Fiscal Cliff 1.01 – Why Should You Care?
The Fiscal Cliff Explained
“Fiscal cliff” is the popular shorthand term used to describe the problem that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.
Among the laws set to change at midnight on December 31, 2012, are:
- the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers),
- the end of certain tax breaks for businesses,
- shifts in the alternative minimum tax that would take a larger bite,
- the end of the tax cuts from 2001-2003, and
- the beginning of taxes related to President Obama’s health care law.
At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect. According to Barron’s, over 1,000 government programs – including the defense budget and Medicare are in line for “deep, automatic cuts.”
In dealing with the fiscal cliff, U.S. lawmakers have a choice among three options, none of which are particularly attractive:
They can let the current policy scheduled for the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – go into effect. The plus side: the deficit, as a percentage of GDP, would be cut in half.
They can cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe. The flip side of this, of course, is that the United States’ debt will continue to grow.
They could take a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth.
Can a Compromise be Reached?
The oncoming fiscal cliff is a concern for investors since the highly partisan nature of the current political environment could make a compromise difficult to reach. This problem isn’t new, after all: lawmakers have had three years to address this issue, but Congress – mired in political gridlock – has largely put off the search for a solution rather than seeking to solve the problem directly. Republicans want to cut spending and avoid raising taxes, while Democrats are looking for a combination of spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve – particularly in an election year. There’s a strong possibility that Congress won’t act until the eleventh hour. Another potential obstacle is that the next Congress won’t be sworn in until January 3, after the deadline.
The most likely outcome is another set of stop-gap measures that would delay a more permanent policy change until 2013 or later. Still, the non-partisan Congressional Budget Office (CBO) estimates that if Congress takes the middle ground – extending the Bush-era tax cuts but cancelling the automatic spending cuts – the result, in the short term, would be modest growth but no major economic hit.
Possible Effects of the Fiscal Cliff
If the current laws slated for 2013 go into effect, the impact on the economy could be dramatic. While the combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion, the CBO estimates that the policies set to go into effect would cut gross domestic product (GDP) by four percentage points in 2013, sending the economy into a recession (i.e., negative growth). At the same time, it predicts unemployment would rise by almost a full percentage point, with a loss of about two million jobs. A Wall St. Journal article from May 16, 2012 estimates the following impact in dollar terms: “In all, according to an analysis by J.P. Morgan economist Michael Feroli, $280 billion would be pulled out of the economy by the sun-setting of the Bush tax cuts; $125 billion from the expiration of the Obama payroll-tax holiday; $40 billion from the expiration of emergency unemployment benefits; and $98 billion from Budget Control Act spending cuts. In all, the tax increases and spending cuts make up about 3.5% of GDP, with the Bush tax cuts making up about half of that, according to the J.P. Morgan report.” Amid an already-fragile recovery and elevated unemployment, the economy is not in a position to avoid this type of shock.
The cost of indecision is likely to have an effect on the economy before 2013 even begins. The CBO anticipates that a lack of resolution will cause households and businesses to begin changing their spending in anticipation of the changes, possible reducing GDP before 2012 is even over.
Having said this, it’s important to keep in mind that while the term “cliff” indicates an immediate disaster at the beginning of 2013, the impact of the changes – while destructive over a full year – will be gradual at first. What’s more, Congress can act to change laws retroactively after the deadline. As a result, the fiscal cliff won’t necessarily be an impediment to growth even if Congress doesn’t address the issue until after 2013 has already begun.
The Next Crisis
Unfortunately, the fiscal cliff isn’t the only problem facing the United States right now. At some point in the first quarter, the country will again hit the “debt ceiling” – the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff.
Credit Crunch for Small Business
The credit crunch is now impacting small businesses – and it is crucial that they prepare themselves for it. Banks, nervous about the prospect of more borrowers defaulting on loans, have for months been tightening their rules when it comes to lending money to consumers and major corporations. And now, industry experts say lending jitters are being extended to small firms as well, making it harder for them to find loans.
In past years, credit was relatively easy to come by as banks, particularly larger ones, aggressively pursued entrepreneurs, offering larger loans at cheap rates to untested companies. Now, with the balance sheets of many large banks weakened, lending to smaller businesses has been curtailed as well. However, many community bank and credit union executives say that for now, they have neither toughened lending standards nor raised interest rates on loans to small businesses.
