits (for ever) etc. Your share and control of the business is diminished. The good news is your need for external financing will be lower if you follow the advice in this blog.

    Investments and fixed assets

    Have you bought a new car or computer (system) or moved to new premises? This does not immediately affect profit but it does hit your cash. If you paid by cash you will have taken money out of your bank account.
    Or you may have taken out a loan to pay for it. That’s often the best way to do things and it reduces or even eliminates the impact on your cash in bank. But it increases your financial obligations going forwards.
     

    Change in working capital

    In nearly every company I see, there are issues in how working capital is managed. The strength of working capital management can be a good indicator of how well a business is managed. 
    The good news is that this is where small changes can have a big impact on both cash and profitability.
    The components of working capital you need to manage are:

    Receivables (debtors)

    You may need to give credit to get a sale. That means money tied up with your customers is not in your bank account. Tips for improving your management of debtors:
    1) Don’t give more credit unless you need to, and don’t give more than you need to.
    2) If you do give credit, make sure your customers pay when the debt is due. Late payment uses up even more cash and increases the chance you don’t get paid.
    3) If a customer is struggling to pay, work with them to create a payment plan.
    I recently did some work for a highly rated consultancy. It was growing and profitable. A major customer had been allowed to build up a substantial debt. That is not uncommon. The mistake they made was they continued to do work for this customer which eventually went bust which very nearly destroyed the consultancy.  

    Payables (creditors)

    That is how much you owe to suppliers, staff etc. A few tips:
    1) Include credit in your negotiations with suppliers before you buy anything. This is the point they are keen to sell and are most likely to be flexible.
    2) Pay when the debt is due not before. Some business owner like to pay early. That is not a great idea – you use up cash and you lose the ability to get better prices that early payment could afford.
    3) Keep track of how much you owe and when. If you do not do this you may not have the money to pay on time. Stories of businesses driven into receivership by an unexpected tax bill are all too common. Make sure you have a list of everything you owe and when you need to pay.
     
    When you look at your debts include:
    • stuff you owe but don’t have the invoice for (or you have the invoice but you haven’t entered it into your finance system). So if a supplier has delivered goods or done some work for you, you have a debt that you will have to pay (this is called an accrual).
    • What you owe to your employees (wages, bonus, pension etc)
    • What you owe the tax office (and this should never be a surprise). Make sure you know what you owe and put aside the cash to cover these liabilities.

    Inventory (stock)

    This is one of the most difficult things to get right because you have to be good at so many different things:
    • You have to be able to forecast future demand at the right level of detail. That is by SKU (stock keeping unit). There is no point having 100 HB pencils and no ballpoint pens if people need ballpoint pens.
    • You have to time your buying so you have the stock available when you need it.
    • You need to know how much stock you have on hand and on Purchase Order.
    • And you need to be proactive about managing the stock you on hand and on order. If it looks as though you are going to have too much of any SKU, work out how you can clear it.
    You do not want to have all your cash tied up in stock. And badly managed stock can destroy your profits. It hits holding costs (storage), there is more chance of damages, it may become obsolescent (particularly true in food, fashion, electronics), the chance of theft increases, and you may only be able to sell with big discounts or even find you can’t sell the stuff.
    Too little and you miss sales opportunities losing potential profits and leaving your customers unsatisfied.
    More often than not businesses end up with too much of what they don’t need and not enough of what they do.
    Manage your stock right and you can transform your cash position and your profitability.
    One customer bought goods from overseas for web-based retail in the UK and EU. The business was successful, growing fast with a strong reputation. In working together it was clear there was tight control on buying so much so that goods were often out of stock. That hurt in three ways – customers weren’t able to buy goods that weren’t in stock so they lost profit, customers service ratings went down and their rankings on e-commerce sites were hurt hitting sales when they got the product back in stock. They calculated that the first factor alone meant sales were 30% below what they could be. 

    Work in progress (unbilled work)

    The longer the time between doing the work and billing for it the less cash you have. And unfortunately the greater the chance your customer will dispute your bill. So invoice often and on time.
    If you are working on a project which will take several months, negotiate to be paid in stages – say at the completion of each phase or substantial chunk of work. Ask for a prepayment. If you want to get paid at completion of each stage make sure you agree scope with your customer and get them to sign off the completion of each stage.
    Work in progress almost caused a successful and profitable car repair workshop I worked with to go out of business.  They had no money and consequently were unable to pay their suppliers on time. The owner was always “out” to avoid having to speak to creditors (think what impression that would create on potential customers). The business was hamstrung.
    At the same time, the parking area was full of unrepaired cars, so full I couldn’t find a space to park. If he’d had a magic wand to remove that backlog he could have solved his cash flow issues at a stroke. This is an extreme example but many businesses have money tied up in work they haven’t completed or billed for.
     
    Profit is not the same as cash. As a business owner you need to actively manage both to be successful. A couple of examples to illustrate the difference:
    1)  You buy £100 of goods on 60 days credit and sell them the next day for £80 cash. Your cash position is great – you have £80 in your bank. Profit less so – you’ve lost £20 on the sale. That type of business is not sustainable. You won’t have the cash you need to pay the supplier when the 60 days are up let alone any of your other business costs. This is not as extreme as it may seem. Many business owners don’t actually know whether they are making a profit or loss on their sales once they take all relevant costs into account.
    2) You buy those same goods for cash and sell them a month later for £120, so you have made a profit of £20 on the sale. But you have to find £100 to cover the fact that it takes you a month to sell that stock. This could be a good business but unless you can find that £100 to pay the supplier the business will fail. 
    So avoid using your bank balance as the only measure of how well your business is doing.
     
