Nov 13, 2015 | Management, Small business
Many small businesses do not know the answer to that fundamental question.
It is technically illegal to trade while insolvent, but many small businesses do it every day, often without knowing.
So how do you measure “solvency”?
Being solvent means you are able to pay your bills when they fall due, but measuring it exactly involves a little judgement and understanding of the commercial circumstances of the business.
However, there are two simple measures almost always used by a lender, or anyone else with a need to check the health of your business.
Both are about the manner in which you manage your cash, which should be right on the top of any management agenda irrespective of the size or complexity of your business.
1. The current ratio.
The current ratio is the first calculation a prospective lender will do , it is pretty easy to calculate, and most bookkeeping packages have it as one of the standard reports available.
Current ratio = Current assets / current liabilities
“Current” in a accounting speak means less than a year, so your current assets include cash, inventory at sales value, accounts receivable, and any short term investments you may have.
Current liabilities are those bills that will have to be settled within the same year. This number is accounts payable, short term maturing loans to be repaid, and the one many miss, the provisions for an accrued liability you may have for things like employees long service leave and other benefits.
2. The “Quick” ratio.
The second commonly used ratio is the “Quick ratio”, which as implied, is a measure the very short term ability to cover debts. Many businesses have a lot of money tied up in finished goods inventory, work in progress and raw materials. All can be challenging to liquidate in a short time, so the quick ratio is a simplified ,measure of the immediate ability to pay the bills.
Quick ratio = (Current assets – Inventory) / Current liabilities.
These ratios are the same apart from the inventory valuations and provisions, and are usually used together.
The valuation of inventory is always a challenging question.
In valuing finished good inventory for a “quick” calculation , the appropriate number is the realisable value within a month. If you have three months inventory on hand, it is unrealistic to believe you can sell it all in a month and get full price. Valuing WIP and raw materials inventory is even more difficult, as who wants a half completed product, and suppliers will be very reluctant to take raw material back at full invoice value.
As noted, these ratios are virtually always used when seeking funding, by any means. The potential funder will look at both ratios before any other detailed discussions. A bank will generally require a quick ratio of at least 1:1, and preferably 1: 1.1 or more, depending on their lending policies.
Are you trading illegally?
Do you know?
Jun 5, 2015 | Governance, Management, Small business
whoops!
Do I have enough cash to……………….?
This is one the 4 fundamental questions for small business survival, and is the one I hear far too often. It is all to do with how much cash is available at any given time to pay the bills.
It is almost inexplicable to me that many operators of small business do not understand their cash flow, how it works, how it can be managed, and how to leverage it. After all, it is their lifeblood.
The sad reality was brought home again a week or so ago talking to a tradie I met casually who was hurting badly because a developer he had subbied for over many ears was not paying him, and he in turn was not paying his bills, as he had used up his overdraft. He was in effect funding the developer, and ultimately the receiver, and seemed unlikely to get any of his money back.
A common occurrence and all too easy to address with a bit of planning.
There are some pretty simple things that can be done to assist in the management of cash, but like all things it takes a little bit of work up front, and a disciplined process
1. Routine.
The steps to a positive cash flow are simple, if you make them a part of your routine, you can follow them with little effort, although at first, it can be a bit confronting.
- Have robust, enforceable and explicit terms of trade. For anything that requires credit terms to be extended, make sure you have a signed agreement that specifics all aspects of the terms under which you agree to provide your goods and services. These terms are an enforceable contract, and in the event it is necessary, is actionable. There are templates available that can be personalised for your needs and used without cost or with just a small charge. Some service providers such as EC Credit Control will assist in the preparation, as will your bank, although your bank has a vested interest in lending you money, not making what you have work harder.
- Do credit checks. By giving credit, you are effectively lending someone your money. It makes sense to check if they have any history of fraud or default, which can be done easily for a modest fee. You pay for access to a database that is in effect a credit footprint of everyone who has applied for and been given credit, and the data includes their credit history, and any outstanding judgements. Veda is one of the agencies that provides this information as a service, there are several, most banks will provide the service for a fee, often they wholesale services like Veda. Often if you choose to outsource your debtor management in some way, these sorts of checks are a part of the service.
- Issue invoices immediately and follow up politely but persistently and in a highly predictable manner. Most businesses wait until they receive an invoice before they initiate any consideration of a credit period, let alone get around to paying, so the sooner you issue the invoice, the earlier you have a chance to be paid. A client of mine about two years ago instituted a process of sending a polite “thanks in advance” for payment on the invoice due in a couple of days. He thanks his clients for the expected payment, indicating being paid on time is one of the ways he manages to maintain the high value he is able to deliver. It had a significant impact on his debtor days, and served a marketing purpose to highlight the quality of the service he provided, and as it was highly automated. After the initial set-up and a few teething problems, the process became virtually automatic, and a boost to his business.