Some businesses that received loans in recent years are falling behind on payments – and default rates are expected to accelerate. As a result, experts say some lenders are already tightening their lending criteria and they expect more to follow suit.
So small companies may want to think about ways to insulate themselves from the credit crunch.
Here are some suggestions:
- Pick a lender that caters to your situation.
- Keep detailed and professional financial records.
- Be prepared to put up personal assets, like homes, as collateral, which can make a big difference for young companies seeking funding.
The Best Lender for You
One of the most important decisions small businesses face as they hunt for loans is which lender to turn to. Business owners should keep in mind how different types of lenders evaluate loan applications.
Big institutions that promise speedy approvals or rejections of applications, generally rely on credit-scoring models based on the business owner’s personal credit history. By contrast, community banks, credit unions and other smaller lenders often lean more heavily on their knowledge of the local economy and the would-be borrower’s business model and track record of running or launching businesses.
Lease financing companies have been aggressive in providing low document leases – usually up to about $75,000 – and can be great sources for equipment and asset financing.
Credit unions are nonprofit institutions owned by their depositors. They tend to make smaller loans than banks and have been making a big push to attract more small-business customers. In addition, entrepreneurs should look for lenders with programs aimed at specific types of small businesses: women, minorities, veterans. Of course, when applying for a loan, it also helps to have an existing relationship with the lender.
Detailed Documents
While some banks had been hawking loans that don’t require business owners to provide much financial documentation beyond recent tax returns, that’s now changing in a big way.
When applying for loans, small businesses should be ready to produce cash-flow statements, balance sheets, and even financial plans. Having these documents on hand is likely to impress bankers and could tip the scales in favor of getting a loan approved. Companies should consider hiring part-time, high-level professional financial help to improve documentation and help present a professional image to bankers.
Collateral
Entrepreneurs in search of funding also need to be prepared to put their personal assets, like a home, on the line. But experts say that while banks are getting more skittish and with home values falling in many parts of the country, business owners shouldn’t count on that as the only collateral.
Bottom line…things will continue to get tougher for small business financing, and banks will tend to favor companies that have their financial houses in order, that produce reliable and accurate financial statements, and that can demonstrate a deep understanding of their business model. If you could use some help in preparing for a loan please give me a call. I can help you put your “best financial foot forward” and become your advocate.
Are You Ready for Obamacare?
Unless you have been living in a cave, you know by now that the Patient Affordable Care Act (PPAC), sometimes referred to as Obamacare, has been passed by Congress. You must also know then that in June of this year the United States Supreme Court deemed health care reform to be constitutional and accordingly upheld the PPAC in its entirety. Although the lion’s share of the impact of this law will be felt/enjoyed by consumers there will certainly be an impact on businesses of all kinds. In some cases that impact is already being felt. Considering that, beyond wages and salaries, employee benefits are becoming the largest operating expense for most company budgets, it certainly behooves business owners to get ahead of the curve and understand the impact of this law.
So what are some of the changes that will affect business owners?
Most significantly, starting in 2014, the law will require employers to offer health insurance to employees. Specifically, businesses with 50 or more employees that do not offer coverage, or offer insurance that is too expensive or that does not meet minimum standards, may have to pay penalties. Considering that 96% of the nation’s firms with 50 or more employees already offer health insurance to their workers, might indicate that a small minority of firms will be ensnared by this penalty. However, there seems to be a prevailing opinion that companies may be financially better off by terminating insurance plans and paying the penalty instead. Just like all aspects of this law, the devil is in the details, but that may be a valid economic path for a business owner to take. However, recent studies have indicated that most employers do not intend to drop insurance coverage for their employees recognizing the competitive value of attracting and keeping good people. Regardless if you have more than 50 FTE’s, you will need to learn the specifics of the law to decide what is best for your organization.
What if you have less than 50 employees? These companies, which represent 75% of the firms in our country and employee 34 million people, won’t face any penalties for not offering coverage. However the government is already offering tax credits to small businesses and non-profits as encouragement to offer health insurance to its employees. These credits, which can be as much as 35% of the cost of premiums, require that the employer cover at least 50% of the premium charge and average annual salaries cannot exceed $50,000. The credit is scheduled to increase to 50% in 2014.