    The level of profit your business makes is itself is the result of many decisions:
    • The market you are in
    • What you sell and who you sell to
    • how you set your pricing
    • how much discount you give,
    • what are the costs involved in making and fulfilling that sale
    • how well you buy
    • how well you manage your fixed costs
    • how well aligned different parts of the business are
    • how efficient you and your business are
    • how quick you are to spot and address opportunities and threats, etc
     How well you make those decisions depends a lot on the information you have available to you and the quality of your financial management. It is not something you can afford to leave to chance.

    Summary

    So there you are. To have the cash you want you need to:
    1. have a viable business model,
    2. have the controls, reporting and management capability to ensure you are making the profit you should be making,
    3. actively manage your working capital,
    4. be careful about investments (and expenditure),
    5. get funding if needed,
    6. be aware of how much money you need to take out of the business and ensure your business can afford it.
    The cumulative impact of getting these right can transform your business.
     
    Contact me if you’d like to find out more about how you can improve profit, cash and make your work place a better place to work. Or if you’ve any questions about the content of this blog.

  • Everything you wanted to know about credit management but were afraid to ask …

    Everything you wanted to know about credit management but were afraid to ask …

    This blog gives a deeper dive into the themes brought up in my previous blog on Eight things you can do to make your business more profitable – 4. Tighten your management of debtors.

    Why give credit?

    Sample credit report

    The fundamental principle is that you give credit to win and grow you business. Keep this at the back of your mind. Customers can be tricky. They may use credit granted by one supplier to help get them fund the business with another or for something totally different altogether.

    We know that if we want to make a sale we often have to give credit. This may be because the balance of power is tilted in favour of the customer or because it is standard practice in the industry you are in.

    Sales negotiations are not just about price. If you raise credit early in the discussion you will be amazed at what is possible. If you raise it after all other details have been negotiated then you are unlikely to see any flexibility.

    There will be circumstances when you should not grant credit. If the customer has no track record or a poor credit history or low credit score. In these situations you would be in your rights to demand CBD or COD(cash before/on delivery).

     

    Why is credit management so critical to the success of my business?

    Businesses fail or are lack the funds to do what they need to do because of poor credit management. All businesses need to have strong credit management policies. Why?

    1. You have to pay the cost of funding it. This can be expensive – factoring can easily cost 15% of loaned amount (on an annualised basis). Cash tied up in credit cannot be used for growth or other initiatives.
    2. If you don’t address issues promptly you may have far greater losses as you continue to provide goods or services long after you should have taken action. What would have been a £10,000 loss can easily grow into a £20,000 or £30,000 loss.
    3. Losses go straight to the bottom line – you have to sell far more just to get back to where you started. If your Gross Profit (sales less all costs of the sale including shipping and commissions) is 25%, you will need to sell an additional £40,000 to make up for a £10,000 bad debt.
    4. It is a waste of time and management focus – well established credit procedures allow you to keep on top of credit. Once allowed to slip it takes a disproportionate amount of work to bring back under control
    5. You are likely to have nasty surprises. When problems surface you often find that you need to make significant write offs. Additionally if you are relying on that payment then you may not be able to meet your own commitments which can have serious consequences.
    6. It can poison your relationships with customers. Your conversations with your customers should be about how to develop the business not when you are going to be paid. Customers with a poor credit history with you will tend to feel guilty. As a rule people tend to avoid situations that make them feel guilty so … they are far more likely to work with somebody else.

    How do I know if I have a problem?

    A quick checklist.

    1. Do you produce a monthly (or weekly) aged debtors report? (see main image)?
    2. Do you review it each month (week)?
    3. Is most of the debt in the first column (Not Due) with little if any more than 30 days overdue?
    4. Do you know the reason for everything not in the first two columns?
    5. Do you have an action plan to make sure that you can get the money back?
    6. Do you check progress against the action plan and make people accountable?

    If your answers to any of these questions is “No” you probably have a problem.

     

    So how can I manage credit better?

    The foundations of any good credit policy are your Terms of Sale (or Sales Contract). Make sure it includes the following points:

    • Retention of Title – Ownership of goods or IP lies with you until the customer has paid
    • Payment terms (when debt becomes due) and Credit Limit are clearly shown
    • Customer is liable for debt recovery costs.
    • Interest to be charged on overdue invoices and interest rate to be used. 
    • Receipt of goods or services – customer is responsible for raising any issues with quality of goods or services within a few days of receipt. Customer is responsible for signing POD at time of delivery.
    • The Customer agrees to carry out reconciliations of account regularly and ad hoc if required.
    • Customer must provide remittance or payment advice to notify allocation of payments made to invoice/credit note received. In the absence of this FIFO will be used (ie payments used to settle oldest outstanding debts first).
    • Process for management and agreement of credit notes – can be a big issue with larger customers.
    • Acceptable payment methods including agreement as to when payment has been received – eg cheques to have cleared.

    You have two controls available to manage credit on an on going basis:

    Credit terms – the number of days after invoice date that payment becomes due. These are normally set by industry practice.

    Credit limit – the maximum amount of credit that you are prepared to extend to a customer. This depends on an assessment of risk (eg past experience, use of credit rating agencies) and size of business.

    A good ERP or order management system will check both of these automatically as you enter orders. It can be set to warn or to block these orders from processing further. It is then up to you whether you choose to release or not.

    Circumstances may require you to provide flexibility on either credit terms or credit limit (see section on exceptions). Relaxing both at the same time is almost always dangerous.

    What else do I need to do?

    You need to be scrupulous in your paperwork – don’t give your customer any excuse to delay or refuse payment.

