New year, new budget – is it worth the trouble? Absolutely!

We’re a week into the new year – how’s business going against budget? No budget? Big mistake! You’ve heard all the old hack phrases about aiming at nothing and hitting it with surprising regularity...but seriously, how can you drive a business without a road map?

A sales or revenue budget is a start and if that’s all you have then it’s better than nothing. But so often clients tell us that they have no way of knowing what their sales will be next week or next month let along next year! Our answer is “that’s just a cop out!” Even if your business is one where the customers walk in the door, ring the phone or email the order you can still set a budget for sales. Look at the monthly sales for the past, say, 3 years. Do you see any seasonal pattern? Has there been any growth? What are the current conditions in your market? These all give you a starting point to set a sales budget for the year ahead.

So now you’ve got a sales budget – what are you going to do with it? Well there are a number of things that are all quite easy:

• Compare your monthly actual sales against budget and think about why they’re different. Talk to your team about what is happening, think about what products/services were popular or unpopular, were outside events impacting (e.g. news stories about economic woes, elections etc) or did you have any activity that might have made an impact (like advertising, product placement, promotions etc)?
• Check whether your monthly budget sales exceed break-even, i.e. are you going to make a profit at that level of revenue? You don’t know? Well you’ve just highlighted another important measure you need to get on top of – more about that later.
• Try something new – focus on a particular product or service, talk to customers about the things they’re not buying from you, set a sales target for your team with a reward or celebration if you reach or beat it. If you’re not sure what to do – just do anything! Doing something different will always have an impact.
• Work out how many items/hours or whatever you need to sell or produce to make that budget. Work out how many sales you need to make – i.e. what is your average sale? Work out how many customers you need to meet to hit your target. These are critical numbers you should always be measuring. When you break the activities down that together results in a sale it’s much easier to think about what affects those little bits and what you might try that will improve your results. For example, if the average customer buys $265 of product/service each time you make a sale, think about what else you could offer them to increase that. They’re already there and buying from you...

      You get the message I’m sure.

So what else? Well:

• Work out an overhead budget. These are the costs you’re going to incur whether anyone sets foot in your place or not.
• Work out your gross profit – the difference between what you sell something for and how much it costs you. For some service businesses, say a hairdresser, where the service providers are on wages you can just treat sales as gross profit. For others you know what your products cost you.
• Work out your break-even sales. This is the value of sales where the gross profit equals the overheads. 

For example:

- Monthly overheads are $22,500
- Gross profit is 50%
- Break even sales = overheads/GP
                            = 22,500/0.5
                            = $45,000

How much do you need to sell to make $150,000 per year profit? That’s $12,500 per month. Just add that amount to your overheads and re-work the break-even equation:
- Monthly overheads plus profit target = $22,500 + 12,500 = $35,000
- Gross profit is 50%
- Profit target sales = (overheads + profit)/GP
                             = 35,000/0.5
                             = $70,000

So now you can start to use your budget to drive business performance. How much profit do you want to make? What sales targets do you need to set to make that? How many sales/customers do you need to hit that target? What are your results now? What are some things you need to do to reach that target?

Now we’re talking Strategy. And all because you thought about setting a sales budget – but more importantly, without one you can’t even get started.

Counter-Punching a Downturn

How a Business Manager responds to a sudden downturn in trading conditions is critical to how the business will come out of that cycle.

Downturns occur in all businesses and industries and not just because the economy generally is turning. It can be triggered by the loss of a major contract, client or customer; an unexpected interruption in your supply chain; market conditions in a particular sector you focus on; loss of a key employee or the defection of a key team to a competitor; or a myriad of other possibilities.

The sudden downturn is characterised by an immediate reduction in new revenue generating activity. Depending on the nature of your business this may reflect in actual current revenue immediately or not for a period of time - it all depends on the lead-time nature of your business or industry. It is absolutely critical that you understand this characteristic and are able to recognise and detect the change.