Another item that impacts all businesses is the requirement, effective September 23 of this year, that insurers must provide a summary of benefits and coverage (SBC) to participants and beneficiaries spelling out the specifics of the plan. Yet another change in the law has reduced the limit on pre-tax contributions to flexible spending accounts to $2,500.
There are a multitude of other changes that either have already kicked in, or will soon. For example, business owners (or any employee for that matter) who earn more than $200,000 per year will now have to pay an additional .9% Medicare tax on the amount in excess of $200,000.
Thousands of pages of law and related interpretations have already been written on this matter so this short space here cannot begin to do justice to the subject. But the message should be clear. Whether you consider this law to be the long overdue savior of beleaguered health care consumers or you are choosing to ignore it in the hopes that a Republican victory in November will make it go away, as a business owner you should be learning as much as you can. As always, the best place to start is with your business advisors. If I can be of any help, please don’t hesitate to call.
In the words of John Wooden, failure to plan is planning to fail.
The Best Way to Grow Your Business
Although every business wants to grow, some types of growth are certainly better than others. Let’s consider the following 2 options:
OPTION 1: Grow Sales by 20%, and net income increases 50%.
OPTION 2: Grow Sales by 50% (a lot more work and risk than Option 1), and net income only increases 20%.
The best way to grow is when net income growth out-paces sales revenue growth. For every additional unit of sales, we want to generate more profit, not less. How can we accomplish this? How can we assure that our increased efforts are yielding better, more profitable results?
Jim Collins, the author of Good to Great, found that the more an organization sticks to its core competency, the more opportunities the company had for the good kind of growth – the kind of growth where net income increases faster than sales!
What is your core competency? It’s what you do well and, when you do it, you’ve proven that it can make money. If you are a trade contractor, then it is your trade. If you are an attorney, then it is the law. If you are a widget manufacturer, then – I think you get the point.
I have experienced many occasions when, in its desire to grow, a company strays from its core competency and involves itself in a business and industry it doesn’t know very well. Sadly, these new ventures begin to drain time and resources (most importantly, CASH!) from the main business. In essence, the core competency of the firm subsidizes a less successful venture. As a result, everything begins to suffer.
Sticking to your competency requires a great deal of discipline, but it is the best way to grow your company. By sticking to your core, you will find the most profitability and enduring growth opportunities!
Financial Intelligence
Business leaders do not start their organization hoping to spend a lot of time doing accounting and finance, but rather doing what they do best, to fill an unmet need or provide a great new service. All leaders, however, need to have a high enough level of financial intelligence to know they are making the best possible decisions for their business. In addition, the more financial intelligence their employees have, the better the decisions of the organization will be as a whole.
Financial intelligence, although it is a recently defined term, has its roots back in 1954, when the management guru Peter Drucker wrote in his groundbreaking book, The Practice of Management, “[The worker] should know how his work relates to the work of the whole. He should know what he contributes to the enterprise…if he lacks information, he will lack both incentive and means to improve his performance… it is in the best interest of the organization that the worker has the information”. One piece of this information that Drucker was talking about is financial information. It is not enough that the employee has the information, but that the employee knows what it means and what to do with it.
Proponents of financial intelligence in organizations believe that if all employees understood financial information and how it is measured, then they would make decisions and take actions based upon this financial understanding to the benefit of the organization. If everyone knows the mission and goals of the organization and knows how the decisions they make help achieve these goals, the organization would be far better off.
Financial intelligence relates to the knowledge and skills of accounting and financial principles. It is not just theoretical knowledge, however, but requires practical real world application and experience. Overall financial intelligence requires understanding four key attributes:
- The Foundation: One must understand the basics of business measurement including the Income Statement, the Balance Sheet and the Cash Flow Statement. It also requires knowing the difference between cash and profit (there is a big difference), and why a balance sheet balances.
- The Art: Finance and accounting are both art and science. The two disciplines rely on estimates, assumptions, and rules to accomplish the end result. Financial intelligence ensures that one can identify where assumptions have been applied to the numbers and how applying different assumptions can lead to different conclusions. Understanding the assumptions behind a budget or forecast is critical to helping you make adjustments to your business when things don’t turn out the way you thought.