- Keep the credit period ASAP. In this case, the acronym is As Short As Possible. Generally the negotiation on credit terms will take place at the beginning of the relationship, and that is the best time. Make it as short as possible, I always advise starting with 7 days from invoice date, be very happy with 21, and if it is in your interests, give a bit more, but if you start with 30 days from the end of the month, watch your sales bunch into the beginning of the month, which effectively gives a customer up to 60 days to pay, before the invoice is overdue, and you can start chasing payment. This is a gap you are funding, bankrolling your customers, and generally people in business are not there to be a philanthropist, leave that to Bill Gates.
- Do a weekly rolling 13 week cash forecast. This is a simple exercise, but knowing what is coming at you offers the opportunity to manage it with the least pain, ignoring it can be terminal. Generally this cannot be automated, but most bookkeepers and service providers can do it simply, although most would say monthly is sufficient. I strongly recommend weekly for small businesses.
2. Automate.
One of the more innovative automations I have seen is the one noted above, but most of the basic bookkeeping routines are now highly automatable via mobile connections into software that can manage all the recording and invoicing processes. For a tradie, assembly and issue of an invoice via email against a signed and dated acceptance of the cost can be done on site the moment a job is complete. No paperwork to end a long day. Automating can cost a bit to set up, and ensure it all works, but the expense is well worth it.
3. Outsource.
Most parts of the process can be easily outsourced if you choose not to do it yourself. Think of this outsourcing cost as insurance, and the cost of buying back a bit of your own time and peace of mind.
- Book-keeping. There are many book-keeping services available, and whilst they may vary in quality and cost, it is pretty easy these days to find one you are comfortable with, who provide the mix of services you require.
- Debtor and debt management. There are many service combinations possible from the straight invoice financing where you in effect sell your invoices to a finance broker who then owns the debt, to more relationship sympathetic arrangements where a third party undertakes to be your accounts receivable function, and often do some of the risk assessment functions noted above. Selling your debt, or “factoring” still smells of desperation, but outsourcing accounts receivable is pretty sensible and often very cost effective.
4. Leverage.
Most understand the concept of leverage when it comes to moving a physically heavy object, but have never thought of it in relation to their business, and particularly their two most crucial resources, their time and their cash.
- Closely managing terms and collections so that your average debtors is shorter than your average creditors means you are collectively enjoying having your creditors fund your business. However, I recommend paying your bills as they come due, as a history of reliability can pay big dividends when things suddenly go pear-shaped.
- Inventory. In many businesses the greatest consumer of cash is inventory, and closely managing it can save considerable sums. For a retailer like a fruit and veggie market, they take most of their revenue by cash or credit card, for which they get paid within 24 hours, but often pay for their stock on 21 or 30 days, by which time they have turned the stock over several times. Lovely. Measuring stock turn is a great metric if you have inventory.
Finally, there is a further measure not usually recommended that I particularly favour, Net Cash Consumption or NCC. It is a simple measure you can apply over any period, simply the difference between cash in and cash out over a time period. For small businesses I usually exclude capital items, so it is a measure of trading cash generation, or destruction. If the measure is positive, that is a good start, if it is negative for any extended period, trouble. I usually recommend a rolling 3 month measure, short enough to be sensitive, long enough to accommodate the operational vagaries that occur like paying the receptionist long service leave. Adding it as a graph on the bottom of your cash flow forecast automates it. Easy.
If you would like more information, or the opportunity to discuss any of this, just give me a call.
Jun 3, 2015 | Change, Governance, Management
For 20 years, Mary Meeker of KPCB has been collating and publishing an annual report on the growth and growth of the net and the services and products it carries.
This 20th publication contains information that will be useful to every business.
The local lemonade stand, to the huge Multinationals dominating the commercial landscape, there is vital stuff for you.
Just a few of the points that jumped out at me:
- Mobile data usage rose 69% last year
- 55% of mobile data traffic is from video
- Ads in mobile account for 8% of ad spend, but mobile accounts for 24% of time spent with media.
- Mobile use in underdeveloped economies is disproportionately strong. In effect, they are jumping the stage of fixed line infrastructure developed economies went through. If you want to do business in Asia and India, go mobile.
- Government policy, regulation and use of the net lags public usage substantially, around the world
- The number of hours a day people are spending in front of a screen s still growing, and though it has flattened off a bit, but it is 9.6 hours/day. (US data)
- The number of productivity tools becoming available is still exploding, as is the number of platforms for distribution of information and data
- The nature of work is changing rapidly, as is the location of those doing it.
Whoever you are, if you are in business, and want to stay there, it is worth flicking through the report.
PS. June 13.
Mary Meeker released a presentation of her amazing report, listening to her talk through the report makes it easier to absorb, way easier than just looking through the huge pile of slides.
