Things go wrong!
Run! Action! Quick decisions. Busy, busy, busy! Constantly moving forward (or so you think) at an unrelenting pace. Covert glances at cell phone during meetings. Use cell phone in car, texting in the car, tweeting in the car. Rush from meeting to meeting. Implement! EXECUTE! And never forget to be PASSIONATE.
The axe can fall suddenly. In many ways it’s better that way. But sometimes you’re aware of the axe being sharpened. And that sharpening process can be pretty grating on the nerves. I’m talking here about losing your job. Not because you fouled up, but because of corporate downsizing or re-engineering, as they like to call it.
We all hate paying tax. There’s the old cry of “no taxation without representation” and many South Africans perceive a total lack of value in return for taxes paid. There’s no real protection from crime, and government-run services are steadily deteriorating. But even if value was received, many people wouldn’t pay tax anyway because they’re crooks.
The tax authorities do not have goon squads running around trying to catch tax invaders. Why not? Well, when the evader dies, there are two possible scenarios. The person could have no assets, in which case the tax authorities lose interest because there is nothing to collect. But what happens if he accumulated wealth? His estate has to be wound up. The final stage of this process is the inspection of his file by the Master of the Supreme Court. But the file has to go there via the Receiver of Revenue’s office, its at this stage that the tax people say ‘we have no record of this person, Mrs Widow please provide us with copies of your husbands tax returns”. “Oh he never submitted any, not paid any tax”.’ Well we calculate that for him to have an estate worth R1 million, and for you to have lived for the past 20 years, he would need to have made about R3 million. The tax on that would have been about R1 million, so we’ll have it. Sorry Mrs Widow”
So you could leave your family without any money when the taxman takes what’s due to him – plus of course the penalties which could be treble the tax you should have paid? Is it worth it?
Of course, the receiver doesn’t always wait for people to die. Some tax evaders’ stupidity helps a lot. You’ve probably read newspaper articles about a burglary at Mr Shopowners house, where R50 000 in cash and jewellery worth R30 000 was stolen. You can bet that somebody at the tax office is going to have that tax file out and look to see whether that kind of loss is in keeping with the income that has been declared in the past. People who have businesses with cash taking are very tempted to ‘steal’ from themselves and only declare part of their income. A business owner once told me, “I bank all my cash except the R100 notes, those are mine”.
And then there are the people whose lifestyles do not gel with the income they declare. If this comes to the attention of the tax authorities, then difficult to answer questions will be asked. Assets must have been acquired through income. If you claim to have won at Sun City too often this won’t help because you will then be classified as a professional gambler – and your winnings will be taxable.
If you’re one of those people who have been, ah, shall we say, out of touch with the tax authorities, what can you do? If you’ve been earning a salary and have had tax deducted from every payment received then the best thing to do is to make sure that you have all the IRP5’s, retirement annuity details and so on for all the years for which returns are outstanding. Then go down to your local tax office and ask for help. Pleasantly. And you’ll be pleasantly surprised. One can get more friendly and efficient assistance, from the tax office than the Post Office or any other government department.
If you go to them, rather then them catching up with you, penalties can be kept to a minimum and their assistance is free. If you’ve been in business and have neither submitted tax returns nor paid tax, then you need to go to an accountant who specialises in your ‘size’ of tax return. If you’re a small operation you’ll be better off going to a smaller accounting practice rather than a big one. You need empathy and lower operating costs.
You also need someone senior dealing with your return, which is not always the case when the little guy goes to the big accounting firm. What it costs depends on time. Hand over muddled cartons of paper and you have to pay for it to be sorted before it can be processed.
Coming clean takes some courage. But no matter how much people may hate paying tax, they always sleep a little better when they have no outstanding business with the taxman.
One of the biggest challenges facing South African managers is that of changing their locus of control. More jargon you might say. Well yes, but it is nevertheless an interesting concept and one which is relevant to our local situation. If you have an external locus of control, you see everything that happens to you as the fault of the government, the market, the economy, management, the unions – in fact anyone but yourself. On the other hand, people who have an internal locus of control operate from a perspective that it is they alone who will determine the outcome of their efforts. There is of course a continuum between the two extremes and while most individuals will recognize themselves as being somewhere along that line, there is a tendency for the ‘external locus’ end of the spectrum to be somewhat oversubscribed.