- Analysis: Financial intelligence means you know how to analyze the numbers to gain a deeper understanding of their meaning. This includes the ability to calculate surpluses, leverage, liquidity and various efficiency ratios and key indicators. When you understand the factors that make a program generate healthy surpluses, and how that factors into the overall success of your organization, you make better strategic decisions.
- The Big picture: Financial intelligence means you can understand your nonprofit business’s financial results in the context of the big picture: the overall economy, the competitive environment (other nonprofits and for-profit companies), regulations, and changing client needs.
Business leaders, managers, and employees in general who understand these principles and the effects of their decisions on the organization, will provide a competitive advantage to their organization.
5 Top Reasons Companies Fail…
| - Don’t Fall Prey to Any of These
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| Companies fail for lots of reasons, but financial mismanagement generally tops the list. Here are five of my favorite reasons why firms bite the dust – based on many years in the trenches helping companies beat the odds.
1. Revenue – or rather quality of revenue. Many entrepreneurs – if not most – have a sales background, and they do what they do best – sell! I have seen many great sales tracking processes, incentive schemes, CRM systems and rosy projections. What I often don’t see are client gross profitability models, incentive packages that reward profitability and collectability, and concern about concentration of clients. When it comes time to value your company – make sure you have revenue quality. 2. Failure to Measure Gross Profit. Many small companies fail to distinguish between overhead costs and cost of sales. Cost of sales are those costs that are needed to make a sale: cost of product, cost of service delivery, payroll for service fulfillment. Overhead are costs that would be incurred whether you made zero sales or not: rent, admin, office costs. Failing to distinguish these costs properly means you have no idea how you are doing relative to peers, and have no way to control overhead or maximize profitability. 3. Lack of Costing Data. Many companies fail to develop metrics that can tell them the cost to deliver a product or service per unit. When you pin down your cost of service delivery, you can start to find ways to reduce or transfer costs and improve margins. it can be very enlightening when you find that revenue per unit does not come close to covering costs. 4. Poor or No Forecast. Unless you update your plan continually you cannot know where you are going. You have to forecast cash and revenue growth in order to plan for credit needs. Forecasting is essential if you want to convince buyers that you know what you are doing. 5. Forgetting the 80/20 rule. This well-known rule says that 80% of the dollars come from 20% of the transactions. Also 80% of your problems likely arise from 20% of clients. Once a month make a habit of reviewing your client list, your product or service list and your customer service issues list. Can you eliminate some of those bottom feeders, or put them on auto-pilot? It will make life easier and help put more focus on the real drivers of your business.
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What Can a Part Time CFO Do for You?
A CFO or Chief Financial Officer is the person on your executive team who sole purpose is to increase cash flow, improve profits and help in improving the bottom line. The difference between a CFO and part-time CFO is only the hours. Unfortunately, many companies who have a need for a skilled CFO do not have the funding to actually hire one. Another senior officer on the payroll might just be a bit too much. In these cases, they might bring on a CFO temporarily to get them running in the right direction and teach them how to keep it up.
The main responsibilities that are performed by a part-time CFO include overseeing all of the company’s financial and accounting practices. This can include such jobs as preparing the budgets, preparing timely and accurate financial statements or even being the long-term trusted business advisor for the CEO. It includes developing systems and tools to give the CEO of the company vital information about the finances as well as give recommendations on the operations of the company and strategies. A CFO will also oversee the budget planning and put into motion any strategic plans for managing the company’s costs. Sometimes it requires a specialist to really look at the business functions and make authoritative, educated decisions.
Some of the other duties include taking care of the cash flow of the company, and making predictions on where those profits will go, or where they will need to go. They must also optimize and maintain good relations with any banks they do business with. The part-time Executive will also take on the responsibility of mentoring your designated staff so that the procedure setup by them will be carried out properly; allowing the CFO to leave the business in your hands.
Many companies are taking the option of hiring part-time to help solve their money woes. Very often, this simple measure can turn a company’s financial standing right around and set them on a far more profitable path. The cost that the company will pay for a part time CFO will be significantly lower than hiring a full-time financial professional that they would have to offer benefits to as well as other factors that need to be taken care of when you hire an employee.