    • Make sure you put details of customer PO (Purchase Order) on your delivery note and invoice. Sometimes customers will not pay if there is not a valid PO.
    • Send a delivery note with each shipment.
    • Get a signed POD (Proof of Delivery) for all shipments. If you are providing services have your customer to confirm receipt of services as stipulated (for example signing off each stage of a project). If not agree with them what you have to do to remedy the situation.

    If your customer pays monthly, send a statement showing what they owe a week before their payment run. Follow up with the customer to confirm they will be paying this amount. This will flush out any problems. They may say they don’t have a POD or claim that some goods were missing and use this as an excuse to not pay anything. I have seen too many cases where a major customer has delayed payment in this way.

    Carry out regular reconciliations with customers to make sure that you both agree what is outstanding (at an invoice level). How often you do this depends on the size and complexity of your dealings with the customer. You may choose every month for larger or more complex customers and once a year for the rest. If you fail to do this you will almost certainly have far more work at a later stage, weaken your position if you need to take legal action and more often than not find yourself writing off the difference between what they say they owe you and what you know they owe you.

    Have a standard process for dealing with overdue debts. For example if a debt is 10 days overdue you call, if over 20 days overdue you may stop shipment, if 30 days overdue you may start threatening legal action.  Keep records of all communication – time, date, who you spoke to, what was agreed etc.

     

    My customers aren’t paying on time, what can I do?

    Have a credit exception policy.  There are always going to be times when a customer is not able to pay on time. You need to find out as early as possible that a customer is experiencing issues. That way you both have more options for managing the situation.

    Tip – Aim to link the granting of an exception to some benefit to you. They are getting a benefit from you and so should be prepared to give something in return. This has the side effect of putting a price on not paying on time. This will magically reduce the number of exceptions you have to deal with

    The first step is to speak to the customer to understand the reason and whether it is a one off short-term cash flow issue or something more serious. In order of increasing severity you have the following options:

    1. Ignore it – not a great idea unless short term exception and the amounts are not large.
    2. Payment plan – agree with the customer what they will pay and when until they are back within terms. In general such a plan will include:
    3. Payment before shipment – you can require that customer pays before you ship (or manufacture) any fresh orders.  This keeps the absolute size of debt unchanged but refreshes the age of the debt.
    4. Stop supply – if it is obvious the customer is unable or unwilling to pay then it may be necessary to cease supply of goods or services.
    5. Legal action – use this as a last resort. In most cases the threat of legal action will result in payment. Some customers wait until just before the case comes up in court to pay.
    6. Initiate proceedings to wind up the company – if all of the above don’t work then this may be the only option open to you. In general as an unsecured creditor you are unlikely to recover the debt in full.

    Be clear who can approve credit exceptions – for smaller companies it should probably be the MD or FD or both.

     

    Who should be responsible for managing credit?

    Great question and one that many people don’t ask. Many companies will give Sales this responsibility. Not smart. Sales people are targeted and rewarded on the level of sales they make. Credit control tends to be seen as something that gets in the way of them achieving their targets.

    In general the best place to put credit management is Finance or Customer Service (if not part of Sales). At the same time involve the Sales team in the management of credit. That way you are making credit decisions – terms, limits, actions – with an understanding of commercial factors – customer development plans, special considerations etc – rather than blindly following a policy.

    Tip – If you can link Salesperson commissions to money received on the basis that “a sale is not a sale until the money is in the bank”.  This can be done by freezing commissions on sales that are more than say 30 days overdue. This aligns the interests of Sales and the company.

     

    You may also find the advice given by the Federation of Small Businesses useful in their February/March 2013 edition of First Voice

  • Eight things you can do to make your business more profitable

    Eight things you can do to make your business more profitable

    Money DrainWe all know they key to being a successful business is to sell more. But we’d be wrong. Most business owners are pouring money down the drain. Here are 8 things you can do to make your business perform better and make more profit. Each can make a substantial difference to your business’s performance. Taken together they can be transformative.

    1. Understand your costs and their drivers

    This is one of the biggest causes of low profit and business failure. It is that important.

    Business critical decisions have to be based on robust information and an understanding of the impact on both sales and costs. Decisions such as what level to price at, where to spend and where to cut back, whether to take on a job or buy a new piece of equipment or whether to outsource. Get these decisions wrong and at best you make less money than you should. I’m often amazed how little grasp even well informed business owners often have of costs. As a first step put together a customer/product profitability matrix – this can be eye opening and will show you where to focus.  

    2. Control levels of discount given

    Any discount you give goes straight to the bottom line. And there is often no visibility of discounts given. If you don’t measure it you can’t manage it.
    Sales people are generally rewarded on sales. One of the easiest ways to get sales is to sell on price – to give discounts. Discounts are like a drug. Once you have set customer expectations it is diffcult and expensive to change them. One company I know had to pay several £m to buy back discounts which previous management had granted to a major customer.
    What you can do:
    – make sure your accounts show discounts.
    – have a clear policy on discounts

    3. Strengthen your management of stock (inventory)

    (This point also applies to service businesses where unbilled work is the equivalent of stock.)
    There are obvious costs of holding stock: the cost of the cash you have invested in stock and the cost of warehouse space to hold it. The non quality costs of poor stock management can be even higher and are often invisible. They all hurt your profit. Sometimes substantially. These include:
    – shrinkage (stuff goes missing)
    – degradation and obsolescence. Some products have a sell by date, some such as fashion or electronics becomes out dated. All product looks less attractive the longer you hold it. In both cases you are unlikely to be able to sell at anything close to intended price.
    – write off and disposal costs – you can no longer sell the product and often need to pay to dispose of it.
    Against this you need to balance the missed opportunities of not having an item in stock when needed.
    What you can do: tightly control stock at an item level. Ensure ensure good rotation. Look for slow sellers and if necessary clear them. look for fast moving items and ensure you don’t run out. Estimate the value of sales missed through lack of stock.

