Business Survival Blueprint

Table of Contents 1. Business Survival Blueprint ......................................................................................... 4 2. The Nature and Impact of Recession.... Wake Up! ..................................................... 6 3. Improve Profitability... In Fact How To Guarantee It ................................................ 9 How not to do it ....................................................................................................................... 10 A better way ................................................................................................................................... 11 Classify your costs accurately ................................................................................................ 12 2 stage approach ..................................................................................................................... 14 Break-even formula ................................................................................................................ 16 Which side of the high jump bar are you? ............................................................................. 17 Impact of a downturn or recession ........................................................................................ 18 You’re better off than most.... no you really are! .................................................................. 18 Your turn .................................................................................................................................. 21 How profitable do you need to be? ........................................................................................ 22 Best and worst... so far? .......................................................................................................... 26 Sales revenue in a recession ................................................................................................... 26 Recap ........................................................................................................................................ 27 Cutting overheads ................................................................................................................... 27 Relevance to break-even ........................................................................................................ 28 4. Pricing Strategy – Key Profit Margin Benchmarks ................................................... 29 Two different types of business ............................................................................................. 29 Gross Margin % v % Mark-Up on Cost ................................................................................... 30 The Gross Margin Triage ........................................................................................................ 30 Transaction based business ................................................................................................... 31 Time based business ............................................................................................................... 32 Worth bothering? .................................................................................................................... 33 Isn’t it obvious? ........................................................................................................................ 33 The ideal ................................................................................................................................... 34 5. What Is Working Capital.... And Why Is It Pivotal? .................................................. 36 What are assets? ...................................................................................................................... 37 What are liabilities? ................................................................................................................ 40 Current and quick ratios – useful? ......................................................................................... 41 Working Capital ....................................................................................................................... 41 Trade Debtors / Accounts Receivable ................................................................................... 42 Working capital as sales change ............................................................................................ 43 Outstanding days ..................................................................................................................... 44 Impact of working capital v profit ......................................................................................... 46 Balance sheet understanding ................................................................................................. 47 Working Capital summary ...................................................................................................... 48 6. Improve Cash Flow – How to Make It Inevitable ...................................................... 49 Profit comes through as cash? ................................................................................................ 50 Monthly cash flow forecasts ................................................................................................... 50 Payable Strain .......................................................................................................................... 51 7. Cash Flow Problems Right Now? What To Do Next ...................................................... 