Everyone should watch this, absorb it and figure out how to leverage it for your business.
Apr 10, 2015 | Management, Small business
It is interesting to consider the notion of ‘knowledge’ and how experts are given that label.
Often it just means that someone who is seen as an ‘expert’ may have just a little bit more knowledge that those who are listening.
Consider the primary school teacher, teaching maths to 10 year olds. To them, the teacher is an expert, knows it all, but could that same teacher teach maths at high school, graduate, or post graduate level? Probably not.
In primary school they are a relative expert, but the depth of knowledge required to teach maths at a post graduate level is far higher than primary school. On the other hand, could the teacher of post graduate maths teach 10 year olds?
Often not, as they do not relate to the level of knowledge that exists, and the way these kids will think and learn. The Uni professor may have all the maths skills, but often no skill at relating to their 10 year old audience, often simply because of the assumed level of expertise .
“How could they not know that?”
This post evolved out of a series I am doing, teaching basic software skills to small businesses by relating them to the things they need to do in their business every day, cash flow, P&L, and the other basic stuff that are absolutely essential to a business, but ignored by many small businesses simply because they do not understand what is being said.
There are legions of free “how to” videos, manuals, and the rest, readily available, but still I see small businesses every day who do not understand the importance of actively managing cash flow, or if they do, how to go about it.
Accountants know this, but they have generally failed dismally to communicate it to their small business client base. Generally it is not because they do not want to, but rather because they fail to communicate at the really basic level many small businesses require. On the other hand, owners of small businesses are often loathe to engage their accountants in this sort of conversation at $200/hour when they know they will not understand a thing.
Clearly the assumed level of knowledge is too high they get confused, and do not relate, but that is not their problem, it is that those setting out to teach the stuff have failed to understand their audience.
Mar 27, 2015 | Management, Marketing
Digital evolution
It is fascinating to observe human behavior. Of great interest to me is the intersection with the practices evolving to deal with the digital world, manifested in all sorts of unexpected ways.
One is the huge range of digital tools now available using the so called ‘Freemium” model. Give away a subset of the software’s capability for free, thus getting trial and hopefully conversion to the paid versions. This has been very successful for many platforms, LinkedIn, Mailchimp, Surveymonkey, and is increasingly being applied by platforms to generate advertising revenue as they offer free user access to the platform.
On the other hand, over human evolution, there are lots of common characteristics evident, three in particular that are relevant to any discussion of the freemium model that most would recognise:
- People want what they cannot have.
- People chase things that are moving away from them
- People value what they have to pay for, irrespective of the payment being in effort or some other means of exchange.
At first glance the Freemium software model is breaking these evolutionary rules, but on closer examination they are actually using them to their advantage.
By making the paid capabilities of the software explicit as free users try to do more and more with the familiarity that comes with software use, they get frustrated with the limitations and upgrade to the paid version.
For small businesses, whatever the business they are in, from the local retailer to service provider, combining these forces can work for you.
For example, if you want your car serviced, do you want it serviced by the bloke who can fit it in today, or the bloke who is so busy you have to wait 2 weeks?
It might also cost a bit more.
Creating some tension, then enabling people to resolve the tension, generally delivers greater satisfaction with the outcome, as those converted find ways to justify to themselves the value of their decision.
It has certainly worked with me, and it allows small businesses particularly to experiment at low cost, with nothing at risk apart from a bit of time.
Mar 23, 2015 | Collaboration, Innovation, Leadership, Management, Strategy
Plan backwards
All sorts of planning activity is aimed at defining the point where we want to be, then assembling the resources and capabilities to get there.
That is how planning is done, almost always, because by and large, it seems to work, and it keeps the spectator crowd happy.
Libraries have been written that describe all sorts of methods and models that can be used. They can be very useful and thought provoking, providing a framework to help articulate the factors that will impact the business, and the options you have in responding, but they rarely offer an antidote to the malaise affecting the development of really distinctive capabilities, genuinely new products, processes and business models.
The real innovations, the things that change everything seem to come from a different place, “left field” being the most common description.
Most planning ends up being just an extrapolation of the past, despite the well meaning and significant effort to make it something else.
Perhaps a better way is to put yourself in the future place, then work backwards, identifying the steps that need to have been taken to reach the point where in your mind, you are now.
Be specific about the end, articulate it clearly, and then “Plan Backwards” by considering the factors that delivered value for you. I generally call this process ‘Hindsight Planning’.
- What did you do that worked, and conversely, what might you have done that did not work?
- What capabilities did you need to develop?
- What trends drove changes to the industry you were able to leverage?
- Where did the technical innovations you leveraged come from?
- Which markets and customers were successfully addressed?
- What big customer issues were addressed?
- What did the business model(s) you used look like?