    4. Tighten your management of debtors (accounts receivable).

    Credit is often needed to do business. So you may need to give credit. But once you have agreed credit terms there is no excuse for not collecting it on time. Money your customers owe you is money you need to find and money you can’t use for other things.
    But it goes well beyond this. For every 30 days a debt is late, the chance of collection goes down by 50% and the effort to get it doubles. I have seen very few companies who manage credit well and some being close to failure as a result of poor credit management. 
    What you can do:
    – have a clear credit policy which your customer agrees to
    – know how much extra you need to sell to cover a bad debt
    – confirm with your customer that they have received goods/services as agreed.
    – review aged debtors list weekly
    – reconcile your account with customers at least annually.

    5. Aggressively reduce complexity

    In nearly all organisations complexity proliferates and accumulates over time. The costs of managing complexity may not be obvious but are huge. It consumes time, resource, focus, energy and opportunities. Complexity increases exponentially with each new element, with each exception or special case. Complexity prevents you understanding what is going on in the business so you are less able to make good decisions. It makes your business less agile and less able to do new things. It is the enemy of good execution and a thief of profit.

    What you can do:
    – resist shiny object syndrome (a big ask I know)
    – always look for how you can simplify. Always challenge yourself to cut out things that are not adding value.
    – design systems and processes so they can accommodate business cases and keep exceptions to a minimum

    6. Ensure your processes work from end to end. 

    All businesses are a collection of interconnected processes. Your business has processes whether you you like it or not. The success of your business depends on the quality of these processes. Most processes span several functions. This is where the problem starts. Function owners will tend to optimise their function at the expense of the process. The result? Poor customer service, lost opportunities, low staff motivation, fire fighting and increased cost. All leading to lower profits.
    What you can do:
    – ensure people are aware of the end result you are trying to achieve.
    – follow the process from beginning to end to see where it is not working. Put in different real life examples and exceptions.
    – simplify
    – ensure incentives encourage cross functional co-operation.

    7. Manage your staffing levels effectively.

    In a retail or restaurant business staff costs can be the single biggest expense. Demand fluctuates by day or hour. It is often difficult to predict leading to over staffing or over stretched staff. As a supervisor or manager it is in my best interest to have more staff than I think I need. In manufacturing businesses, managing this according to demand can make a dramatic difference to the bottom line. In a consulting business you need to be aiming for a 70-80% utilisation level.

    What you can do:
    – Compare staffing number and cost against activity for each day.
    – Make supervisors/managers responsible for staff costs as % of sales revenue.
    – Help your supervisor to plan staffing levels based on historical patterns.
    – Look at flexible staffing arrangements where appropriate.

    8.  Implement effective purchasing processes and controls

    Your two biggest costs are staff (7) and what you buy. Most business owners fail to manage purchasing or see it as a value adding function. There are two aspects – buying the right things and how well you manage your buying.
    Buying the right things – make sure that every purchase is aligned with your business goals.
    Management of buying – first ensure that you are buying competitively. Your decision should be based on value and fit. Only with commodities should you base on price alone and even then there are often other factors (eg service, guarantees etc).
    Secondly make sure that you pay for what you received, that it matches what you have asked for (ordered) at the price you agreed. Simply by matching order, receipt and invoice you may be able to find substantial savings.

     

    And as a bonus – a more difficult one but one that has the potential to make more difference to your profit than all the above combined:

    9. Ensure you have strong management information. 

    Unfortunately very few businesses have the information needed to make good decisions. As a result most business owners are operating in the dark. It can be incredibly stressful not knowing what is going on or why things are not working as you expect. You need information which is:
    – trustworthy – you want a single version of the truth which does not change
    – comparable – you need to be able to see how things have changed.
    – timely – as close as possible to the events. Tip – Annual accounts produced 8 months after the year end do not cut it.
    – understandable – you have to have information in a format that is easy to understand and makes it easy to see what’s going on.
    – granular – allows you to slice and dice to find the reasons for differences. For example cutting your business by sector, product type, geography etc.
    Without investing in good information capture and collection you will never be able to make as much profit as you could.

    Contact me to see how I could help you to make your business more profitable.

  • Is money really the language of business?

    Is money really the language of business?

    Screen Shot 2013-08-01 at 19.31.17There is a provocative (in the best sense of the word – provocative is good as it makes us think) post on LinkedIn by Liz Ryan. It is entitled “The Three Biggest Lies Told in Business“. At number 2 – “Numbers are the language of business“. Her point is that it is people and how they interact that makes business work. Numbers don’t do anything without this. They just sit in cells in a spreadsheet. Is money the only way to measure business success? Is it the only kpi worth tracking?

    Screen Shot 2013-08-01 at 19.33.50

    One of my heroes is W Edwards Deming. His ideas shaped many of the companies in Japan in the post War period. Some say he was responsible for  the “Japanese miracle”.

    As a young Production Manager at Mars some 20 years ago I watched several videos of WE Deming. He talked about “Money being the language of management“. Those in operational roles talked about things (volumes, hours, pieces, level of quality). So somewhere in between these two we have the expression that heads this blog.

    The tyranny of money

    There is a certain prevalent thinking in business that it is only about the money. The only thing that is important is the achievement short term profit targets. Management’s responsibility is solely to deliver as much profit as possible to the shareholders. Focus on the short term. This thinking is corrosive to the business, to the people who work in those businesses and society as a whole.

    Accountants have to take a lot of the blame.  Finance for Non Finance Managers courses typically start by asking “Why are we/are you in business?”. Any answer which is not “To make money” is wrong. That is not to say money is not important. no business can survive for very long if it does not make money or deliver a reasonable return to its investors. But is that the same thing as saying “the only reason we are in business is to make money”?