54 Daily cash flow ......................................................................................................................... 55 Timeframe ................................................................................................................................ 56 13 week cash flow ................................................................................................................... 56 The right format for your cash flow ....................................................................................... 57 Cash accounting ....................................................................................................................... 59 Invoice finance ......................................................................................................................... 59 8. Over To You ....................................................................................................................... 61 Quiz Answer ............................................................................................................................. 62 4 1. Business Survival Blueprint Welcome to this interactive business survival blueprint! Well I say interactive , it’s more of a workbook to be honest. But what it does require is that you actively engage with the content, answer the questions and perform the calculations asked of you. Together we will make sure you start taking the necessary steps to get your financials and your business, back on track, despite the economy. Like it or not, we’ve been in the grip of a financial crisis since 2008. Little has changed for the better in the years since and for many, talk of a ‘double -dip recession’ means little other t han more of the same The combined impact on businesses continues to be severe:  Sales are generally much harder to come by  Margins are under pressure as competition intensifies for available work  Relentless inflationary pressures drive up costs which most are unable to pass on  Limited capacity (and willingness) on the part of banks to lend and consequently, an inability for businesses to access loans and overdrafts... Needless to say, the most vulnerable have sadly already succumbed. But the combination of these factors persists in creating what could rightly be described as a perfect cash flow storm So strategically, how should you respond, given this environment such that you can, at a minimum, sit this out – play the long game - until the underlying economic conditions improve a little? Well that’s exactly what we aim to set out in this interactive blueprint. My name is Colin Fittall and I run Bottom Line Impact Ltd. For many years now we have helped ordinary entrepreneurs and business owners who have found themselves in often acute financial difficulties. And using the techniques we set 5 out in this e-book we have managed to plot a course away from the rocks where others could see no way out. You will find these particularly pertinent right now because there is no reliance on extra borrowing to put things right; just a relentless focus on understanding how the numbers in your business really work. The old adage, Cash Is King is very much to the fore. As with all things of this ilk it’s an easy phrase to trot out but much harder to deliver in practice. There is a finite limit to what you can do cash flow-wise bobbing-and-weaving, ducking-and- diving to get by. So we need to approach this a different way and understand how we can design the various aspects of our business to ensure we can generate cash from what we do. And as you will see we are going to use what we describe as a two-pronged attack. This means focusing separately on the profit and loss account and then on the balance sheet. It’s the combination of these two elements that will create a robust cash flow. 6 2. T he Nature and Impact of Recession.... Wake Up! Wholly unexpected? Irrespective of the fact that a recession is technically two consecutive quarters of negative growth and a downturn is merely bumping along the bottom with next to no growth, they both translate into a weak economy and a pretty miserable trading environment. There is a danger that given the hyperbole we see everyday in the media in its various guises that we view both downturns and/or recessions as freak occurrences, visited upon us by some unique set of circumstances. And by implication, we take from this that they are unpredictable, unforeseeable and thus impossible to plan for. Nonsense... complete and utter drivel. Recessions are a regular (and frankly not infrequent) and thus recurring feature of the economic landscape. They are both normal and inevitable. The trick is being able to position yourself to withstand and even profit from them when they strike. What is your business situation right now? This is a question I routinely put to entrepreneurs and business owners I train. And there are doubtless a myriad of different ways of asking the same question but we’ve settled on having them position themselves somewhere along this horizontal dotted line. © Bottom Line Impact Ltd 2010 ... SO WHERE ARE YOU? [2.1] Cash Flow Strength Things are OK but I think we could do better Indicator ‘ Unsure if I can pay the wages this week’ ‘ I’ve got £100k in the bank. I’d like £200k’ 7 Now here’s one for you... In fact it’s important that you do. You need an innate sense, or instinctive feel, for where your business is at; whether it’s left or right of centre and how far along. Listen; depending on which side you think you currently sit (and for goodness sake be honest with yourself about this) the priorities will differ as will your vulnerability to the ravages of a recession. If you are to the