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Value Adding News - March 2009

Welcome to Maxell Consulting's newsletter - Value Adding News.

The newsletter is designed to help businesses increase their value, make their business more attractive or have greater confidence about the decisions they are making about the future of their business.

In this month's issue

How to preserve value by preserving cash flow - Part II?

When it comes to the value of a business one of the key determining factors is the cash flow of the business.  Typically buyers look at the cash flows the BUYER expects in the future.  They estimate the future cash flows based on past performance.  However some alarming survey findings where reported by CPA during August 2008 about how small businesses manage their cash flow:

  • 41% of small businesses surveyed NEVER prepare cash flow forecasts.
  • 70% of small businesses surveyed DO NOT prepare quarterly financial statements.
So how can you preserve the value of your business during hard economic times if you don't even know what your cash flow is doing and what is cash flow anyway?

So what things should a business do to preserve cash flow?
They key activities to preserve cash flow can be broken into four categories:
  1. Increase gross profits.
  2. Reduce working capital.
  3. Reduce debt
  4. Cut unnecessary investment
  5. Measure and report cash flow regularly
Last month we looked at what can be done to grow gross profits.  This month we cover ideas to reduce working capital and debt.

Reduce Working Capital
Working capital is basically the available funds you use to operate the business.  It is typically measured as current assets less current liabilities.  It includes both accounts receivable and accounts payable, inventory, cash reserves and sources of immediate funds such as short term loans, credit cards and any overdraft.  Even service-based businesses need working capital to fund the time it takes to collect customer payments.

The more working capital you need to run your business effectively, the less cash you have available to invest in the business or use to pay owner's dividends.  An increasing trend in working capital requirements from one period to another can indicate inefficiencies are creeping into the business and reducing your profitability.

Key points that help reduce your working capital include:
  1. Have terms that encourage early payment of invoices by your customers, such as discounts or credit for future purchases.  Even a well said "thank you for early payment" note builds customer loyalty.
  2. Try to offer customer payment terms that also match your supplier payment terms so you aren't financing the time between paying suppliers and collecting your cash.
  3. Regularly review slow moving items on your inventory and clear them out using special offers.
  4. Instigate a weekly report on stock levels and review your purchasing patterns to avoid over-stocking.
  5. Implement a review system to match future purchasing patterns with projected sales and reduce excess stock purchases.
  6. Minimise the extra costs involved in addressing customer complaints, product returns and warranty claims, through a focus on quality and customer service.
  7. Use regular payment options (such as weekly or fortnightly) for high-value items, where third parties make automatic deductions from customer accounts and pay you regularly.
  8. Use factoring finance to provide access to a portion of your invoices each month to smooth out the cash flow cycle.
  9. Set up an employee incentive program that eliminates waste and reduces costs.
  10. Implement a procedures and systems manual to ensure staff function consistently and lock in identified cost reductions and improvement opportunities.
Reduce Debt
The most effective way to reduce debt is to implement a structured plan of making payments each month against the principal as well as covering interest.  In the past many businesses assumed they could "roll over" debts once they feel due and so just focused on covering interest costs.  The current financial crisis has highlighted the risk of not reducing the principal, as many banks are now deciding reduce their risk exposure.

Key points to focus on when reducing your debt burden include:
  1. Only use short term debt to fund ongoing day to day operations, not purchase long term assets.
  2. Consolidate your loans with one provider and make sure your day to day cash requirements are funded from short term debt rather than long term loans.
  3. Sell off redundant assets or parts of your business and use the proceeds to reduce the principal of your debt (sometimes consolidating your business provides opportunities to sell off redundant assets).
  4. Sell some of your operating assets (such as vehicles and equipment) to a bank or finance company and lease them back.  Use the cash payments to reduce debt.
  5. Develop a monthly cash flow plan that includes payments to reduce the principal debt.
  6. Keep a regular track of debt levels and repayments and review the extent of your liabilities on a monthly basis.
Reducing your working capital requirements is not a "once off" fix you do  when the bank is screaming for payment.  It takes a disciplined approach at developing reporting and management systems to down and

The final two key activities that preserve cash flow shall be sent out as a special article in two weeks time.  Look out for the article and a special offer for newsletter subscribers only.

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How much value do you create in your business?

In most circumstances a business owner invests their own money (and some from others) in the knowledge (or sometimes faith) that they can increase the size of the investment.  They believe they can create value! 

But at what point does the business start to create value and when is it destroyed?  And much more importantly how do you use this knowledge to double the value of your business?

When is value created?
Put simply, you create value in a business when the return on invested capital is greater than the cost of that capital. 

It is basically calculated from:  (Net Profit Before Interest but After Tax) / Capital Employed

The term Capital Employed refers to all assets less non-interest bearing liabilities (such as accounts payable). 