    So why does Deming refer to money as being the language of management? It is worth a bit of thought. Here is one explanation. See if you like it:

    Money is the language of business and for the same reason we invented money.

    Before money, people traded goods:  I will trade my sheep for your grain. The problem arose when

    1. you don’t want what I’m selling. You want some timber for your barn but don’t need sheep or wool. and
    2. if there is a big difference in value between what I have and what you are trading (so for example I have a sheep but only want to buy enough grain for one loaf of bread).

    Money solved this by creating a common and shared means of exchange. I can convert my sheep into money by selling it to my neighbour. I can use that money to buy some of your grain. You can use   the proceeds from selling grain to buy the timber you need for your barn. In other words it allows us to put an objective value on a variety of things. Our goal as business owners is to create value. So doesn’t it make sense to use something invented to measure value as our measure?

    Money allows us to put a value to disparate things – to activities, to projects, to administration, and obviously to goods or services. We can value nearly everything that happens in the business. That could be how much we are getting for our sales, how much we are spending to make those sales, the costs of fixed assets that allow us to operate, how much we owe, how much we are owed. It provides us with a tool to make objective comparisons and to support our decisions – is it more cost effective to buy this building or to rent it?

    In this way money is really is the lingua franca of business. And if I capture data correctly I can use it give real insight into what areas of the business are working well and what are not. Which customers or channels or products or sectors are performing. I can use it to turn my business plans into a road map. I can see if my plans will work before I start doing anything and can change to address issues. I can track my progress against that plan. I can use that information to understand why things didn’t happen as I’d expected so I do things better in future.

    It is critical but not perfect

    But let’s not forget that it is not perfect. It struggles to value intangibles like customer relationships, how well staff work together, how well our processes and systems support us, our brands, employee satisfaction or the difference we are making in our community.  You get what you measure and so focussing entirely on the finances will drive just the type of behaviour we want to avoid.

    To misquote Churchill “money is the worst form of measurement except all the others that have been tried”.

    So we have to accept finance can only ever be one dimension of success. We need to find ways of measuring our achievement in areas that can not be readily measured financially. May be something that treats making money as one objective but also looks at the needs of our customers, the capabilities we need to build to deliver that and the people and skills needed by the business? That would be the Balanced Scorecard by Kaplan & Norton. Screen Shot 2013-08-01 at 19.40.34

    One of Deming’s insights was that there was not in fact a choice between quality and cost but that by getting quality right you reduce costs. Likewise by delivering in a way that meets the needs of your stakeholders it may well be that not only do you achieve those objectives but also you make more money that your competitors who look only at the bottom line.

    If you would like to learn more about what to measure and how that how to use financial information to gain insight on your business performance and suggest new opportunities then email me on info@jnaa.co.uk

    * I was in two minds as to whether to use the words “Balanced Scorecard” given the reaction it generates in many people. Used right it is a powerful tool. We should not tar the concept with the same brush as the results of poor and lazy implementation.  With all business tools take the bits that work for your business and ignore the rest. Don’t be a slave to dogma.

    By Jonathan Nicholls

  • Have you got the problem most businesses only dream of?

    Have you got the problem most businesses only dream of?

    Do you or your company have a problem to die for, a problem most people only dream of? I’m talking about being too successful – something I’ve noticed again recently with some of the companies I’m working with. And the problem? After years of hard work and struggle these business owners and senior managers have started to make substantial profits. It’s a nice problem to have, but paradoxically, it is often disturbing. Here’s my theory on why it happens and the simple changes to your thinking about value that can set you on track to share one of the nicest problems in business – and maybe even buy a Picasso or two…

    At the problem’s heart are two related concepts. First, the subconscious belief that if someone’s making lots of money they must be ripping customers off or exploiting staff and suppliers; this stems from the zero-sum view of wealth. That’s the idea of a fixed money pot and the notion that if I’m richer than you I’ve taken wealth that naturally belongs to someone else.

    Secondly, there’s the idea of value added or wealth creation and how increasing total wealth means everyone wins. Your customer enjoys great products and you’re rewarded for building a thriving business – so you can delight them with more great products! Everyone, as Hot Chocolate’s Errol Brown sang in 1978, is a winner.

    Remember the economists’ definition of value?

    While we’re back in time, do you recall your school or university economics? Remember the economists’ definition of value added as the difference between selling price and the costs of bought-in goods and services? It’s a customer-centric definition, your customer’s view of goods or services’ worth determines their value.

    Let’s think about art

    Ink sketch of bullfighter - Picasso 1959
    Ink sketch of bullfighter – Picasso 1959

    Picasso's sketch of bullfighting
    Picasso’s sketch of bullfighting

    Now let’s consider art, the kind that, if you found an original in the attic, could change your life for ever! These are Picassos.  Specifically, they’re lithographs from a series he produced in 1959. Their value? A signed version could fetch up to £5,000 at auction. And the original sketches they’re based on? More like £100k, depending on the value to the buyer. So how does a piece of paper that cost Picasso a few centimes get such value? Is it the cost of production or the time it takes to produce? Or something else?

     

    Rarely the right way to calculate prices or determine value

    The idea of Cost to Produce or Time comes from suppliers’ views of value. You’ve probably used cost-plus pricing, where product X costs £50 to produce and is marked up 40% to sell for £70. We’ve all done it, but it‘s rarely the best way to calculate prices – or to determine value. Here’s why.

    Consider those Picassos again, and how buyers determine their value.  I’d be surprised if they took Pablo five minutes to paint – less than the average four-year-old takes to slap some poster paint on a piece of paper and the rest over herself. Ignoring the fact that the child’s efforts will be priceless to mum and dad, what’s the hourly rate for Picasso’s creativity? In this case that would be  about £1.2 million an hour. Nice work if you can get it. And in a way, we can.