- And finally, How were you able to extract value for all these things?
This sort of analysis, if it is to lead to a positive outcome, requires that you recognise and deal with two types of barriers:
Management barriers.
People like consistency and predictability, so when the forecast future looks very like the past, just a bit blurry, they are happy with it, endorse it, and resource it. By contrast, being the harbinger of change that will affect the status quo is no way to get ahead in most organisations. However, it remains a truth that the future never looks the same as the past, no matter how much we would like it to be so.
- Idea averaging. Management absorbs and usually just “averages” or applies committee thinking to a good idea, but at worst, just rejects them for a range of reasons that sound absurd and utterly naive with the benefit of hindsight. Existing businesses are rooted in the networks and frameworks required to make them successful today, and are usually intolerant of new things that involve risk. Usually successful incumbents are well evolved, so are resistant to change, their current way has enabled the current business to be successful, why change? There are many examples of this phenomena, Kodak being a standout, Polaroid another, Cobb & Co another. The current attempts by the taxi industry to resist the encroachment of Uber in my hometown, Sydney, is an example unfolding, and the music industry prosecuting their customers for using their products is an example of one that is just about folded.
- New business models. The successful commercial execution of a real innovation generally requires some new way of delivering the value to customers and extracting value for the suppliers. In short, a new business model. Industry incumbents rarely completely disrupt themselves, by definition, they have too much to lose. Therefore, there needs to be new strategies and supporting business models developed by those outside or on the fringes in some way of an industry. Uber and Apple came from way outside the industries they disrupted, and can you imagine Hilton, or Accor funding that mad idea AirBnB that was gong to crucify their budget tourist dollars?
- The Profit paradox. Profit is counted by looking backwards rather than forward, rewards came after the fact. Forecasting profit, or “fortune telling” is inherently risky, as the only think you know for sure is that you will be wrong, the real question is by how much, but the consequences of getting this brand of fortune telling wrong are significant. However, in the long term, you are only truly profitable if your returns are greater than the cost of capital. If they are equal, you may as well put your money in the bank, because it is safe, less than that and you are long term destroying capital. This simple fact is ignored in almost every profit forecast, statement or review I have ever seen. The conundrum is that to generate a return greater than the cost of capital you must take risks and do stuff differently, some of which will not work out, or only work out in the long term, therefore risking the current profit. It is pretty easy to ramp up the profit made today at the expense of tomorrow, but in this case, tomorrow does actually come.
Creative barriers.
Creative barriers evolve around points of the assembly of ideas, where information, insight, experience, are mixed up to create the otherwise unlikely connections that are the foundation of a creative solution to a problem, situation, or challenge. These are the barriers that most businesses try and get around by the off site strategic planning sessions that rarely seem to be able to deliver the promise of the day. The energy and drive in the workshop room gets absorbed by the day to day of being back in the business. Removal of the barriers is a high priority challenge for management.
The barriers to creativity are many and varied, often overlapping in many places. Following is a ‘brain-dump’ list of the ones I consistently find.
- No commitment from the ‘top’
- It is not OK to be wrong.
- Give up too easily. Edison’s famous quote “Now I know 999 ways that do not work” whilst experimenting to develop the lightbulb resonates still.
- Creativity is hard to quantify, and is therefore often not measured. The old adage what gets measured gets done is right, so creativity is extinguished.
- Lack of resources, time, equipment, money, are all used as excuses for being too willing just to accept the status quo.
- Enterprise culture eliminates risk as far as possible, and creativity is inherently risky and “out there”.
- Rules rule. Particularly in public enterprises, and creativity is not in the rules.
- Challenging orthodoxies, assumptions and the status quo is frowned upon.
- Lack of what I call ‘environmental intelligence’ or an understanding of the macro trends and individual movements in the commercial and strategic environment in which you compete. Seeing trends that impact an enterprise, and their intersections is a rich source of creativity.
- Lack of discipline. Perhaps counter intuitively, creativity includes a range of activities that if subject to some disciplined and focused thinking can deliver great results.
- Not having the right people. Creativity is perhaps the most collaborative of human activities, well, almost. Not having the right people is a commonly owned albatross.
- Everyone can say “no”. Formal layers of approval for ideas act on creativity like a wet blanket on a campfire.
- Creativity is not a required contribution from everyone, it is assumed to be the product only of the young, or the marketing department, of the boss’s wife. Creativity should be everyone’s job!
I could go on, the list is huge, it is a wonder that creativity survives at all given the barriers.
An idea is the outcome of all that has gone before, and the triggers around at any given time, rarely is it the ‘Eureka’ moment. Ray Kurzweil who has a stellar track record in seeing the future in technology believes we need to become comfortable with what he calls “Hybrid thinking” and I can only agree but see that the ideas he articulates have a far greater range than just creativity and innovation in technology.