If this percentage is greater than the cost of capital (both debt and equity) then your are creating value.

For example:
Your business is funded by a mortgage-secured debt and some of your own savings and the average cost of all capital is 15%.  Your net profit before interest but after tax is approximately $500,000 pa and your total capital employed is $2.5M.  Your Return on Invested Capital is then ($500,000 / $2,500,000) or 20%.

This means your business is creating more value (5% more value) than the cost of the investment.  But if your Return on Invested Capital is only 10%, then you are destroying value.

So how does this help to increase the value of your business?

  • Look at your options to increase the profits of the business without increasing the investment.  This often requires a focus on gross profits, cash flow and market attractiveness.
  • Reduce the investment in your business by consolidating and selling redundant assets.
  • Reduce the cost of your debt by consolidating loans.
Sign up for a free assessment to see how much value you are creating in your business.

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Companies In The News

Learn from companies in the news.

  • AMCOR & Rio Tinto:  During February AMCOR expressed public interest in the flexible aluminium based packaging business that Rio Tinto acquired from the Alcan acquisition a year earlier.  AMCOR is in the "box seat" to get the business at an attractive price both because of the current economic climate and the priority that Rio Tinto has in reducing debt. The lesson:  Timing is everything when acquiring a business - be prepared before you make an offer and know your target!
  • Sale of Swickers Queensland factories (ex Hans) to CMH Alliance:  Whilst Hans went into liquidation, the administrators have managed to sell the Swickers business as a going concern.  This is proof that whilst a business can demonstrate it has an ongoing viability and opportunities, it will remain attractive to other industry players and investors. Perhaps this sale should have been made before Hans went broke?  The lesson:  Be prepared to jettison assets early to avoid financial crisis and value is not destroyed completely until the business is no longer viable!
  • Brambles announced jobs cuts and reductions to excess pallets during February to prepare itself for a future recovery in demand: "When key customers and key markets return to growth ... provided we continue to win new business, we will be very well placed for the long term".  The lesson:  Be ready for growth - do it now not later!

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Latest Economic News

The economic news that may impact your business value.
  • Reduction in oil demand saw oil prices below $US40 per barrel for most of February.   This is welcome news for transport dependent companies as it helps to secure business value by preserving cash flow.
  • China GDP grew by 9% in 2008 compared with 13% the previous year and has recorded a consecutive six month decline in manufacturing activity.   However this may be the bottom according to CLSA Asia Pacific Markets.   China’s manufacturing sector accounts for over 40% of its economy, reflecting an overall direction in its economy.   Businesses that rely on Chinese activityt should make sure their forecasts reflect these trends when budgeting for future export sales.
  • Japan recorded its sixth straight month of falling new car sales in January 2009, with sales reaching its lowest level since February 1968.   It seems the Japanese auto market has been shrinking in recent years due to sluggish wages, high fuel costs and the wide availability of public transport.  This highlights the continuing loss in value for the Australian automotive parts manufacturing sector.

Quote of the Month

  • He that hath lost his credit is dead to the world. (George Herbert 1639)

Value Adding Ideas

  • Reducing debt is critical under the current economic climate.  Consolidate your loans into one arrangement to reduce interest expense and financing fees.  Sell off redundant assets or find ways to get better performance from your existing assets.  A lower debt level will increase profits but more importantly make your business more attractive to buyers and reduce your overall business risk.

Business Buying and Selling Trends - March 2009

  • February continued to be a quiet month for business sales, with the number of advertised businesses for sale in Melbourne newspapers continuing to average less than 100 per week.  Many business owners are now seeing a dramatic fall in orders and reduced profitability, and feel they will not get a good price when selling in this climate.
  • Much of the news for February has focused on business closures and cutbacks.  Big names such as Nylex and Midas Australia, Storm Financial have joined many smaller businesses such as Albury-based Drive Systems International and textiles manufacturer Melba Industries Pty Ltd.  Paperlinx has quietly announced the sale of part of its Australian Paper operations to Japanese paper maker Nippon Paper, and of course Pacific Brands took the award for the biggest PR blunder when it announced its employee cutbacks and future business strategy.
  • Whilst all this sounds like bad news for those wanting to build value in their business, it highlights the importance of planning ahead for your exit strategy and building in growth plans now that will boost the value of your business later when the timing is right to sell.
Contact Maxell Consulting to discuss more detailed information on the latest business trends and what they might mean for your business.

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Next Month's Newsletter

  • How consolidation can create value. 
  • Increase your business value by getting rid of customers.
If there is something you would like to find out about, let us know by sending us an email or by going to our Contact Us page and filling out the enquiry form.  We want to provide you with the information and help that you need.  We are only too happy to find out about what you want.

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