    You can’t ignore value to your customer

    Now to software. The marginal cost of an MS Office Professional download is almost zero to Microsoft. Yet I am prepared to pay royally for it because I need it to do my job. Clearly they are not operating on a cost plus model.

    What about books? why are authors paid more the more books are sold? There’s little extra work for them whether it’s 10 books or a million.

    By basing value on inputs we’re ignoring the value to our customers. That’s a mistake.

    Is this worth any less than it was 2 months ago?
    Is this worth any less than it was 2 months ago?

    Back to art and the well-publicised case of a thought-to-be Marc Chagall nude bought for £100k in 1992. Why does a painting, supposedly by one of the masters, but later assessed as fake, lose so much value that it’s now worthless?

    Compare this with paintings that, once considered fake or ‘by the school of’, are now attributed to the artist. Their value rocketed.

    The power of brands

    In business we see this with brands. Theoretically, two identical shirts could come from a factory with different branding – say Ralph Lauren and Primark – and very different prices. Likewise Apple’s logo on a phone greatly increases what we’ll pay compared to lower-tier brands.

    Brands reassure us – as the saying went, no one ever got fired for choosing IBM. We’ll pay for reassurance and we’ll pay more for more functionality – how well goods or services perform. Generally, at the low end of the market massive functionality improvements do not cost that much more. However at the high end, small functionality differences command massive price differences. We see it in most markets: tangible goods like cars or violins; services like lawyers, footballers or restaurants.

    Where does a person’s value come from?

    People’s value often comes from a lifetime’s hard work. Picasso could capture movement and energy with a few brush strokes. A headhunter I know earned thousands of pounds filling a post – with one call to the right person. Whether this seems right or not, his client was actually paying for the headhunter’s accumulated market knowledge.

    Scarcity usually increases prices. BBC Radio 4 examined ticket prices for concerts and events. What sold for £20 at box offices is often sold on by ticket agencies for up to £800. Likewise, first-edition books usually fetch much more than later editions. If you bought JK Rowlings’ The Philosopher’s Stone in first edition you’d now have something that people would pay £50,000 for, even though you can buy virtually the same book for a fiver on Amazon. With time, scarcity value usually increases (supply of Picassos is fixed or declining). Simultaneously, people become more aware of the value and demand rises because more people can afford one. Scarcity (in the form of fixed supply) is also why trains cost more at peak time and holidays during school vacations cost multiples of the same trip taken during term.

    Fashion, time and convenience

    Fashion and trends mean last year’s unused, mint-condition mobile phone is worth far less than this year’s. Similarly, brown mahogany eighteenth- and nineteenth-century furniture is no longer fashionable. Top pieces may still command high prices, but prices for mid-range pieces have plummeted because this furniture doesn’t fit today’s tastes and lifestyles. And that’s despite the fact that by definition supply is limited.

    Timeliness (when I need it), convenience (where I need it) and service levels play a part too. That’s why we’ll pay nearly a pound for a Mars bar from a vending machine on a station platform when they’re four for a pound in supermarkets. Or why I’ll pay a printer twice standard rate to get my job quickly (or far more if an event’s approaching and my original supplier let me down).

    And the ability to make money

    There’s value in the ability to make money as three examples demonstrate. We’re reminded of it every time football transfer fees push higher – or whenever a star player’s weekly salary is mentioned in the press. And why not? No one can argue, given their ability to attract more people to games and enable TV rights to be sold for astronomical sums. Books are similar, with publishers earning higher royalties the more copies sell. And on the flip side, fewer copies sold cost the publisher less – a perfect example of aligned incentives. Now think about your business. If through use of Ad Words you can get a certain value of guaranteed sales, how much would you be prepared to pay?

    And a lesson for negotiators

    From works of art to Mars bars, value is measured in the eyes of customers. The principle even applies in negotiation, where you should value things in the other person’s terms, not yours, and always put a price (not necessarily financial – be creative) on any concessions you make. This gives your concessions value (and a cost) and helps dissuade the other person from coming back for more and more.

    How to apply this in your business

    If you understand your customer and what’s important to them, you’ll design products or services to maximise the value to them – and achieve win–win. Think like this and you’ll start questioning established norms, such as how web developers make their money from creating websites but charge modestly for site maintenance. If value to their customer means generating lots of profitable traffic, shouldn’t ensuring that the website keeps doing this be worth much more?

    Here’s a quick check-list of value for you to take away and think about:

    • Cost/Time
    • Brand – reassurance, Attribution/Affiliation
    • Functionality and Quality
    • Scarcity
    • Taste and trends
    • Availability when I need it
    • Service
    • The ability to make the customer money

    Which of these resonate with you? Are there other factors that make something valuable to you. Do you agree with my thoughts on the importance of value – or not? What’s important to you? Please leave a comment and share your views.

    You too can have the problem every business wants

    If you deliver products or provide services that give your customers value and make money at the same time, you are creating wealth. From experience, if you do something brilliantly and meet customer needs better than others, you’ll join the businesses I mentioned at the start. The trick is all about understanding what is valuable to your customers. That is not always easy. You may find yourself too close to your business to clearly see what’s most valuable to your customers. Restoring that clarity and helping businesses to act on it is one of the areas I can help with – so you too could have the problem of making more money and being ‘too successful’.

    Be warned though, success can mean making a lot of money; and that’s something you’ll need to prepare yourself for. You will be in the position to choose how you use that money. Whether you use it to support a cause close to your heart or invest in a Picasso or a (genuine) Chagal for the boardroom is your choice.