Unless you're monitoring and measuring the those key revenue generating activities you may well not realise that a sudden downturn is around the corner and you're about to slam into a brick wall! Current revenue will continue to flow based on sales made, orders received, current contracts being worked through or medium/long term assignments being worked out. But if your pipeline is empty or running at half strength then that downturn is coming fast and if you're focussed on the work you've got to do today you may well not realise that you've got much less work to do tomorrow.

So knowing what your leading indicators are and monitoring and measuring them regularly is critical to business health.

So the downturn has hit (for whatever reason), revenue has slumped, profitability is impacted and cash-flow will follow it down. What do you do? In the immortal words of Douglas Adams' Hitchhikers Guide to the Galaxy - DON'T PANIC! What you do next will not only affect how you fare in this downturn but how well you come out of it. The best businesses do better in downturns and come out of them stronger and better positioned than their competitors and frequently stronger and better positioned than themselves prior to the downturn.

Your first task is to understand what has happened - this may be obvious or it may not be.

Once you're clear on the underlying reason for the change in your business climate then, and only then, should you consider what action to take. Is it a transient event or is the ground moving beneath you? How long will it take to work its way through? Is it impacting your competitors? What about your customers or clients? These are all questions requiring consideration - they will give you direction for the steps you take next.

There are only two sides to the profitability and cashflow equation for SME's - the money that comes in and the money that goes out. There is a very real and absolute limit to steps you can take to reduce the money going out - zero! By that I mean you can only reduce costs and expenditure to the extent that the business is able to continue to operate. If you cut so deeply that you damage the fabric of the business then you'll likely have nothing with which to come out of the downturn with.

That said, shutdown is a viable strategy and there are some smart people in, for example, retail business today who are running there business as a managed shutdown because they can't see a future - for them the ground has shifted and for whatever reason they've decided they can't shift with it.

Back to cost cutting. This has two benefits:

1. It reduces your costs and supports cashflow; and
2. It conveys a message to your team.

The second benefit may well be just as important as the first. It's critical that you've framed the cost cutting correctly - tell your team what has happened and what you're going to do about it. If you're going to cut hours or overtime or staff or salaries or bonus', i.e. anything that will directly affect them, do it right away, tell them why and reassure them as to the future. In relation to other costs, they convey a message that the situation is serious, action is required and you're doing what's necessary. Get them on board - they can help you.

Identifying the costs to cut is never simple but try this process:

1. List all of your expenses and outgoings and place 3 columns alongside them headed Compliance, Capacity and Convenience.
2. Any cost which impacts on your ability to stay in business is a Compliance cost - put a tick in that column alongside it. For example, rent. In the short-term you can't change it and without it you're not in business.
3. Any cost which directly supports your ability to produce, provide and sell your goods or services is a Capacity cost - put a tick in that column.
4. Everything else falls into the Convenience column and these are your first targets. You can cut them aggressively - better to cut harshly and then add back than not to cut enough.

Time to turn your attention to the money that comes in - for SME's this will be revenue. Unlike expenditure there is no limit to your ability to grow this and you should focus on it with laser-like intensity. There are only 4 ways to grow a business and 3 of the 4 relate to revenue.

One golden and absolute rule you need to follow here - you've got to protect your margins at all cost! If you're impacted by a downturn the last thing you need to do is damage your business fabric by discounting prices. There are smarter ways to provide customers with buying incentives and they will relate to benefits for increasing their business with you.

Another maxim to remember here - it costs substantially more to attract a new customer or client than it does to increase your trade with an existing customer or client. It's also less risky - you already know whether your existing customers are good credit risks, you've got a relationship established, you can talk to them about mutual benefits. So exhaust opportunities to increase trade with your established customer base first.

No business-person wakes up in the morning wishing for a sharp downturn to hit thinking "that will be a great opportunity to tune up my business!" - but that is the silver lining to the downturn cloud. So when it hits follow these simple rules:

• Don't panic!
• Analyse what has happened to get direction
• Then move decisively to take action
• Categorise your expenditures, identify your targets and cut quickly and severely
• Then focus on your revenue aggressively - existing customers first

You'll emerge a better, smarter, leaner, stronger and more profitable business.

Negotiating the Resources Boom for Contractors, Fabricators & Suppliers – Riding the Bucking Bull and Living to Tell the Tale!