Getting Cash from Your Bank – The 5 C’s of Credit
One of the most common questions among small business owners seeking financing: “What will the bank be looking for from me and my business?” While every bank has its own unique criteria, many use some variation of “the five C’s of credit” when making credit decisions. Broadly speaking, they are:
- Character
- Cash Flow
- Collateral
- Capitalization, and
- Conditions
Let’s take a look at each of these ingredients and how they may impact your funding request. Review each category and see how you stack up.
Character — Your willingness to pay back your loan
What is the character of the management of the company? What is your payment history and patterns in other loans you have taken? What is management’s reputation in the industry and the community? Bankers want to lend their money with those who have impeccable credentials and references. The way you treat your employees and customers, the way you take responsibility, your timeliness in fulfilling your obligations — these are all part of the character question.
This is really about you and your personal leadership. How you conduct both your business and personal life gives the lender a clue about how you are likely to handle leadership as a CEO. It’s a banker’s responsibility to look at the downside of making a loan. Your character immediately comes into play if there is a business crisis, for example. As small business owners, our personal stamp on everything that affects our companies. Since the bank may not know you, your credit score tells the lender how you will pay your business loan. Many times, banks do not even differentiate between us and our businesses. A poor personal credit score is enough information for a lender to outright decline a business loan. In a commercial lender’s eyes, there is no differentiation between handling personal obligations or business obligations. They are one and the same.
Cash Flow— Your capacity to pay back your loan
What is your company’s borrowing history and track record of repayment? How much debt can your company handle? Will you be able to honor the obligation and repay the debt? There are numerous financial benchmarks, such as debt and liquidity ratios, that investors evaluate before advancing funds. Become familiar with the expected pattern in your industry. Some industries can take a higher debt load; others may operate with less liquidity. As a conservative guideline, you should have $2 of income (business and personal) for every $1 of debt.
Collateral — How lenders get paid if the business fails
While cash flow will nearly always be the primary source of repayment of a loan, bankers look at what they call the secondary source of repayment. Collateral represents assets that the company pledges as an alternate repayment source for the loan. Most collateral is in the form of hard assets, such as real estate and office or manufacturing equipment. Alternatively, your accounts receivable and inventory can be pledged as collateral. Generally, lenders will want a 1:1 ratio, or a $1 of collateral for every $1 you borrow. Bankers typically discount an asset and lend on that basis. So for every $1 of collateral the bank will lend anywhere from 70% to 85% of the value depending on whether it is fair market value or liquidation value.
The collateral issue is a bigger challenge for service businesses, as they have fewer hard assets to pledge. Until your business is proven, you’re nearly always going to pledge collateral. If it doesn’t come from your business, the bank will look to your personal assets. This clearly has its risks — you don’t want to be in a situation where you can lose your house because a business loan has turned sour. If you want to be borrowing from banks or other lenders, you need to think long and hard about how you’ll handle this collateral question.
Capitalization — How much money have you put into the business?
How well-capitalized is your company? How much money have you invested in the businessyou’re your business has grown, have you reinvested the profits, or paid yourself a bigger salary? Investors often want to see that you have a financial commitment and that you have put yourself at risk in the company. Both your company’s financial statements and your personal credit are keys to the capital question. If the company is operating with a negative net worth, for example, will you be prepared to add more of your own money? How far will your personal resources support both you and the business as it is growing?
Conditions — SWOT: What are the strengths, Weaknesses, Opportunities, and Threats that affect your business?
What are the current economic conditions and how is your company affected? If your business is sensitive to economic downturns, for example, the bank wants a comfort level that you’re managing productivity and expenses. What are the trends for your industry, and how does your company fit within them? Are there any economic or political hot potatoes that could negatively impact the growth of your business? (I wrote at length on SWOT analysis in my January blog, which you can find at: http://www.edwardalloncfo.com/category/budgets-strategic-plans/.)