right.... Most of these businesses will be largely or even completely immune to any downturn. And we’re not talking her e about the minority (like insolvency practitioners) who benefit directly from economic misery. But there really ARE those for whom it’s business as usual. The wealthy (i.e. cash - rich) are always the last to be impacted by the worst affects of a recession. And of course such people bargain-hunt for opportunities to purchase businesses and/or assets cheaply as weaker entities falter. So there is truth in suggesting that the stronger you enter a recession, the stronger you emerge from one. If you’re to the left.... The reality for many - depressed revenues, weaker margins combined with higher (inflation-driven) costs - steadily undermining their financial viability. And these changes can be sudden. Projects cancelled and budgets slashed in some cases overnight. One of my clients who contracts with local authorities to provide elderly care services commented that local authorities NEVER moved fast on ANYTHING until these current cuts. And reducing their service levels was not an option. I invite you to position your business somewhere on this line. 8 In such circumstances businesses find they have literally no time to react before the size of the impact becomes clear. A business doesn’t need to be struggling or those running it, oblivious about their numbers, to find they are plunged headlong into a cash flow crisis. So if any of this resonates at all with you, this is exactly what we want to address. 9 3. Improve Profitability... In Fact How To Guarantee It ‘ Break-even ’ is a fundamental benchmark every entrepreneur and business owner MUST know so...... Look, there are few questions as critical as this; particularly in a recession. Of course ideally it’s not a target to aspire to (unless you’re incurring significant losses) but it gives you a floor that you don’t want to dip below. And it’s vital to know where this lies. The best way to visualise ‘break - even’ is as a high jump bar. The higher it’s set, the higher you need to jump to clear it. In financial terms, if it’s set at a challenging height, it means you need to find a high value of sales before you can make a profit. Conversely, the lower it’s set, the easier it is to clear. You don’t have to be Heiki Drechsler (supreme German high jumper) in her prime to get over it. In financial terms you want it to be so low that making a profit becomes inevitable – as easy as falling off a log – you’ll need so few sales, whatever the climate. Does the latter sound appealing? You bet it does! That’s why this is such an important element in helping you steer your way through a recession, however long it lasts. At what height would you like to set it for your business? No... honestly... because contrary to what you may have thought, this really is down to YOU. Do you know the value of sales orders you need to secure EVERY month simply to break-even? 10 How not to do it From many years spent delivering financial training, most entrepreneurs and business owners, when asked, claim to know their break-even sales target. You might find it surprising. I certainly did; at least initially when I started asking this question rou tinely... ... but not for long. It soon became apparent how this figure was being derived ... by all of them. WHAT IS YOUR BREAK-EVEN? © Bottom Line Impact Ltd 2010 [3.1] The Conventional £SR £TC SR = Sales Revenue TC = Total Costs Calculation Of break-even = View it as cheating It will send you off down the wrong path. It was simply their total costs in a typical month “As long as sales are at least ‘£x’ I’ll cover my costs.” Simple right? Well, actually too simple. It’s an approach that plays right into the hands of those who think improving the financials is a matter of higher sales and/or lower costs. This is the obvious interpretation of [3.1] above. And that’s unfortunate because it’s an approach that so often fa ils to deliver in terms of ‘ cash in the bank ’. The other explanation of break-even assumes your business only offers a single product or provides a single service. This is, of course, nonsense. Even the smallest of businesses is unlikely to be in this position so it’s not a viable way to calculate your break-even sales target. (But there are no shortage of so-called finance guru’s on the web advocating exactly this approach.) 11 A better way So let’s try a different tack... but in so doing let’s make sure we are looking at all the salient elements in a consistent way. Management accounts produced by your accountant, book-keeper or printed straight from an accounting package will likely fit one of the two formats shown below. (Obviously these are summarised.) P&L FORMAT: © Bottom Line Impact Ltd 2010 ‘OLD FORMAT’ MGT A/C’s [3.2] Profit & Loss Account ‘ old style ’ Sales xx,xxx Cost of Sales / Direct Costs Materials (x,xxx) Direct labour (x,xxx) Other direct costs (xxx) £SR format Gross Margin (x,xxx) x,xxx £DC Overheads (x,xxx) Profit xxx £OH £P/ (L) P&L FORMAT: © Bottom Line Impact Ltd 2010 ‘NEW FORMAT’ MGT A/C’s [3.3] Profit & Sales xx,xxx (Cost of Sales) (x,xxx) £SR £DC Loss Account Gross Margin x,xxx £GM ‘ new style ’ format (Operating Costs) (x,xxx) PBITDA x,xxx £OH (Depreciation & Amortisation) (x,xxx) £OH Operating Profit xxx £P/ (L) Sundry Income / (Exceptionals) PBIT (x,xxx) xxx First point to make is that there is not a lot of difference between the two formats. The first one is perhaps more traditional while the one below it, by virtue of the greater use of acronyms, is maybe slightly more contemporary. (‘PBITDA’ by the way stands for profit before interest, tax, depreciation