Closely linked to the above concept of locus of control and blame, is the issue of taking credit for positive outcomes in which you really had no hand. I refer here to the silence of managers when their companies do exceptionally well, not due to their efforts, but probably as a result of a weak Rand. The outstanding success of exporters when the Rand was weak in the past is a case in point. When the Rand strengthens, however, and their results are not looking quite as good, they loudly proclaim that it is the due to the Rand’s strength. I remember a captain of industry once doing just that on a television programme – while elsewhere, at the same time, the Governor of the Reserve Bank was saying that exporters should stop whining about the strong rand and focus on their productivity in order to be competitive – he made a good point. In blaming other people or circumstances we lose sight of the core issues. South African business has a productivity problem. A weak rand does help exports in the short term, but what of imported input costs?
Let’s look at this issue of blame from another angle. Many individuals blame their lack of advancement (or loss of jobs) on affirmative action – forgetting, of course, that they may well be in the positions they hold because of the very real, yet at that time unnamed, affirmative action policy of the former regime. The reality is that all South Africans have to some extent or other been affected, either negatively or positively, by some form of affirmative action. Those who complain about the unfairness of their employment situation tend to lay the blame on external factors. Perhaps they would do better to focus on internal factors such as their not having kept their skills or knowledge current or a failure on their part to adapt to a diverse working environment.
Relationship problems provide yet another prime setting for the laying of blame. Most breakdowns in organisational effectiveness are caused by problems between people – problems that stem either from organisational structures that inhibit the flow of information or undermine the power of managers in the structure; or personality clashes. Here too an external locus of control plays a major role. Those who do not see a problem with the structure will blame the people, and those who do not see a problem with the people, will blame the structure. Truth is, organisational structures consist of people. The effective manager will cut through the bureaucracy and solve the people problems by negotiation. Remember, in life you don’t get what you deserve, you get what you negotiate.
And when all else fails, blame the economy, the government or even big business. Yet at this time there are businesses in Argentina and Brazil …….Venezuela and Zimbabwe that are operating profitably. Why? Because the management of those successful companies are not wasting time looking for where to lay the blame for poor profits or losses and, let’s face it, there is a long list of things or people we can blame for most things. Rather, they are looking for opportunities – breakdowns in service delivery and shortages are not viewed as problems but as sources of business.
How do we get past this culture of blame? What is needed is managers who behave more like entrepreneurs. Entrepreneurs are good at opportunity identification. They are strong negotiators, good at selling (themselves and their ideas) and topping the list, they believe in themselves – they have an internal locus of control.
Many organisations express the desire to have their managers behave more ‘entrepreneurially’. With entrepreneurship being more of an art that a science, this is not an easy objective to meet. You can’t lay it down in policies; you can’t really achieve it through training or education. What is needed is a climate that fosters entrepreneurial behaviour; a climate in which managers are encouraged to seek opportunities, to negotiate solutions and to believe in themselves. Setting limits is not conducive to entrepreneurial behaviour so managers need to know that successful entrepreneurs don’t take risks – they manage them. Finally, and perhaps most importantly, they need to take responsibility for their actions – they need to operate from an internal locus of control.
Life is too short for the blame game.
The things I outline below all relate to what is called Working Capital Management. Don’t worry too much about what exactly that means. The important thing to remember is that it is not the sole domain of the accountants. Just about every non-financial member of the staff of a business can play a positive role in Working Capital Management – or cause problems.
One critical purpose of Working Capital Management is to ensure liquidity – remember cash-flow is the oxygen of a business, if cash stops flowing in the business dies. Another aspect of Working Capital Management is that if working capital is optimised it makes the business more profitable.
Sales and getting the cash in
There is an old adage, “a sale is not a sale until the money is in the bank”. So what ensures that you get the money in the bank?
An ideal inventory level would be zero. Businesses keep inventory for two reasons. 1. Speculative – they anticipate price increases. 2. Strategic reasons – they don’t have reliable suppliers and feel they have to keep a buffer stock. There may also be the matter of economic order sizes – they import container loads that only get used up over a period of months.