Keep in mind that in evaluating the five C’s of credit, investors don’t give equal weight to each area. Lenders are cautious, and one weak area could offset all the other strengths you show. For example, if your industry is sensitive to economic swings, your company may have difficulty getting a loan during an economic downturn — even if all other factors are strong. And if you’re not perceived as a person of character and integrity, there’s little likelihood you’ll receive a loan, no matter how good your financial statements may be. As you can see, lenders evaluate your company as a total package, which is often more than the sum of the parts. The biggest element, however, will always be you.
5 Common Small Business Challenges
| In working with small growing entrepreneurial businesses, I have discovered several common financial related issues with which they struggle. When I first start working with these businesses, most if not all of these issues exist. All of them are critical to their success in managing and growing their businesses. The good news is that with time and focus they can be rectified. In no particular order, here are 5 that I see most:
1. Lack of Timely and Accurate Financial Statements
In today’s business environment, decisions are made at a fast pace. Information is readily available via the Internet, yet internal financial information to improve the decision-making process is sadly deficient. Most business decisions have financial implications, and without this basic financial information, it may be a shot in the dark. Many times the financial statements are put in a drawer and never reviewed because the information is too old (not timely), the business owner doesn’t believe the information is correct (not accurate) or the financial statements support the preparation of the income tax return, not running the business (not operational). They usually only become important when the business owner needs to meet with the bank. 2. No Cash Management As we all know from operating a business, cash is king! It is the common denominator for all businesses NO CASH = NO BUSINESS. Other than the current cash balance (most of the time determined by looking at the bank’s balance) most small businesses don’t manage their cash. Cash management includes understanding your business’s “operating cycle” (i.e. cash to cash cycle). To improve your “operating cycle” it is imperative you understand what it means, how to calculate it, and what influences it before you can improve it. Many times I will ask “what do you expect your cash balance to be in 6 months?” Most of the time they are fighting cash flow problems today and can’t think about the future past this week. Managing cash flow will provide a real sense of control over the business. 3. Poor Pricing Management
Setting the price of our products or services will drive revenues and just as importantly the “gross margin” for the business. Unfortunately, not enough time and attention is provided to this aspect of business. In working with small business owners, I find many have not revised their “pricing formulas” for some time, while others don’t really know their underlying costs to derive a sales price that provides profit. Many products are market driven because of competition, so it is imperative to know not only the direct costs but all costs necessary to produce a profit. Gross margin analysis by product line, products or customer is critical for small businesses. 4. Lack of Systems & Processes
Processes, whether documented or not, exist in all businesses. It is the way we perform the work necessary to produce our products or services. In most small businesses, the underlying processes to accomplish the work are rarely documented or reviewed as a whole (i.e. system). Developing efficient and effective systems and processes generally reduce costs and/or improve productivity. In businesses where there is a high turnover of people, documented processes are critical for training to ensure employees achieve higher productivity quicker. 5. Minding and Grinding Not Finding
Jerry Mills, founder and CEO of B2B CFO®, developed a simplistic organizational model for small businesses. He identified the 3 roles in small business as Finders, Minders and Grinders. Grinders represent the employees whose focus is about today. They generally work in the production side of the business. Most Finders start as Grinders. The Minders live in the past; their work is in the administrative, accounting, customer service or warranty departments. Minders are just as critical as Grinders to the success of the company and must be led. All Finders live in the future. They are the visionaries, innovators, and relationship builders. They are the passion and the drive for the business to grow and succeed. The entrepreneur is the Finder and must stay in the Finding role. Unfortunately, as businesses grow the Finder gets pulled into the company and works in Minding and Grinding activities. Without a change back to the Finding role, the entrepreneur/small business owner severely limits the business’s ability to grow. In working with small business clients, they almost always identify with this organizational model. As I mentioned at the beginning of this piece, these challenges for the small business owner can be corrected. Most of them are fundamental changes. As with most challenges and the related changes, awareness is the first step. . |
Do You Want to Make Your Annual Budget More Effective?