and amortisation.) That is as much as I want to say about it here. So whichever of these (or whatever equivalent format) you use, the approach we’re going to take is equally applicable. £GM 12 Classify your costs accurately In both cases you‘ll see that costs are analysed into two distinct groups:  What we term, ‘Direct Costs’; and  Overheads or ‘Operating Costs’ * * In the new format [3.3] you’ll see that ‘operating costs’ relate to routine overheads with depreciation and amortisation listed separately below (whereas these costs are combined within ‘overheads’ in the old format Profit & Loss Account). I frankly don’t care too much about this ‘overheads / operating costs’ distinction. Depreciation and amortisation (which relate to the writing down of fixed assets over time) are non- cash items and usually small. So for simplicity I’ll just use the generic term overheads from now on. You will also note we use the term Gross Margin as opposed to Gross Profit . In most cases these two terms are used interchangeably and that is how we will use them here. More important is the distinction between Direct Costs and Overheads and the differing behaviour of each group. Below are a couple of diagrams that set out some practical principles that you should apply in your own business. There will always be some ‘ shades of grey ’ but in these cases, however you choose to classify a specific cost, just make sure you apply the same treatment consistently over time. TYPES OF COST Direct Costs © Bottom Line Impact Ltd 2009 [3.4] Direct Costs: practical guidance • You ONLY incur the cost if you get the sale . Want the work? No choice • The separable costs of a job you would include in creating an estimate • Stem from (and can be identified with) fulfilment of a customer order. • Should be able to attribute Gross Margin (SR – DC) by customer. 13 So with Direct Costs, the principle is that these are job-specific, incurred only once you’ve secured the work. TYPES OF COST Overheads © Bottom Line Impact Ltd 2009 [3.5] Overheads: practical guidance • You ONLY have the cost because the company (business / branch / subsidiary etc) actually exists and ‘ does what it does ’. • Typically these costs are more a function of time than activity • So if you win an extra job / contract – cost unlikely to change So review how you’re classifying your costs as either ‘ direct’ or ‘ overhead’ respectively to ensure they are as accurate and consistent as they can be in order to produce a robust break-even sales target. Clearly the overhead cost-base will vary a little with differing sales levels, particularly where any changes in revenues are sizeable so it’s important to see these principles in context. So Total Costs (‘TC’) equate to the sum of Overheads plus Direct C osts as shown in the slide below: © Bottom Line Impact Ltd 2010 2-STAGE APPROACH [3.6] Overheads: £DC TC = Total Costs DC = Direct Costs OH = Overheads practical guidance = Let’s re -visit the £DC / £OH ‘ cost- £OH split ’. £TC 14 Now with the benefit of grouping costs into these two categories we can come at the calculation of your ‘break - even’ figure from a different direction. We call this our 2-stage approach 2 stage approach ‘ Stage 1 ’ highlights the fact that by virtue of securing the sale you incur certain direct costs so the sales revenue figure in itself is somewhat illusory. Your real income is your Gross Margin – this being your true income after deducting the direct costs. For some, this represents a fundamental change in focus. The slide below conveys this visually. STAGE 1 © Bottom Line Impact Ltd 2010 [3.7] Gross Margin: Your real income £GM £DC ‘Gross Margin’ - the ‘real’ income of the business With stage 1 we get to focus on the quality of the gross margin earned. This is measured by calculating the Gross Margin percentage which is the gross margin divided by the sales revenue. In the case of these slides it’s about 50% (see [3.8] below) but of course you would normally extract these numbers from management accounts. x £ SR 15 GM%: QUALITY © Bottom Line Impact Ltd 2010 [3.8] Gross Margin percentage £GM £DC How RICH is each ‘£’ of Sales in terms of Gross Margin? GM%: £GM £SR = 50% ‘ Stage 2 ’ demonstrates that over the course of (usually) a month, you need sufficient Gross Margin, in terms of GBP or USD, to cover your overheads – this being break-even. STAGE 2 © Bottom Line Impact Ltd 2010 [3.9] Gross Margin: Your Ultimate Target £GM £DC SR = Sales Revenue GM = Gross Margin DC = Direct Costs OH = Overheads = In contrast to stage 1 where the focus was on quality , the focus in stage 2 shifts to quantity – you ideally want your gross margin to not just equal your overheads but to comfortably exceed them. £SR £SR £GM £OH 16 £GM: QUANTITY © Bottom Line Impact Ltd 2010 [3.10] High v Low-Margin Businesses 2 extreme ways to the same end • HIGH GM% on LOWER sales revenues • LOW GM% on HIGHER sales revenues Ultimate aim: £GM > £OH v As [3.10] above suggests, to hit a stated GBP or USD gross margin figure, the higher your gross margin percentage, the lower the sales revenue needed. Break-even formula So the formula that brings stages 1 and 2 together and delivers our break-even sales target is shown in [3.11] below: BREAK-EVEN FORMULA © Bottom Line Impact Ltd 2005 [3.11] Break- even Target Formula OVERHEADS GROSS MARGIN % The VALUE of sales that need to be generated in order to break-even. So if we assume that our overheads were GBP 1,000 per month and we earned an average gross margin of just 10% on what we sold, our break-even sales target would be GBP 10,000. Alternatively, if our overheads stayed at GBP 1,000 but our