    By: Jonathan Nicholls

  • “Planning is a waste of time!” – Type B

    I’ve spent much of the last few years working with small business owners. I have found it immensely fulfilling and a real privilege to work with so many dynamic and decent people who have achieved so much.

    At the same time we know it can be very lonely running your own business. There are very few people you can turn to. You don’t want to worry your spouse or family members. You don’t want to impose on your friends good nature. You can’t talk to staff without being indiscrete or seeming indecisive. It is difficult to know which of the many consultants or advisers out there you can trust.
    As a result lessons are often learnt the hard way through things going wrong.

    As a broad generalisation I’ve found that owners fall into one of two categories which I’m calling Type A and Type B.

    spinning plates

    Type B

    This is where most owners start off. They love being indispensable. They get a buzz out of firefighting and fixing things. They love being independent. Many went into business because they hate routine, being tied down, being told what to do. Ironically they often end up as the hardest working and worst paid people in the company. Waiting for the big break which always seems just round the corner.
    Many hated being managed by others so are often poor people managers themselves. They either micro manage or abdicate or (worse) oscillate between the two. (There is a massive difference between abdication and effective delegation.) There is no obvious consistency so the team finds it challenging to know what they should do or how they should do it.

    Type A

    More often than not they start as Type B. Something happens. Something which makes them realise they have to change if they are going to build a profitable and sustainable business. The first step is on the road is effective business planning. Just the act of planning can be transformative:
    – It is a dry run. You can see what works, what doesn’t work and what you need to do to increase your chances of success.
    – You can anticipate and mitigate potential issues increasing your chance of success.
    – Your can make sure the activities of all parts of the business are aligned.
    – Your staff know and understand what is expected of them. They are more motivated and engaged.
    – You now have a benchmark to measure progress against. By understanding any reasons for differences to plan, you can quickly respond. This allows you to take advantage of new opportunities and changing what is not working. And to do so far more quickly and effectively than your competitors who haven’t planned.

    As a bit of fun I’ve put together a caricature of the two types. It’s not serious but does I hope contain an element of truth.

    different approaches to planning

    The facts speak for themselves

    – 90% of SMEs that do not plan do not see their fifth birthday.

    – 95% of successful SMEs plan their success (Growth Accelerator research into hypergrowth companies).

    What do you think? Does this fit with your experience?

  • Is running a business a bit like playing tetris?

    Is running a business a bit like playing tetris?

    You can learn quite a bit about how well a business is run by how well it copes with those inevitable bumps in the road. It may be something that is beyond our control:

    • a key supplier goes out of business or stops selling a critical component,
    • an important customer insists on new terms or switches to the competition,
    • a key member of staff leaves at short notice,
    • new legislation comes in which puts us at a disadvantage…

    Or it may be that we messed up in some way – we got an order wrong or missed out something important  or failed to set appropriate expectations. All businesses face these types of problems. It is how they deal with them that differentiates between the successful and the unsuccessful.

    How most businesses (don’t) work

    In many ways there are parallels to playing Tetris. I’ve taken a slightly artificial example to illustrate how many businesses operate.
    You will notice that the bottom of the picture is partially obscured – in real life we often fail to capture or use the information we need to manage the business effectively. We can be so tied up managing the day to day and reacting to each challenge as it comes that we don’t have the time to spot the opportunities and threats coming at us further down the line.

    A block being out of place means we need to focus all our efforts on fixing that issue. In making up for the misplaced piece, we lose time, can not plan ahead so easily and thus make more mistakes. We simply don’t have the spare capacity to do both at the same time. With any system close to full utilisation small problems can rapidly escalate into crises.

    This is how many people manage their business. It is not all bad. It can be fun firefighting, sorting out problems. Don’t we all enjoy the adrenalin buzz of being indispensable, of living life in the fast lane? Isn’t this the one of the main attractions of computer games? But energy spent here is energy that cannot be spent developing the business.

    A smarter way

    The next example is much less fun, perhaps even boring. But this is what you need to be aiming for in the day to day operations of the business. What seems to make leading sportsmen better than the competition?It is time. It is almost as if time slows down for them. In business, it is you who have the information and the time you need. You are in control and like a top sportsman you make it look easy. There are fewer unpleasant surprises.

    This allows you to focus your efforts on what is important to you, whether this is developing new products or services, improving existing offerings, attracting new customers, selling more to existing customers, working on operations or simply allowing you to relax knowing that the business continues to generate sales and profit with little day to day input from you.

    So it’s your choice. What kind of business do you want? If it is the second one then you should get in touch to see how we can help.

     

    A big thank you to Narjas at iNKLINGS for coming up with the concept and creating the videos.

  • FSB guidance on credit management

    The Feb/Mar 2013 edition of First Voice – the magazine of the FSB – contains an interesting article on credit management. It is largely prompted by the poor payment behaviour of large customers towards their suppliers. Some of which are now asking for suppliers to pay a discount to get paid on time. Hopefully this is something that lobbying and government will be able to change.

    The article also contains some useful tips on how to ward against late payment which are largely complimentary to what I’ve included in the original post. I have taken the liberty to reproduce here as I’m not able to link directly to the article.

    1. Re-visit your trading terms and conditions to ensure they are still fit for purpose and aligned with the type of companies that you do business with.
    2. Do a due diligence test of your trading practices. Look at your recent trading history and assess the risk of entering into other contracts of a similar nature.
    3. Carry out a credit check on your customers before doing business with them, get a bank reference, take up trade references, and get their full address.
    4. Consider setting a maximum credit limit for your customers
    5. If the customer is a limited company or a limited liability partnership, consider asking for the directors/partners to give personal guarantees.
    6. Always provide written terms and conditions and make sure these are agreed by the customer before any goods and/or services are provided.
    7. Set out what you’re doing, and when payment is due. Simply putting terms and conditions on the back of your invoice will be too little and too late.
    8. When goods and/or services are supplied, ask the customer to sign an acceptance form to minimise the possibility of a dispute arising later.
    9. Ensure the invoice goes on time, to the right person and sets out clearly what you’ve done, the amount owed and when it is due.
    10. If the customer is late paying, find out why and, if necessary, send a reminder with a timeframe.

