Taking off

What similarities are there between business executives maximising their company’s profits, and pilots successfully landing a plane? Pilots use checklists and standardised procedures, perform planning and risk analysis, and constantly monitor their position, to ensure that the unexpected can be dealt with in the air. A CFO should use a similar approach to ensure their business reaches its desired destination intact.

My most unnerving experience as a pilot occurred in a thunderstorm. Strong up- and downdrafts saw the plane rising and falling by 4,000 feet per minute, putting me in serious danger. However, by maintaining a level head, and using ingrained procedures, I was able to land safely.

Most FDs will be able to empathise with that predicament. Negotiating turbulence and dealing with sudden buffeting is all part of the job. For example, in a company, the loss of a major customer or withdrawal of a line of credit is the equivalent of a catastrophic loss of power. But navigating through turbulent times equates to successful profits growth. This article provides a 12-step checklist to avoid the worst conditions and maximize your profits.

Flight plans include direction, altitude, and duration. The route is plotted on a chart with selected way points and the estimated arrival time identified. For a company this flight plan takes the form of the annual budget, which is a distillation of the strategic plan into numbers. The way points are identified in the 13-week cash flow forecast, the most critical document a company needs, since numbers don’t lie. Flying along the route requires constantly monitoring the flight instruments on the dashboard. FDs must constantly monitor their company’s key indicators on a financial dashboard.

None of the corporate turnarounds for which I have been engaged had paid much attention to cash flow forecasting. Indeed, it’s fair to say that was the major reason for their underperformance. This is hardly surprising: in the same way that a plane cannot be flown by the seat of one’s pants, neither can a company be managed without a robust strategy – combining clearly stated goals and plans to achieve them through their budgets and comparisons of actual to forecast.

A cash flow forecast is the most critical financial document a company possesses. It is a real time “living” document, and should be reviewed and revised at least weekly, to reflect new information, changed commitments, staff reductions, and actual cash inflows and outflows for the prior week. Reasons for unexpected variances should be identified, and corrective actions begun. After all, no business exists in a vacuum, and changes to both internal and external conditions can have serious implications.

The size of the company will determine the level of detail presented, but key data points must be easily identified. Cash is the fuel that powers any business. Without any planning for cash requirements, a company will go bankrupt. So, just as on an aircraft flight, where fuel consumption must be monitored, so in a company, cash must be monitored so the FD understands its true condition. No pilot wants to repeat the famous Air Transat Flight 236 that, because of a faulty fuel gauge, found itself running out of fuel over the Atlantic. Thanks to the pilot’s flying skills, it landed safely, setting a world record 80-mile glide before touching down in the Azores. A terrifying lesson for a pilot. And for a company FD, the moral is just as clear: expenses must be monitored critically and consistently to avoid running out of cash. Enron is a case in point – its reported profits in year 2000 were less than the sum of its “unrealised gains”. When the markets unravelled, there was no cash behind the company.

So, to be useful, the cash flow forecast will identify expense line items by category, so that the largest ones can be prioritised. Benefits can be obtained by the CFO authorising every material payment to understand who is spending the money and where it is going. The forecast also enables the CFO to understand where the money is coming from, and leads to the next most important action in maximizing profitability.

The easiest way to get cash into the bank is to collect what is already due to you. In a $50 million revenue company, eliminating bad debts can have a $1.5 million impact on profits. (See calculation at end of article).

An early sign of a company losing control is lax receivables collection. There are hundreds of excuses used to delay payment but, if a company has legitimately honoured its obligations, it should do everything in its power to collect. The best way to do this is by assiduous communication from the first day a receivable becomes overdue. If we are at fault, we can begin rectifying the issue. If the customer is on the verge of bankruptcy, we can stop further shipments. Communication between us and our customer, and our accounting and sales departments is critical to efficient collection. Good salesmen can smell a bad credit risk far better than any ratings agency, and with a sales commission policy tied to cash collections, not simply to customer orders, a company should never have to write off a receivable again.

If a company fails to prevent bad debts, further costs have to be incurred in generating new business to offset the lost profits. The cost of generating one new customer can be 20 times more expensive than keeping an existing one. Not allowing receivables to go bad is probably the simplest, and one of the biggest contributors to maximising profits. In many cases, a 15% increase in sales would be required to have the same profit impact as eliminating bad debts.

