To all who made a well thought out plan for 2020: sorry about that, glad you’re still there. To all who despaired of any ability to create a plan for 2021, this blog’s for you.
We have three big reasons for developing annual plans (for this article, think both written plans and budgets):
- to properly and thoughtfully allocate our limited resources to best use,
- to be prepared to take advantage of opportunities that present themselves to us, and
- to be prepared for any bad things that might come along and hurt the business.
I think you can agree with me that avoiding any effort to plan would be a risky idea and inconsistent with effectively managing your company. The problem is doing it in an environment where the unknowns are larger than normal, the length of undesirable events can’t be predicted – yes, even into 2021 – and your resources have been strained just to stay viable and safe, not to mention visible to your market. So how to begin? Centage, a maker of financial analysis software, presented a short list of reasons to not only do a budget but develop what-if scenarios to attempt to avoid being blindsided by what you don’t know. I liked it, so decided to share their thoughts. Here’s the cliff notes version:
Be Prepared. One of the primary reasons companies create what-if planning scenarios is to be prepared to adjust to a variety of unknown situations. It can also prepare you for any situation or potential change in the market. Foreseeing how these changes will have an impact on your business will give you an advantage over your competition, as you can adjust your business accordingly. Think Blockbuster vs. Netflix.
Manage Risks. Managing risk isn’t just about knowing when and what changes to make should something bad happen. It’s also about thinking and planning for various possibilities to see if your internal systems can handle a situation, or if operational changes need to be made. Think of this what-if planning like a stress test for your financial health. Think Lehman Brothers in 2008.
Identify Key Business Drivers. Similar to KPIs, knowing what these are is always a good idea, from planning the future to assessing the past. As you start to work these interest-drivers into your planning, some will emerge as the most meaningful to you and therefore also to the company’s success. Measuring them, trending them, paying attention to them is essential to success for any business.
Understand the Effects of Big Business Decisions. Big business decisions are both frightening and ubiquitous for a company’s leaders. While a what-if scenario won’t make you a fortune teller, it can make clear what the business could look like after the success or failure of a given decision. This information can then arm you to make informed, data driven decisions.
Let me know if we can help. We are Your CFO for Rent.
A long-time friend, Jim Blasingame, who is a well-known radio commentator, business writer and small business expert has recently written a thoughtful article making the case that the soon-to-be-considered $15 national minimum wage is a bad idea, and he gives 10 pretty compelling reasons to back up his position. (Read his article here)
Jim’s well reasoned argument tells us that it will hurt small businesses in most of the country, and ultimately hurt more workers than it helps. His argument may not have much sway on the low income worker who is working two jobs trying to support a family on $7 or $8 an hour, but if that worker’s employer can find a way to eliminate that job as a response to the wage hike, how does that help? When it all plays out, who wins and who loses?
What do you think? I’m curious to know how you feel about that issue, as it will soon be front and center in the news. If you will, send me a YES (it’s a good idea) or NO (it’s a bad idea) and tell me why you think so, and I’ll publish the results of my very unscientific survey here.
A business writer once published an article that an exit plan can also be referred to as a succession plan. Sorry, folks, but that’s just not true. They’re very different strategies intended to accomplish very different objectives, and the actions that a business owner will take to implement a succession plan will be very different from those intended primarily to achieve an exit at the highest possible price.
Let me explain.
First, a more accurate definition of the terms:
A succession plan is one in which the owner wants to turn over the running of the company to either family members or members of the internal management team. It can involve complete or only partial change in ownership. Typically the involvement of the owner doesn’t suddenly stop cold.
An exit plan, by contrast, is just that – a planned exit from all responsibilities of running the company AND a divestiture of the owner’s ownership interest as well. While it’s true that some exits involve the owner remaining partially involved for some period of time, this is almost always designed to maximize the purchase price or ensure that any contingent elements of the purchase price are resolved to mutual satisfaction.
It’s true that both plans will have some elements in common. But there are important differences. For example, remember that a succession involves passing the company to people who already have knowledge of the company, often in-depth knowledge, while an exit involves a sale to (probably) strangers. So, let’s briefly clarify some of the major differences.
Some of the unique elements of a succession plan:
- Where children are the preferred choices, an assessment of their willingness and ability to step in, with or without parental involvement
- Where the management team will be the successors, an assessment of the their preparedness for taking on that role
- A plan for providing training/coaching to fill important gaps in knowledge or experience
- Decisions about any equity consideration that might accompany the transfer of responsibility
Some of the unique elements of an exit plan, by contrast:
- Definition of discrete actions that should be taken to increase the enterprise value of the company, and then the “sub-plan” to implement as many of them as possible
- A dry run due diligence review to help prepare for the real one when the first prospective buyer’s Letter of Intent (LOI) shows up, along with their CPAs and lawyers.