    To this I’d add to check the website of the company to see whether the values talk about supporting local businesses, social responsibility, ethical standards etc. If you are experiencing systematic behaviour that seems to contradict these statements then one of two things are likely to be the case. Either these values are not filtering down through the organisation or the organisation has a conscious policy of not living by the values they espouse. In both cases the threat of escalation can help to resolve one way or the other. If it is deliberate policy then gently enquiring about the difference between words and actions can help to focus minds. Of course this needs to be done in a sensitive way to maintain and protect the relationship with the customer.

  • Making sense of what you (don’t) see

    Making sense of what you (don’t) see

    margin icebergFailure to understand what lies beneath the towering ice mountain in front of us can have disastrous consequences. On the other hand the benefits of insight are far greater than one might imagine.

    Standard Financial Statements are the bit visible above the surface.

    It is knowing what lies beneath that allows you to decide on the best course of action. (An aside – you need this information in time to react. It doesn’t do much good to find out there is an iceberg in your path just before you hit it!)

    In the case of an iceberg, basic physics tells us how much is below the surface (the relative densities of ice and sea water). Likewise the results shown in Financial Statements are the consequence of various interrelated business processes. By understanding these, you are in a position to make a step change to the performance of your business – benefits that go far beyond a better understanding of the numbers.

    A “real life” example
    The following is an amalgam of real life situations encountered working with various leading brands in the fashion industry.

    The iceberg shown in the Financial Statements was worsening margin. The trend, if it continued unchecked, threatened the survival of the company. In the absence of any tools to understand the real causes of this, there were many conflicting theories as to the reasons why. Morale suffered as each department blamed the others. As they say success has many fathers and failure is an orphan.

     

    Our Approach

    We developed an understanding of the business processes affecting margin to create a common understanding of drivers, influence, expectations and accountability. So the first step is to understand the processes:

    Step 1
    Product Marketing is responsible for creating the ranges of products to be sold. They develop the product stories, decide on the colours & fabrics to be used, technologies, price points (recommended retail price), phasing (launch dates) etc. After agreeing the shape of the range, they brief designers who design the individual articles (SKUs) that made up the range.

    Step 2
    The Sourcing team allocates articles to manufacturers to develop (working out best way to make them) and provide estimated cost based on forecast volumes. Product Marketing then works through these costs and modifies the range, design or retail price as needed.

    Step 3
    The Sales team presents the finalised range to customers (retailers) who then place orders for delivery of the articles for several months into the future based on their estimates of what they can sell. The Sales team determines the level of discount each customer will get and other conditions of sale such as delivery, cancellation rights, additional financial support etc.

    Step 4
    The customer orders are consolidated to get the total order by article. Product Marketing then recommends the actual quantity of each article to buy. Sometimes customer feedback will prompt changes in the design of certain articles. These decisions will typically affect the actual cost to manufacture.

    So it is quite easy to see that with so many decisions and so many different parties involved it was not easy to find out the causes of falling margin or who is responsible. The challenge was to find a way to disentangle this various decisions and to create a common language for discussing the problem.

     

    The Solution

    1. Introduce the concept Standard or Reference Cost – the cost agreed by both Sourcing and Product Marketing in step 2. This creates a clear handover between the two functions.
    2. Introduce the concept of a Retail Mark Up (Retail Price relative to Standard Cost). Product Marketing now controls both elements of Mark Up (which can now be used as a kpi for the team) – targets can be set and actual achievement measured. Any differences can be easily identified, reasons understood and appropriate action taken.
    3. Set up the reporting system so that Retail Price is captured. Retail Price is the handover point from Product Marketing to Sales. It is now possible to have full visibility of what Sales controls – the difference between Retail Price and Net Sales.
    4. Report on variances between actual cost and Standard or Reference cost. There are many good reasons why differences may exist such as actual order quantity differing from estimates but more often than not they are “non quality costs” – the result of poor processes and mistakes.
    5. Finally make sure that data is captured at a level of detail that allows users to “drill down” into it to understand where the issues are… is it restricted to a group of customers? a product range? a manufacturer?

    Margin Diagram

     

    The approach is summarised in the schematic below.

    Now that there is a common language for understanding the drivers of margin, we can look at trends identifying where things are not working and who is ultimately responsible.

    The benefits go well beyond just reporting. By building this business process approach into both the planning processes and reporting we have something that is more intuitive and more meaningful to the individual departments.  Planning processes reflect the way that people see and understand the business. Cross functional dialogue is encouraged because each party is able to see the consequences of their actions on the end result. Finally, and most importantly, there is now a way of identifying issues and opportunities at an early stage – whilst there is still time to do something about it.

    In Conclusion
    Standard Financial Reports tell only part of the story, often when it is too late to do much more than damage limitation (repairing the hull).

    By understanding the underlying processes and drivers, then designing a planning and reporting structure that reflects these, it is possible to create a step change in business performance.

    • Plans become meaningful because they are based on business reality and prompt people to think in the right way
    • Issues and opportunities can be spotted early, the reasons understood and the appropriate action taken in time to mitigate risks and take advantage of new opportunities. Unpleasant surprises are reduced.
    • It helps to break down silos as different departments need to work together in the planning process.
    • It encourages greater ownership and accountability.
    • Decision quality improves as people gain a greater understanding of the consequences of their decisions.