What do I have to Manage? # 4 – Be Prepared!

Friday, May 7th, 2010

 It’s been a few weeks since my last newsletter in this management series.  April has been a strange month with all the public holidays – especially here in South Africa.  The worst part of it is having these holidays in the middle of a week, as it really disrupts productivity.  Most of my staff decided to take a day’s leave on Monday the 26th, given that the 27th was the official public holiday, so I closed the office for that day.  It would be nice if sanity could prevail here and the politicians were driven by expedience and not emotion!

This newsletter is the next in the series on “what we have to manage” if we want to avoid constant stress in our business lives.

BE PREPARED

Preparing for “war”.

There’s an old saying that goes, “if you want peace prepare for war.” (Sun Tzu). 

If we apply this in the business sense, we will see that it’s necessary to adopt a conservative approach to all our forecasts and planning as this will help create a bit of a cushion for the shocks which are bound to occur.  In many ways, one could say that it’s worthwhile planning for the worst, while expecting the best! It will also enable us to consider monthly provisions for those annual infrequent expenses, which crop up from time to time.

Have a War-Chest

In this regard, I also encourage business-owners to establish what I call a ‘war-chest’. 

This is quite simply a reserve of cash for those ‘rainy days’ – for those tough times that are sometimes beyond your control, which can occur every now and then.  As a guide, I believe this war chest should ideally consist of cash reserves equal to at least three months total overheads.  This may sound like a lot, but if you start small, it won’t be long before you have built up the necessary amount and this provides one with a great deal of comfort during those tough times.

Early Warning Signals

Sometimes small business owners have very little time to pour over copious screeds of financial reports, with row upon row of numbers, many of which might not mean much.  All they need really are a few key numbers – performance indicators – that will enable them to glance up, make a simple adjustment, and then carry on.  It’s rather like driving your car.  Every now and then, you cast a glance at the dashboard to check your speed, your temperature gauge, and to see that there are no flashing warning lights, and then you carry on. 

In business, it’s much the same.  Unlike a motor car, though, your business doesn’t come with a built-in dashboard – you have to create one.   This could be a simply one-page report which contains a half-dozen-or-so key ratios and trends, which are available each month from most accounting systems.  These dashboards can be purchased as ready-made software, or they can be easily created for you from your own system – customising them as it were.   The ready-made software is quite expensive and probably more intricate than most small businesses need, but it’s relatively simple to get your accountant to design one for you, within your existing system. Or, if you like, contact us and we’ll be glad to help.

Every system of internal control should provide a battery of early warning signals to management. 

They should happen automatically and not only when the business owner requests them. These signals should alert even the most non-financially-oriented business owner if all is not well!

The way to do this is to develop the dashboard based on accumulating data, which will provide the business owner with trends in certain areas of the business. Once-off indicators can be misleading, so we always advocate trends over time in this regard.  The best kind of dashboard, and one which grabs the attention of most people (and especially the busy ones) is made up of graphs and charts.

Using Graphs:

The best way to view this data for most people is by way of monthly accumulating graphs.  If you don’t really know your way around a spreadsheet, it is wise to get your accountant to set these up as standard charts for you so that they’re easily update-able.  (We can also set these up for you online if you want.)

Some of the more commonly used trend graphs may be:

  • Debt collection period in days. –   This graph will plot the average number of days it takes for you to collect your money from your credit customers.   If the trend is upward, it could imply that the collection efficiency is dropping, or that you are allowing more credit than you should. (Or, that your sales are going down).  Either way, it will have a negative impact on your cash flow.  If the trend continues, it may prompt you to have a closer look at specific customer’s accounts, and this could prevent a major bad debt from occurring.
  • Supplier’s payment period in days. – This graph plots the average number of days you take to pay your suppliers for goods and services bought on credit.  If this trend is upward it could show that cash flow is deteriorating, because you have to make your suppliers wait longer for their money, or that you are carrying too much stock relative to your production capacity.
  • Stock holding period in days. – This graph plots the average number of day’s worth of stock you are carrying, at the average cost of the stock.  If this trend is upward is could imply poor stock management,  -that you are carrying too much stock ; or that you are carrying the wrong mix of stock; or, if you’re a manufacturer, that you’re taking too long to manufacture your goods for resale – all of which means more cash out of the game!
  • Break even sales on fixed cost overheads. – If the BEP goes up on a trend basis, it could mean your overheads are increasing, or your gross margins are dropping, or it could be both!  There will be more on this very important subject in a future newsletter.
  • Variable Cost % of Sales – Variable costs are those which are generally only incurred when you sell something – it’s a direct cost of sale.  This graph plots the efficiency of all direct variable costs in relation to sales.  Fluctuating trends here could imply all sorts of production-related problems and need to be closely monitored. (Amongst a host of others.)  One of the most important of these variable costs in a manufacturing environment, for example, is the consumption of raw material in goods sold.  Some manufacturers run their entire business on the basis of this one consumption figure!
  • Budget versus Actuals for expenditure. – Budgets should be adhered to and not simply studied. Excesses should only be accepted if there is a very good reason for it.  And if the budget was only drawn up to keep your bank manager happy, then you’re really in trouble.  Budgets should be prepared as carefully and accurately as possible.  Any variances should be followed up.