Staff costs are usually the largest single expense within a company – often as much as 70%. Jack Welch uses his book Straight From The Gut to explain why a 20/70/10 mentality must be part of a successful company’s HR management, to identify and reward star performers, and eliminate underperformers. Identifying the changes must be recorded on the second most important living document a company needs, the “Organisation Chart Du Jour”, (OCDJ), so called because in the early stages of a turnaround, it might alter every day.

Because ultimately all costs in a company are tied to headcount, efforts to reduce costs must by definition include this area. And the best way to reduce staff costs is to encourage underperforming people to leave of their own volition, by introducing policies to promote top performance.

The best way to reduce overall costs is to cut employment costs, but to do so without having to get rid of anyone, thus avoiding claims of unfair dismissal. A weakness which underperforming companies frequently exhibit is to pay for significant amounts of overtime, because it is often seen as an entitlement in non-salaried positions. Weak management in underperforming companies is often afraid to challenge the status quo. Yet incurring two hours per day of overtime, paid at time-and-a-half increases the wage bill by 37%. Restricting the amount of paid overtime forces work to be prioritised and performed more efficiently.

All positions also require quantifiable objectives. For a financial controller, closing the books within six days of the month end may be appropriate. Management by objectives may come as a shock to some employees whose last “grading” was at school, but by introducing objectives, underperformers may leave rather than subject themselves to meeting quantifiable objectives.

Implementation of the above policies is much fairer than any arbitrary “across the board” cuts, as it is likely that the poor performers will self-select and resign, avoiding any discrimination lawsuits.

The second largest controllable expense is often travel and entertainment (T&E). Beyond the obvious political fallout, the recent parliamentary expenses scandal and chancellor George Osborne’s train ticket imbroglio were salutary reminders of what badly policed T&E policies can lead to. Whether or not the chancellor intended to pay for his first-class train upgrade on a trip from Wilmslow to London will be the subject of political debate, but one of the key issues of relevance to all corporate travellers is that if he had planned his trip in advance, he may well have obtained a first-class ticket for about half of the full price.

Most companies’ T&E policies focus incorrectly on specifying in detail the minutiae such as how much can be spent on lunch, rather than recognizing the macro savings obtainable by planning ahead, which will cut your travel budget in half. Looked at another way, you can travel twice as much for the same price. But it demands a mindset that plans meetings to fit into a schedule, rather than allowing meetings to dictate the schedule.

All T&E policies need teeth, and the CFO should review all T&E reports. By finding egregious spending at the macro level, and patterns of abuse, word will travel through the company that T&E can no longer be abused. Changing that culture must come from the top.

Audit, tax preparation, legal and marketing professional fees are frequently overlooked in the quest to save costs. Are your own staff producing all the schedules your auditors need, or are you paying expensive professionals to do so? Is your company law firm providing basic administrative functions that could be performed in house? Can the tax returns be prepared by you and simply reviewed by your accountant? Is marketing expense held to the same ROI standards that an investment in physical plant would require? If not, why not?

It is no longer a truism that you don’t know which 50% of your marketing is wasted – information is available to assist you track everything. Any web-based marketing can now be tracked down to micro-levels of detail via Google AdSense and other tools. PR and advertising agencies are all now expected to provide clear metrics on ROI.

Insurance should only be used to cover significant losses. Maximize deductibles, and self-insure for small risks. Focus on safety by having a written safety policy, a drug-free policy, and make reduction of accidents a primary goal with clear accountability built in. Require employees to be responsible for vehicle damage, and perform credit checks on employees with fiduciary responsibilities.

Reduce the number of bank accounts, consolidate loans, and renegotiate interest rates. Set up a sweep account to reduce your net debt. Gain an immediate 36% ROI by prompt payments. Normal payment terms on invoices in manufacturing in the US are “2/10 net 30” which means payment is expected 30 days after invoice date, but a 2% discount is offered for prompt payment within 10 days. So either pay 98% of the invoice in 10 days or 100% of the invoice in 30 days. Delaying payment by 20 days costs 2%, equivalent to EARNING 2% in 20 days, or 36% in 360 days (one year).