gross margin was instead 50% our break-even sales target would drop to GBP 2,000. There is an underlying logic here – the higher your gross margin percentage the lower the value of sales you need to break-even (assuming overheads remain £GM £OH 17 unchanged). Likewise if the gross margin percentage remained constant but overheads were lower. I hope you follow these examples because soon you’ll be calculating this for YOUR own business with YOUR figures. So it’s the combination of your overhead cost -base and your gross margin percentage that dictates the height at which your financial high jump bar is set. Which side of the high jump bar are you? You could be only just breaking even of course but usually you’ll find yourself in one of two positions:  You’re making a loss; or  You’re making a profit The priority for any loss-making business is to get back to break-even (initially) and to then restore itself to profitability as quickly as possible. So it’s vital to know where you are in terms of your sales and break-even figures to be able to compute how quickly you can close this gap. [3.12] Break- even When BREAK-EVEN – SO WHAT Why use break-even as a benchmark? © Bottom Line Impact Ltd 2010 You’re Loss Making Well, if you’re struggling.... You really want to know .... Break-even How do you close the gap Sales But even if your business is profitable, knowing where this high jump bar sits relative to your current sales levels is still invaluable. In a pessimistic sense it tells you how close you are to this floor . In a more optimistic sense, if you know how wide this ‘gap’ between your actual sales and break - even figure currently is, you’d be keen, I imagine, to look at how you could widen it further and thereby future- proof your business. 18 [3.13] Break- even When BREAK-EVEN – SO WHAT Why use break-even as a benchmark? © Bottom Line Impact Ltd 2010 You’re Profitable Well, if you’re doing OK Still Sales How do you widen the gap? applies... Break-even Impact of a downturn or recession Now let’s focus this specifically in the context of a weak economy. Businesses that are suffering the ravages of the downturn will be finding their revenues are suffering. So with disappointing sales figures, any positive gap between sales and break-even is eroded. But of course with even more intense competition for any work that is available, there are also likely to be downward pressures on margins. So it’s likely that your gross margin percentage will come in below what you hoped. This will push up the break-even sales target (so the metaphorical high jump bar will prove harder to clear). Now in this particular recession or downturn (call it what you will) inflationary pressures on costs, both direct and overheads, serve to further compound the misery. So this demonstrates how recession pushes your sales and break-even figures closer together (and from both directions). Not good. You’re better off than most.... no you really are! But here’s the thing. In the vast majority of cases, business owners and entrepreneurs facing these pressures have no tools to help them quantify what’s happening and therefore calculate the compensating changes they need to make to mitigate their impact... 19 ... until now. Because even with just what we’ve covered so far, you are in a very different position to most. Here’s why. Take this business and the following facts: Monthly sales GBP 100,000 Gross Margin 40% Monthly Overheads GBP 53,200 Just knowing this information we can compute the resulting break-even sales target: Break-even = Overheads / Gross Margin percentage = GBP 53,200 / 0.40 = GBP 133,000 So with sales revenues of GBP 100,000 and a break-even sales target of GBP 133,000 the business is probably not going to be in great financial shape..... and it wasn’t. So how do you get this sorted? Well, being in a recession, the business owners knew how tough it was to get more sales. There just weren’t any available. When it came to their product, customers just rang round potential suppliers to get the cheapest price so in the short-term they were stuck with a gross margin of 40%. So what could they do? Well, if you can’t get more sales and you can’t change your gross margin, what options are left open to you to increase the gap between your sales revenue and 20 break-even sales figure? (Or in this case at least get the relationship the right way round!) Play with the only variable they’ve got – overheads. Now these guys were just scaffolders but with this one example they have put many a big-company Chief Executive to shame. One of the directors decided that with sales averaging GBP 100,000 a month he wanted break-even to come in at no more than GBP 80,000. This would leave him a half-decent gap between the two. OK but his starting point was a break-even of GBP 133,000. So to get that down to GBP 80,000 by just overheads alone, what would be the size of the change needed? So starting with our break-even formula again: Break-even = Overheads / Gross Margin % But knowing that our missing figure is now overheads we can change this to: Overheads =Break-even x Gross Margin % So we now just feed in the numbers that we already know: Overheads = GBP 80,000 x 0.40 = GBP 32,000 To sum up, the business owner now knows that to move the business from a monthly break-even of GBP 133,000 to GBP 80,000, he needs to reduce his monthly overheads from GBP 53,200 to GBP 32,000 - a drop of GBP 21,200. Review that calculation again should you need to and make sure you can follow the logic all the way through. Now I’ve already alluded to thi s being a real-life case history which indeed it was. So what happened in the end?