| Think S.W.O.T. and 10 Level Analysis |
It’s that time of year again! It’s time to start thinking about 2011. Are you one of those people who cringe at the thought of the annual business planning process? Love it or hate it, this process is a key ingredient for success. I’d like to suggest two tools that might make your annual planning process more effective:
S.W.O.T. Analysis All good annual plans start with some derivation of a S.W.O.T. Analysis. What is a S.W.O.T. analysis? It is simply a brainstorming and prioritizing of your company’s Strengths, Weaknesses, Opportunities, and Threats. Let’s take a look at these more closely: Strengths consist of all of the things your company does best. Some people call these your core competencies. These might be the things that give you a competitive advantage in your market or industry. For a consumer products company it might be how you manage your brands. For a manufacturer, it might be your outstanding quality or your efficient production process. For a service organization it might be your long established relationships. Whatever it is that your company does best, write it down. The goal of listing out your strengths is to identify your core competencies so that your plan for next year will include strategies on how to leverage your strengths to grow sales and market share. Weaknesses include all of the things you don’t do well. We all know what they are. It may be an antiquated ERP system. It may be a manager in over his/her head. It may be persistent quality issues. It may be lack of robust processes. It may be untimely and inaccurate financial statements. Other common weaknesses include poor customer service, out of control spending, poor vendor quality, poor internal communication, etc. The goal of listing out your weaknesses is to identify the behaviors and events that inhibit your firm’s success so that your plan for next year will include strategies to eliminate or reduce these weaknesses in order to improve the effectiveness and results of your business. Opportunities include all of the changes that you foresee taking place in your market or industry that will result in potential new business for your company. These could be internally generated opportunities (like new products, or new technologies) or externally generated opportunities (like new markets for existing products, or new customers). The point of identifying opportunities is to hone in on where your firm has growth potential and thereby identify areas of the business to dedicate resources in order to capitalize on that potential growth. This could mean hiring more people, or investing in capital equipment, or investing in research and development. Threats relate to all of those things, internal and external, that can hinder your success or disrupt your business model. Examples of threats could include things like a potential work stoppage if your union contract expires next year, new competitors entering your market, new disruptive technology introduced by a competitor (like the iPad or iPhone), changes in governmental regulations that could increase operating costs (like environmental or tax law impacts), or expected price increases for raw materials (like oil or steel). The goal of identifying threats is to make sure your plan for next year is aware of these potential threats and you’ve included measures to minimize the negative impact these things could have on your business and strategic direction. So, before you “crunch the numbers”, make sure you go through your S.W.O.T. Analysis. Going through this thought process will make your numbers more meaningful and will dramatically increase your chances of success next year. Let’s assume now that you’ve done your SWOT Analysis and crunched your numbers and have in front of you a monthly Income Statement, Balance Sheet, and Cash Flow projection for 2011. Congratulations! You are now 2/3 of the way completed. You may be asking yourself, “Why am I not done? I’ve done the strategic planning and crunched the numbers. What else is there?” If you’ve missed something in your S.W.O.T. or other changes occur in the marketplace that you could not have possibly seen at the time of your annual budget, I’d like to suggest that you also do an analysis that gives you a road map to change your plan on the fly. That analysis is called a 10 Level. 10 Level Analysis is a tool that can be used with the annual budget to identify adjustments that need to take place if your sales volumes differ significantly from plan. This analysis looks like your budgeted annual income statement with 11 columns. The sixth column contains your budgeted numbers for the year. The five columns to the left of the budget column reflect your annual Income Statement at volume levels below budget in 10% increments (-10%, -20%, -30%, -40% and -50%). In similar fashion, the five columns to the right of the budget column are your annual Income Statement at volumes higher than budget in 10% increments (+10%, +20%, +30%, +40%, +50%). It is extremely important to point out that this is not merely a mathematical exercise. The key to this tool is to identify your required adjustments (both up and down) to variable expenses for each 10% increment or decrement to sales. That means quantifying changes to staffing and spending, if applicable, for each 10% change in volume. In addition, if you are so fortunate to be in a situation next year where volumes are trending significantly higher than budget (in the +40% to +50% range), then you may also need to identify at what increments you will need to invest in capital equipment as those volumes may exceed your current open capacity. The end result of this 10 Level Analysis is that you have an action plan and road map for revisions to your annual plan when you have significant changes in your volume assumptions. You know what to do with staffing, you know what to do with variable spending, and you know what to do with equipment and capacity for each 10% change to your budgeted annual volumes. To summarize:
So, if you want to make your annual budget more meaningful, I’ve got two thoughts – S.W.O.T. and 10 Level. Good Luck! |
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