There are costs and risks a associated with holding inventory. These are called ‘holding costs’ – sometimes referred to as ‘hidden costs’ – but they are very real. Some can be quantified and some are risks that have to be considered. Consider the following:
These additional costs could negate the positive effect of the increased margins due to having obtained a lower price for bulk purchases from your suppliers (holding costs are sometimes referred to as ‘carrying costs’). Some of the factors mentioned above are quantifiable costs, and some are risks, such as in the case of the potential for obsolescence.
Many people play a role in inventory management, those preparing sales forecasts, the purchasing staff, and stores managers. You need to keep an eye on all of them. Once when I was working as an accountant at a factory I took a walk to see the store’s manager who was also responsible for making certain purchases from a supplier in Germany. I had difficulty walking through to his office because of newly arrive pallets of chemicals crowding the aisle. I asked about the large size of the shipment and he replied, “There is so much work involved in ordering from Germany that I ordered a year’s supply”. I was speechless.
The management of the above items, accounts receivable and inventory plays a major role in ensuring liquidity.
It is not uncommon for businesses of all sizes to experience difficulties in getting payments from some customers.
There could be a number of reasons for this:
Regarding 1. above it is important to ensure that all debtor related activities i.e. prompt invoicing, issuing of credit notes and statements are extremely well run.
If a customer is experiencing financial difficulties this could be a big problem. A large amount not received could have the effect of crippling your cash flow. If this results in not being able to make payments your business could end up getting a bad name. Your customers will get to hear about this. If the products you sell require the honouring of warranties or ongoing support you may lose sales.
It may also be that the amount you do not receive has the effect of putting you out of business.
Choose your customers carefully. Don’t just chase sales. Remember the old saying, “A sale is not a sale until you have the money in your bank.” Relying on reports from credit bureaus is not enough. If the amount of any sale is large then make enquiries of your own. Visit the customer to get a feel for the business. Speak to people in your network and find out if they know of anything negative about the customer.
Be the Wheel that Squeaks the Loudest.
People are often reluctant to ask for money is due to them because they fear that annoying the customer will lose them future sales to the customer. Ask yourself whether a customer who is a potential threat to your cash flow (or your entire business) is worth having.
Will you lose business? Not necessarily. I was once assisting a client prepare a cash flow forecast (this was something they had never done before - which explained why they had not anticipated the cash flow problems they were experiencing) and needed information about the timing of payments. I gave a list of the amounts owing to the owner asking him to indicate with an ‘A’ those creditors that absolutely had to be paid by the month end, to indicate with a ‘B’ those that could be delayed for a week and with a ‘C’ those that could safely be rolled for a month. When examining the annotated list I was surprised to see that he had marked a very large amount with an ‘A’. I was surprised because the product being bought was a commodity that was available for a number of suppliers and so I felt that their payment could be delayed. When I queried this with someone in the creditors department that person smiled and told me that on the 25th of every a woman from that business called the owner and told him that a driver was on his way to collect a cheque. I must have looked puzzled because I was told, “He’s scared of her.” She was the ‘wheel that squeaked the loudest’ but he kept buying from them.
Don’t prejudice the survival of your business for any of the reasons I have stated above.
Assets & Profits are like food to humans. We can live without food for a long time. We can’t live without oxygen. Cash flow is the oxygen of a business. It stops, the business dies.
Introducing the profit triangle
The easiest way in which to gain an understanding of how profit is made in a business is to simplify things by examining three interrelated things: Margins, Volumes and Expenses, and to gain an understanding of how they relate to one another in causing profit.
Before proceeding with this explanation of the profit triangle let me explain what is meant by the margins, volumes, expenses and profit shown in the above diagram.
In the context that I will be discussing margins in this article, a margin is the difference between the selling price and the cost price of the units being sold.
Volumes are the quantities (in numbers of units) of the things that are sold and the units could have any number of descriptions depending on the type of business and products being sold e.g. kilograms, tons, metres, litres, hours, days and so on.
Expenses are those costs that it takes to run the business and which remain relatively unchanged in a particular financial period. Examples are rent, salaries, insurance etc.
