The CPA as Adviser to Business Managers in Uncertain Times

1. The CPA as Adviser to Business Managers in Uncertain Times Building Better Business Ric Payne Principa 2010

2. A Quick Poll Are you an internal CPA advising and/or supporting your company’s management group or are you an external CPA acting as an adviser to your business clients? • Internal • External

3. What is a recession? • The technical definition is two consecutive quarters of negative growth in Gross Domestic Product.

4. What is the consequence of a recession? Reduction in consumer spending Decline in business revenue Decline in business profit Reduction in cash flow Falling asset prices (houses) & higher business & financial risk limits credit availability Reduction in capacity - layoffs

5. A Quick Poll • How would you rate the current economic environment in terms of its impact on your company if you are an internal CPA or your clients' businesses if you are an external CPA? • Very bad • Bad • Neutral • Good • Great

6. What is the consequence of a recession? All of this leads to … Business failures Unemployment Lost savings

7. Recessions are not the reason companies stall Bain & Company study: Only 1 in 7 companies achieve reasonable growth for 5 years straight despite their best efforts to do so. Source: Steve McKee, When Growth Stalls: How it happens, Why you’re stuck and what to do about it. Jossey-Bass, 2009.

8. Recessions are not the only reason companies stall • Characteristics of stalled companies: • Higher team turnover • Lower margins • Weaker customer loyalty • Tougher cash flow issues BUT!!! Source: Steve McKee, When Growth Stalls: How it happens, Why you’re stuck and what to do about it. Jossey-Bass, 2009.

9. Recessions are not the only reason companies stall • Reasons for stalled growth: • Issues involving trust and respect • Inability to make lasting decisions • Paralyzing lack of confidence • Tendency to over think things • Propensity to either resist change or switch directions too frequently Source: Steve McKee, When Growth Stalls: How it happens, Why you’re stuck and what to do about it. Jossey-Bass, 2009.

10. How do business people often react in tough times? • Cut prices to stimulate demand • Cut costs to preserve cash WRONG DECISIONS!

11. Recession is an opportunity in disguise Financial Performance Top Quartile 20% of top quartile firms Bottom Quartile 20% of bottom quartile firms 1990-1991Recession Source: Bain & Company (Harvard Management Update, Reprint U0209E)

12. Recessions are “intense crucibles of opportunity” Top Quartile More than 70% of these companies sustained gains made during the recession 20% of top quartile firms Bottom Quartile 20% of bottom quartile firms Less than 30% of these companies were able to regain their pre-recession positions. 1990-1991Recession Source: Bain & Company (Harvard Management Update, Reprint U0209E)

13. Recessions are “intense crucibles of opportunity” “Twice as many companies made the leap from laggards to leaders during the 1990-91 recession than in the surrounding periods of economic calm.” Good times hide the brutal reality of under-performance whereas hard times reveal real strengths and weaknesses. Source: Bain & Company (Harvard Management Update, Reprint U0209E)

14. Recession is an opportunity in disguise “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell” Sir John Templeton

15. Here? Or Here If you could choose a time to start a business State of the economy Time

16. It’s also important to remember the direction of business cycles State of the economy Time

17. An overview of your strategy • Survival – Cash is King • Order of importance: Cash, Profit, Revenue • Get your house in order by doing what you should have done in the good times – act decisively and quickly • Confront the brutal reality but take advantage of pessimism and weakness • Master your emotions – fear or faith (it’s all in your head) • Communicate honestly with all of your stakeholders • Ensure your business operating model is sound before borrowing money (preferably do not borrow at all!)

18. An overview of your action plan • Assess your vulnerability • Stabilize your business • Take advantage of any weaknesses revealed by your competitors

19. Assess your vulnerability Complete the Management Health Checklist

20. Margin of Safety You need to know what your Margin of Safety is MOS = Current Revenue – Break-even Revenue B/E revenue = Fixed Expenses ÷ GP% MOS = 40%

21. You need to know what your Margin of Safety is When you reduce your fixed costs you increase your MOS Margin of Safety MOS = 53%

22. Margin of Safety You need to know what your Margin of Safety is If you have a low MOS your are exposed to higher business risk you therefore should have higher cash reserves to accommodate demand fluctuations.