- Engagement of an M&A attorney and an investment banker to support the process, handle the legal issues and create an environment that will earn the best selling price.
Admittedly this is a short and incomplete list of differences, but I hope you get the point. While a decision to move forward with a succession will involve much less complex planning than a sale and exit, neither is a walk in the park. Recognize which direction you want to go, pull together your team to lay out the plan, and don’t confuse succession with outright exit.
We have a long-term client that manufactures custom products for their customers. One of those customers contributes over 80% of the company’s annual revenues, a situation that has been in place for years. We call that “concentration,” a condition that is usually seen as a serious business risk, because losing such a customer can make huge dent in revenues and thus profits, perhaps even causing the failure of the business. Add to that a condition that all those products are made to the design requirements of the customer, who also own the designs and the exclusive right to decide who can use those products.
How can you possibly look at such a business as anything but a disaster waiting to happen? How can that be a positive attribute of this company if, for example, the owner wanted to sell it and retire? Technology evolving as it is today, so much manufacturing production is now done in Asia at much lower cost, and access to alternative suppliers for most everything is easier today than ever before. Our client’s (former) CPA told them over 20 years ago that they should sell it and run, because everything was ultimately going to be made in China.
So how come they’re still around? How come they’ve experienced some of the most profitable years in the history of the company over those same 20 years? How is it that their huge customer hasn’t gone away for any of the reasons outlined above? The answer lies in managing that concentration and managing the relationship. Here’s how this company is doing it:
- Many of their products require very precise quality standards, that they manage and adhere to scrupulously. Very high quality consistently delivered. Strong cost accounting controls.
- Most of their products require a steep learning curve to manufacture correctly, something not easy to duplicate (remember all those stories about manufacturing going overseas and then coming back again? This is one reason for that).
- Because their products often go into equipment with a long service life, some of their products have been made and delivered for years without changes, making the manufacturing process easier over time as familiarity lowers production costs, learning curve, etc.
- They have consistently been responsive to their customers’ shifting production needs, often shuffling scheduling to help their customer meet JIT requirements, thus lowering the customer’s need to keep large inventories on hand.
- As a result of all that, their customers’ buyers keep coming back because it’s easier to go to a supplier that you know will perform than to go through the pain of finding and training another supplier and living through their learning curve.
Is this the kind of company you would try to build from the start. Not likely. But if you have one, or inherit one, perhaps there is real lemonade that can come from your lemon(s). You build on your strengths, fix your weaknesses, and tout your company as a success story whose revenue is amazingly predictable and predictably profitable. Any buyers out there?
The Private Directors Association (PDA) put on a really good virtual session this week on the subject of evaluating the directors of a privately owned company. Their thoughts and ideas apply more broadly than the topic might suggest – they are applicable to advisory boards, nonprofit boards, and even public company boards (although the complexity goes up steeply for those boards). So in keeping with my ideal audience, that will be the last time I mention public company boards. But for the rest of you who are not involved in those boards that will not be named, the highlights of the presentation (colored somewhat from my own board experiences) are these:
- While evaluation of board member performance is not widely conducted now, the trend is on the rise, mostly due to performance pressure caused by today’s dynamic economy and the trends toward addressing diversity and inclusion (the buzzword being “D&I”)
- Any assessment of individual directors needs to be carried out with complete confidentiality to preserve the working relationship of the board, the feelings of individual directors (yes, they have some too), and the ability to take appropriate action without incurring legal risks along the way. That means discussions between the Chair/CEO and the affected director on a 1-on-1 basis.
- By contrast, a problem director situation that is not corrected – by performance adjustment or removal – creates an environment in which the faith in board judgment is damaged, or as one presenter said “you lose the credibility to lead.”
- One of the key obstacles to effective board evaluation is balancing the need for board member collegiality vs. the need to deal with a problem or conflict.
- Key tools that have proven useful for board member evaluation include:
- Surveys of individual board members that are constructed to help a director evaluate their own performance as well as solicit their concerns about other board members,
- A governance committee whose job includes working with the CEO or Board chair to create and implement a grading system to guide the process based on the goals of the organization, and
- The availability of outside consulting firms that specialize in helping companies create the infrastructure for such a process, and even to conduct the evaluations as na independent third party.