Do not assume buying in bulk at a lower price is a good deal – demand can change, making inventory obsolete, or your supplier may prefer making more frequent smaller deliveries. High levels of inventory incur high storage and insurance costs, and capital is tied up, all amounting to perhaps 20% of the value of inventory per year.

In manufacturing, large costs occur when a production line is stopped to change from one model to another. Planning to minimise down time can do more to keep costs down than the activities identified above.

When landing a plane, the margin for error is pretty small. In a business, the margin for error is the difference between what it costs you to make something and the price at which you sell it. Ergo, the greater the margin, the greater the profit.

Gross margin analysis is not just an academic exercise. In the course of my career as a turnaround expert, it has enabled me to identify one incidence of fraud and another of malfunctioning equipment.

The fraud occurred at a company that did not perform reconciliations between bulk inputs and retail outputs. But with sales prices increasing, and purchasing costs decreasing, gross margins were going down when they should have been going up. The reason was because a number of employees were selling the retail products for cash under the table.

The second scenario occurred when new “state of the art” flow meters were installed on a bulk fluid pipeline, readings from which the supplier used to bill my client every six months. We billed retail clients monthly based on their volumes. Performing gross margin analysis, by month, using 12-month moving averages for both the period before and after installation of the meters indicated an overcharge from our supplier of about 7%. It took two years to resolve that situation, but our margin analysis figures were the key to identifying the error.

Delivery costs can be reduced by 50% using simple techniques requiring no capital investment. Examples include turning engines off when trucks are not moving, or, as UPS has done in the US, route planning to minimise left-hand turns (it would be right turns in the UK), which can save 15% of costs merely by cutting waiting times to cross the traffic flow.

Providing fuel cards and requiring mileage to be entered at every fill up, and reviewing fuel consumption by a driver can save another 20%. Sending drivers on safe driving courses, holding employees responsible for damage they cause to vehicles, and requiring clean driving records all create insurance savings.

Capital investment that can deliver savings might include mobile GPS reporting, and route planning software. And the biggest single cost saving comes from buying vehicles which are one to two years old, letting someone else absorb the first 50% of depreciation. Think carefully before entering in to any leasing arrangements – you have to take delivery of new vehicles, and return them when they still have many years of useful life left in them.

Use tax laws for your best advantage. Don’t set up subsidiaries if you expect a loss if, by using a branch instead, you could flow losses up to offset some profits elsewhere. The worst situation a multinational can find itself in is to make a worldwide pre-tax consolidated profit, but an after-tax loss, because of trapped tax benefits. Ensure that you use the flexibility in transfer pricing rules to choose the most favourable accepted methodology.

Other tax benefits often overlooked (especially by American firms operating in Europe) include not understanding that VAT on purchases is a receivable at the company level is able to be offset against the payable due to the government from the taxes charged on sales.

In conclusion, to maximise profits, the company’s CEO and CFO, acting as pilot and first officer, use two critical checklists, the 13-week cashflow forecast and the OCDJ. They collect receivables and control expenses by maintaining a sense of order throughout their company. By planning in advance and knowing where they are, by not losing control and focusing on the outcome – maximum profitability of all actions – they arrive and land successfully.

* Calculation of $1.5m profit increase by eliminating bad debts in a $50m revenue company. This uses data averages from my eight turnarounds:

1. Days sales outstanding (DSO) reduced from 90 to 42 days, a reduction of 48 days.
2. Write offs of 2% of revenues are eliminated, an increase in cash, and profits, of $1m
3. Interest rate on borrowings in loss-making companies is 8.5%
   Daily revenues are $137,000, 365 days per year. ($50m/365)
   The capital tied up by these EXCESS receivables is $6.6m ($137,000 per day multiplied by 48 days)
   Annual interest savings will be $561,000. ($6.6m x 8.5%)

Average bad debt write-offs in poorly managed companies are 2% of revenues. Therefore, additional annual savings of $1 million will be achieved by eliminating bad debts. And in today’s bumpy conditions that can give a company the lift it needs.

• Taking off, Finance & Management Magazine, Issue 206, January 2013

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