Barely a day goes by without another headline, TV news story or current affairs feature on the Resources boom and how WA is the top gear in a 2-speed economy. But for many small and medium sized suppliers to our resources behemoths this boom could just as easily blow up in their faces if they don’t keep a wary eye on some key business fundamentals. Here we highlight some of the key risk factors we’re seeing emerging in the market and give you some tips on how to negotiate them.

So what are the particular market conditions which create this risky environment?

·         Relatively few, large buyers with significant market power – the large mining, oil & gas companies and operators

·         Rapidly increasing sales

·         Tight labour and materials supply conditions

We all hear about “bottom line focussed” business operators but astute business managers know that there is a triple bottom line that is the key to a successful and sustainable business.

The first bottom line is Net Profit after tax (NPAT). Business only survives if it makes a profit. The key issues here are: pricing, discounting and cost control. Effective pricing requires up to the minute market knowledge, current component cost information, accurate and complete job specifications and scope and a robust financial model which provides the guidance on minimum margins to be obtained.

Discounting is anathema to good business management. Every business should know its “walk away” price below which it is not worth winning the business – and the walk away price should be one at which the business makes a sustainable profit. Too often we see businesses discounting in order to win significant contracts but without a real understanding of the risks they’re assuming as a consequence.

For example, fabricators to the mining industry should be pricing to achieve a gross margin of about 28%. A typical business turning over $15million should be aiming for a NPAT of $1.2 million. But if they were to discount by, say, 10% in order to win the business then they would actually end up losing $300,000 even if their sales grew to maintain revenue at $15 million. In fact, in order to make the same profit they would need to grow their sales by 55%!

In contrast, if they can achieve a 5% price premium then they can actually afford to lose 15% of their business and still make the same profit.

The second bottom line is Return on Assets. In a rapidly growing business capacity needs to be expanded and this will inevitably mean not just additional hard assets in the form of machinery and materials but also soft assets such as work in progress and debtors. Growth in assets can only be funded in three ways – additional debt, additional capital or retained profits. In a rapidly growing market retained profits are unlikely to be reinvested fast enough to support rapid growth so that reduces the options. And as many businesses in the resources services sector are private companies then additional capital often means additional personal debt.

With most businesses you can’t create additional capacity in a smooth line – putting in a third assembly bay is a 50% increase in capacity but it might only be servicing a 30% increase in production. This sort of scenario is going to inevitably result in a reduction in return on assets.

Instead, look for options to make your assets work harder. Improved production scheduling, additional shifts, more flexible workforces all improve asset utilisation. And in a market like this where capital is scarce and lenders hard to get on with you want to make your assets work as hard as possible.

The third bottom line is Operating Cash Flow. In a healthy business, operating cash flow should always be higher than net profit after tax – the excess is what allows you to fund asset purchases, depreciation, loan repayments and dividends. The huge risk for a rapidly expanding business is depletion of working capital – the ability to pay your bills each month.

The sponges that soak up working capital when business is expanding are work in progress, materials and debtors. Do you know what your working capital funding requirement is? This is the amount of additional working capital you need to fund every extra dollar of sales. The key factors impacting on this are:

·         The level of inventory you keep;

·         The length of time it takes to convert and order into a delivery; and

·         The length of time it takes to convert an invoice into cash.

Expanding faster than your fundable growth rate is a fast track to insolvency. Creditors get stretched and suppliers start to put the brakes on. The bank sees you at your limit constantly and starts to get nervous. Superannuation and tax commitments aren’t met on time, begin to compound and then you have the ATO on your doorstep. It’s a nightmare scenario and all driven by increasing sales, even profitable ones!

The silver lining to all this is that all these risk factors also work in reverse. If you know your pricing and stay in control of your costs you can increase profit without having to increase turnover beyond your capacity. This will turn your business into a cash flow generator and you’ll find yourself in the fast lane. It’s all about knowing what’s going on in your business and remaining in control – or, if you like, keeping a tight rein on the bucking bull!

© Bruce Fielding, Sarion Advisory Pty Ltd 2012