- A periodic Board refresh, as they called it, gives an organization a reason to clean house periodically without pointing fingers. I’ve found that term limits for all board members is a clear way to accomplish this; and really good board members can be asked to stay on key committees, be re-appointed a year or so later, etc. We’ve done this very effectively on nonprofit boards I’ve served on.
For those of you who are directors and want to be better, for those who would like to become board directors, and for advisors to private or nonprofit boards, you might think about PDA membership, as there are now 2 local chapters, Orange County and Los Angeles. Call me if you want more details.
I picked a book out of my library today, written by a successful executive and former basketball player under John Wooden, the GOAT of college basketball coaches. He quoted some of Wooden’s favorite trade secret phrases – he apparently had dozens of them. I think some of them apply very nicely to management today, especially in the aftermath of COVID-19. Here are six of my favorites:
1. The team with the best players almost always wins. If this wasn’t a strong message about team building, I don’t know what is.
2. Be quick, but don’t hurry. A bit challenging to put into practice, but speed without undue haste is pretty easy to understand in terms of any strategy or time-sensitive project.
3. Make your “yes” mean “yes.” To me this means clarity and integrity. Be clear about your position or intent, and then do what you say you will do, without fail. Clear enough?
4. A good leader is first and foremost a teacher. You got there by being good. You built a team of people who are also good, but they don’t know what you know. Fix that wherever you can.
5. The team that makes the most mistakes WINS. This isn’t about screwing up a lot and stumbling across the finish line; it’s about making the mistakes, learning from them, implementing the learning, and getting back in the ring. Entrepreneurs have heard this a hundred times. If you’re going to fail, fail fast, get up and start again with the benefit of the lesson.
6. Surround yourself with strong, opinionated people. If you want your people to agree with you, you’re in the wrong business – any business. Unless you know everything, listen to your team. Said differently, listen to your team.
If you think this post wasn’t really about Finance, I respectfully disagree. It’s very much about Finance. And Administration. And Sales, Marketing, Operations, and R&D. It’s about building and guiding the best team you can find to do the best job they can do – for you and for your company. We are Your CFO for Rent.
Readers of their company’s monthly financial reports typically see an income statement comparing the most recent month’s activity with the same month a year ago, the immediate prior month, or – for the truly enlightened managers – a budget for the month. All sounds normal and reasonable. Except for one awareness the reader will never get unless they have a photographic memory.
The Risk: in all these cases there is a flaw in the lone comparison that can prove dangerous over time: they overlook the fact that a small variance, a minor deterioration from the prior period, a tolerable budget variance, if repeated over a series of past and future periods, can become a major surprise when taken cumulatively. When the surprise is a pleasant one, everyone can laugh and say “How weird we didn’t see that earlier.” When the surprise is unpleasant, however, the tendency is to begin a frantic search for answers: “How did this happen?” “When did this happen?” “Why didn’t we know it was happening?” “Who’s responsible for this?”
One possible solution? A comparative report that shows a series of these measurements over consecutive periods. Trends are most valuable when they give us clues to the future. In high school physics many of us learned the principles of centrifugal force: an object in motion tends to continue in motion in the same direction. Of course, the object your teacher used to make her point didn’t have COVID, market forces, interest rates, recessions, and human emotions to bump it around, or its path would have been more erratic. So, too, the path of many of our economic indicators is often erratic, but that doesn’t change the validity of tracking their trends to begin to estimate where they might go in the future.
A company whose costs are rising slowly and steadily because it doesn’t effectively control them will likely continue to see its cost rise until it takes some action to disrupt the trend. Human nature being what it is, costs are more likely to rise without controls than they are to fall of their own weight, so studying cost trends is useful to enable managers to identify those trends soon enough to keep the cumulative effect within acceptable limits.
So what should you do? Put a trend report in your monthly financial statement package. It should be an expanded version of your income statement. It should present data for the past 6 to 12 months, month by month, side by side, on one page. Our clients often use 13 months to see how the year-ago month compares to the current month. Check these out monthly and notice how much more you can see. If you really want to keep on top of this stuff, add a cash flow statement in the same format.
So, the value of trend reports: to enable you to predict the likely future performance of some key metric. Sound too iffy for you? Try comparing it to the alternative: guessing.
Disrespectful or just a catchy title? Either way it must be true, because so few small and mid-sized companies do it. Why would anyone who wants to build a successful company avoid doing something that might help them succeed?