23. Assess your vulnerability • What would happen to you business if sales volume dropped by 20% and average prices dropped by 10%?

24. Assess your vulnerability

25. Assess your vulnerability

26. First some fundamentals • The elements of business strategy • Decisions drive outcomes • The 4 ways to grow your profit • Cash is king

27. The Elements of Business Strategy

28. There are just two generic strategies Low Cost Differentiation

29. Average industry profit Strategic Options Average Price Profit Profit Profit Profit Cost Cost Cost Cost The Average Firm The Cost Leader The Differentiator The mix

30. Average Price Differentiator Options Same price Profit Profit Greater Market Share Cost Cost The Average Firm

31. Average Price Greater Market Share Cost Leader Options Lower price Profit Profit Cost Cost The Average Firm

32. Decisions drive outcomes • Where your business is today is the result of decisions taken in the past. • The quality of decisions depends on the quality of information they’re based on. • Most people managing SME’s have a very weak MIS

33. Do you believe the person (or people) you support in your role as a CPA truly understand the financial aspects of their business? Yes No • A Quick Poll

34. There are just 4 ways to grow profit Profit is a residual that arises as a consequence of decisions taken by management.

35. There are just 4 ways to grow profit • Increase the number of customers** • Increase the frequency with which they deal with you • Increase the average transaction value • Improve the productivity of your business processes (i.e. reduce relative expenses)

36. Where you need to focus on the revenue side • Price & transaction size • Transaction Frequency • Customer Defections • Customer Acquisitions

37. Now let’s look at the expense side • Revenue less • Cost of goods sold – varies with the volume of sales (therefore called a variable cost) • = Gross Profit(GP% = COGS/Revenue * 100) Less other operating expenses … = Net Profit

38. The drivers of business profit

39. Neutral Penetration Skim Pricing strategies • Skim pricing • Penetration pricing • Neutral pricing

40. Price is the dominant driver of success • The typical knee-jerk reaction of business people when sales drop is to lower price. • This is generally the worst thing you can do! Unless you have a clear cost-leadership position relative to your competitors and customers are price sensitive

41. Price discounting places enormous pressure on profitability and cash flow

42. Price discounting places enormous pressure on profitability and cash flow Even if customers were willing to buy an additional 50% from you, do you have that much physical capacity to meet the volume? You can’t price yourself out of a recession!

43. In a recession pursue a neutral pricing strategy • Focus on margin not revenue • Offer a range of product or service offerings from low to high value – for low priced offerings you must reduce costs • Articulate a quantifiable (or defensible) value proposition and price to capture a fair share of that value. • Do NOT reduce prices across the board!

44. In a recession pursue a neutral pricing strategy • Unbundle components of your offering • Bundle additional components into your offering • Turn products into services • Turn services into products • Don’t pursue unrealistic revenue goals • Reduce capacity to lower your break-even point

45. In a recession you should pursue a neutral pricing strategy • If you have fixed capacity (relatively high fixed costs) consider “value” pricing. What can we learn from the pricing process used by airlines that could be implemented in any business? Your customers are not all equally profitable: you need to know which ones are!

46. 100% Cumulative Customer or Product Profitability Graph Services or products Insurance business Source: Bob Kaplan and published in the Balanced Scorecard Report (August 2005) called “Add a Customer Profitability Metric to Your Balanced Scorecard"

47. Customer profitability analysis • Cost of goods sold • Discounts given • Returns & allowances • Post sale support/service costs • Finance cost for payment terms given (or taken) • Bad debts or write-offs • Order taking & fulfillment • Etc.. • Revenue from sales less:

48. Product profitability analysis • Cost of goods sold • Discounts given • Returns & allowances - restocking • Post sale support/service costs • Finance cost for stock carrying • Insurance & storage costs • Order placement & stocking costs • Etc.. • Revenue from sales less:

49. Sales function Marketing & Sales function Sales Volume – the second part of the revenue equation Transaction size Number of transactions New customers Repeat transactions It’s all about customer service and creating a WOW experience

50. Sales Volume – the second part of the revenue equation You can never make it too easy for a customer to deal with you.