When I facilitate sessions with groups of managers regarding what is needed to improve profits in their companies I ask them for specific ideas on how they think they can improve profits. I emphasise the need for them to come up with specific ideas. This is sometimes difficult as I often hear “Increase volumes” or “cut overheads”. These are not specific. When I ask how they will increase volumes they are often at a loss. I also ask which overheads and they also come up with non-specific ideas. To me a specific action is one that can be given as a clear instruction.
What is needed is to look at each part of the triangle and to see what can be changed to increase profits.
Let’s start with margins. There are two things that can be changed. The selling price or the inbound cost of the product. Or both.
Selling Prices. The common wisdom is that if selling prices are increased sales will decrease. This is not necessarily correct. A survey conducted (there were responses from 2,463 companies) showed that if they increased their selling prices by 1% their profits (on average) would be increased by 11.1%. This is clearly a desirable outcome. So how do we increase selling prices?
When attempting to make sales salespeople often focus on the great features their product has. People don’t buy features – they buy solutions to problems. Salespeople need to know enough about a customer’s problems to know what they cost the customer. Their explanation, of how the product or service can solve the problem at a lower cost than the cost of the problem, will make the customer less sensitive to the price. In addition, demonstrating a knowledge of the customers’ business will help establish a relationship with the customer. There are far too many canned presentations being used.
It is extremely difficult to buy from certain companies. If, for example, Telkom could reduce the psychological pain in doing business with them they would be able to charge that 1% more.
Also remember that excellent service in providing the product and ongoing support (where applicable) will also reduce a customer’s focus on price alone. There is also the factor of higher prices being an indication of quality.
Reducing the cost of inbound products. Here the usual way is to make bulk purchases. But this can be problematic. Buying more does not mean that more will be sold. The ‘hidden’ or holding costs need to be considered.
Interest. If a company that is in a borrowed situation it is, in effect, paying interest on unsold stock. If the company does not borrow money it is losing the opportunity to invest surplus funds and earn a return on them.
Obsolescence. When stock is around for longer there is the risk that the product may go out of fashion and may not be sold. There is also the risk of damage when being stored for lengthy periods. And the increased risk of theft.
An additional factor to be considered when buying in bulk is that prices for that product may go down. If bulk purchases have been made it may be that competing companies who have not bought in bulk now enjoy lower input costs putting the bulk buyer at a disadvantage.
Increasing Sales Volumes. Sales volumes don’t just increase on their own. Companies may have to spend money on additional training, additional sales incentives, additional advertising and discounts (never engage in discounting – it comes to be permanently expected by customers). All of these cost money – and unless the total of the additional margins far exceeds these costs this could end up being a waste of time. Also remember that ‘buying’ market share does not always increase profits.
Cutting Overheads. It always amazes me that this is often the first target in most companies. In the survey I referred to above the benefit of a 1% reduction for the companies surveyed gave them, on average, an increase of 2.3% in profits.
Headcount is usually the first target. In 2008 large South African commercial bank made major cuts to the number of managers it employed. Those were bad times for most businesses. Now that bank is doing very well. I wonder whether the savings made after the cutbacks will be outweighed by recruitment costs, training costs of building up their management team again.
Sometimes companies will take away small benefits their staff value. I’m not suggesting that companies should not ensure that every Rand that they spend is well spent – but if you annoy your staff they’ll get you back.
Positive ways to reduce overheads should be explored.
All managers and staff should be equipped to understand they Profit Triangle and encouraged to constantly review operations to seek out opportunities to improve profits.
People generally don’t understand costs. For example, many will travel long distances to take advantage of a ‘special’ at some or other ‘hyper’ store. They forget that the running costs of their vehicle can exceed the cost of the ‘bargain’ they seek.
Some years back I heard a listener complaining that an electrician who had spent ten minutes at their house had charged R300. This was followed by many other calls in the same vein. The talk show host then did some multiplication and announced that at these kind of fees an electrician was earning more than a brain surgeon.
This was of course rubbish. When the electrician spends 10 minutes at a customer’s house what needs to be recovered in the fee is the running cost of the vehicle, travelling time, rental on premises, an accountant, advertising and so on. Plus customers are paying for expertise. People could, of course, do it themselves. And electrocute themselves or burn their houses down.
In a business the lack of understanding of costs can have fatal consequences – for the business.