Well there are a lot of very solid reasons, or so we’re told. In fact, we’ve been told one or more of those reasons so often that I made a list of them for my last book. In the interest of thorough research, of course. And then I presented that list to leaders of companies that follow business planning best practices, and I thought the comparison might make interesting reading, so here goes:
|Why leaders say they don’t plan||Why leaders say they plan|
|Planning is a lot of work; busy managers don’t have time for still another task.||Planning actually saves work and time, by helping managers to avoid doing more work than is necessary to reach their goals.|
|Plans are obsolete as soon as they’re done. It’s no sooner done than it has to be revised.||Plans are dynamic and ever evolving as the business evolves. The best ones get reviewed and modified regularly.|
|Plans must always be long and detailed to be of any value; otherwise how would anyone know their part in the plan?||Plans need not be any more detailed than the company needs to guide its activities. Some very focused plans for small business will fit on a single page.|
|Business moves too fast to be held back by a plan. If we can’t think on our feet – and act accordingly – we’re going to be left behind.||The speed of business is a big reason why plans are important, because we can go very far off the mark in a short time. Plans don’t hold managers back; rather, they guide managers’ forward movement.|
|Planning is not as important or valuable as doing something productive. Plans don’t make things happen; people do.||Planning makes what we do more productive by enabling us to avoid doing things that don’t contribute to our productivity as measured by end results.|
|We should leave the planning to the planners and let the managers do their work.||Plans done without the substantial involvement of the managers who are making the decisions are largely useless, because they don’t reflect reality.|
Not to point fingers or accuse anyone of not being good leaders. Just presenting some contrasting thoughts for your consideration. By the way, how’s your 2021 plan coming?
If your revenue was impacted by COVID-19 and its ripple effect – and who wasn’t – you know it’s not going away anytime soon. How do you avoid a 2021 that looks too much like 2020 on your income statement? Maybe you can get better control of your costs – at least those you can control while still filling orders. Is there a quick way to identify where you should look?
Unsurprisingly, there is. First, though, let’s define four key terms that folks toss around, sometimes without fully understanding what they mean, thus the frequent label “buzzwords.” Here are those terms, in English:
Fixed costs vs. Variable costs
First, fixed costs. Few costs are fixed, but those that are can be large and are generally essential. Your office rent is one of them. Your full time employee salaries and benefits are another (except for part-time or hourly or contract workers). Utilities, taxes, depreciation. You’re going to absorb those costs every month, even if you don’t sell a dollar’s worth of product. As one client put it, “lights on, doors open (LODO).”
Variable costs are only those costs that increase in direct relation to sales volume. The cost of raw materials and hands-on (direct) labor, sales commissions, product shipping costs, and the like. So, if you had no sales and didn’t build product inventory in anticipation of sales, you had no variable costs; you may have a lot of idle labor costs, but that brings us to the next set of buzzwords.
Controllable vs. Uncontrollable costs
Controllable costs include underutilized, indirect and administrative labor, the marketing budget, the lunchroom snacks, travel and entertainment expenses, office supplies, employee bonuses, outside professional services, maintenance & repairs, telephone and internet services, and so on. Not necessarily totally removable, but manageable by controlling the circumstances around their use. There are lots more of these than you might think, although they often get considered as “essential to running the business.” Not always so.
Uncontrollable costs are the costs you’re really stuck with today. The aforementioned rent, most utility costs, business insurance and income taxes, lease payments, depreciation, etc. (One mistake cost managers often make is assigning these costs to a department manager, and holding that manager accountable for them. If they can’t control them, we shouldn’t set them up for failure.)
Now the management part. Have your controller or senior staff accountant go down their Chart of Accounts and identify every expense account as F or V and also as C or U. Your job then is to look at every account with an “F” and a “C” next to it, and decide how you might reduce it without impacting your ability to deliver on your sales commitments. Brainstorming first, decisions later.
Some expert once told me that all costs are uncontrollable in the short run, but all costs are controllable in the long run. Even fixed costs can be managed in the long run, but are typically uncontrollable in the short run. The key is to think outside the box and decide that what you’ve been doing has worked in the past but isn’t the only way to do it in today’s world. That’s when the magic happens.
As we approach the last day of this most challenging year, my traditional HNY greeting has more meaning than perhaps at any time in most readers’ lives. So no education today, no hidden insights into financial potholes to avoid or nuggets to grab onto. Simply this:
- I wish for you and yours a safe and healthy 2021.
- I wish for you prosperity for your business, and financial security for you and your family.
- I wish for you that you resolve to make your world a better place. Not THE world, that takes all of us, and a fair amount of patience. But if you do your part in your corner of the world, and I do my part – as I am already committed to do – the world will actually be a better place.
And that is my definition of a Happy New Year.