The factory manager of a tile manufacturer in South Africa was given costing information on the tiles being produced. The cost of each tile included the cost of raw material plus each tiles share of the company overheads. He noticed that when production increased the cost per tile came down – and when production decreased the cost per tile went up. As he was judged on the cost per tile figure he took action.
This factory manager was a really good production engineer. He set about streamlining production methods, coaching supervisors, buying raw materials in bulk to reduce input costs and making several other innovations. He received a pat on the back.
It took a few months for a decline in the company’s profits to emerge.
What the factory manager had ignored (because he did not fully understand costs) was the following.
He had not taken into account sales forecasts. As a result the stocks of unsold tiles built up. The reduction in profits was caused by a dramatic increase in holding costs.
Interest. If a company that is in a borrowed situation it is, in effect, paying interest on unsold stock. If the company does not borrow money it is losing the opportunity to invest surplus funds and earn a return on them.
Obsolescence. When stock is around for longer there is the risk that the product may go out of fashion and may not be sold. This applied to some types of tiles this company manufactured. There is also the risk of damage when being stored for lengthy periods. And the increased risk of theft.
Another area where not understanding costs can be detrimental to profits is in calculating the charge out rates for staff. Managers generally know that people cost more than the salary they are paid. After all, one must add the cost of the company’s contributions to medical aids, pension funds and any other so-called fringe benefits. When I ask groups of managers how they arrive at charge-out rates I get a range of replies. “We add 25%” or “40%” and other percentages. When I ask why I get told, “Because that’s what we’ve been told to do.”
The percentage they’re using may or may not be correct. Consider the following extract from the notes I use on my Finance for Non-Financial Managers workshops:
Most people think that the amount that is paid for something is its cost. It may be in some cases. But usually it is not. Let's take the case of what we pay for labour. Consider the question, "If we pay someone R10 per hour what do they cost the business per hour?" The immediate response is often, "R10". Then after thinking about it people remember things called company contributions: things which the business pays in addition to the wages paid such as the businesses contribution to employee’s pension funds, medical-aid schemes and so on. Yes, these do add to the cost of employing someone but they are only part of the cost. The real cost per hour of an employee will depend on how many hours of work we get from the person while they are at work.
This is probably best illustrated by way of an example. Let's stay with our employee being paid R10 per hour for 40 hours a week.
Example of a cost per hour calculation:
R10 per hour x 40 hrs per week x 52 weeks R20 800
Contribution to pension fund - say 7% of R20 800 1 456
Contribution to medical aid - say R200 per month 2 400
Other payments (Unemployment insurance etc.) say 1 000
There could be other payments such as training
costs, protective clothing but this is enough
to illustrate the point.
Total of annual payments R25 656
Available hours 40 hrs x 52 weeks 2080
Annual leave 40hrs x 3 weeks 120
Time off sick 8hrs x 5 days 40
Paid public holidays 8hrs x 10 days 80
This totals 240 hours
But every day, for a variety of reasons, people are not working. This could include bad management, waiting for material, waiting to be given work to do, or loafing. The 240 hours above amounts to six weeks. Let's assume that for the remaining 46 weeks or 230 working days 2 hours per day is lost. In surveys I have conducted I have been given figures ranging from 2 to 4 hours per day, but let's use two hours.
230 x 2 = 460
So in total we lose
Leaving us with (2080-700) 1380 hours worked in a year.
If we now take the total annual payment amount R25 656
and divide it by the hours worked in a year 1380
then we have a cost per hour of R18.59
The R10 per hour paid increases to R18.59 because of the businesses additional payments in respect of its contributions to employee benefits and the hours paid for but not worked. Naturally the employee benefits and hours lost will vary from business to business but the above example serves to illustrate the point about costs not necessarily being what they seem to be at first glance. The figure of R18.59 is only the direct cost associated with our person earning R10 per hour and does not include any indirect costs applicable to that person and there are many; we have to pay people to calculate his wages, there is the cost of the people who manage him and his fellow workers, the cost of the canteen where he eats and so on, and on.
It is therefore important for managers and business owners to fully understand how to calculate costs. Not being able to do this could have disastrous consequences.
I demystify financials for groups of managers across all of Africa