Oh Dear! Are You a Micromanager?

If you own and manage a one person business, you are, de facto, a micromanager. You have no choice; you make every decision and you manage every process. If, on the other hand, you are CEO of a FTSE100 Company, you can’t be a micromanager because you can’t possibly make every decision and can only manage a very small number of processes, albeit they are likely to be major ones.

In the case of the one person business, if you don’t micromanage, your business won’t function; so it won’t survive. In the case of the CEO of the FTSE100 Company, any attempt to micromanage will cause chaos and undermine your corporate structure. So in one set of circumstances, micromanagement is very positive and very necessary, whilst in the other it is very negative and seriously damaging.

So, at what point does the positive turn negative?

Before answering that question let’s just look at what we mean by micromanagement. You can no doubt find many different definitions but essentially it means: –

• Allocating tasks, monitoring them in minute detail, intervening with the processes and making all the associated decisions. As opposed to
• Delegating responsibilities, within defined parameters, to subordinates, who make their own decisions and are accountable for the outcomes.

As soon as a business involves more than one person, tasks start to be shared. If the people involved are of equal status – directors, partners etc. – agreement is reached about the sharing of both tasks and responsibilities. However, if staff are employed, they tend to be engaged to undertake tasks under close supervision. They are probably given very little responsibility and are unlikely to make many decisions without reference to the boss.

Initially this may work ok. However, as the business grows and the number of employees increases, the boss inevitably spends more and more time making decisions for his/her employees and monitoring their activities. That means spending less and less time driving the business forward. As a consequence, the momentum of the business starts to slow down and the boss becomes increasingly stressed, as he/she becomes the main constraint on progress.

To address this problem, most businesses start to develop some form of organisation structure, with departmental demarcations and key staff taking supervisory/managerial roles. To start with, this invariably relieves the pressure. However, the extent to which this continues to happen depends on whether the boss is still just delegating tasks or whether he/she starts to delegate real responsibilities in a meaningful way. When the boss is able to delegate responsibilities enabling him/her to focus on the more important aspects of the business, the business itself has a much better chance of developing, growing and building its net worth. But where the boss still wants to micromanage, the business is much more likely to struggle and stagnate.

There can’t be a precise answer to my earlier question of, “At what point does the positive become negative?” because no two businesses are exactly the same. However, most people’s ability to micromanage everything that goes on, within a business, and still perform their own essential duties is quite limited; and once the business employs more than a handful of people, micromanagement invariably becomes negative.

Despite this, many owners and directors of SMEs don’t delegate responsibilities effectively and become increasingly frustrated with the lack of progress that their businesses make, often blaming everyone except themselves for that lack of progress. So why can’t they delegate and why do they continue to be micromanagers?

The four favourite answers seem to be: –

• I can’t get the calibre of staff I need
• My staff can’t do things the way I do them
• My staff can’t do things as well as I do them
• I can’t trust my staff

So let me deal with each of these objections in turn.

I can’t get the calibre of staff I need. If that’s true, then it’s likely that you’re not paying enough to attract the right quality staff. But in my experience, that’s not usually the problem. More often than not, the key people, within the business, are more than capable of taking on much more responsibility and are eager to do so. With very few exceptions, where I’ve been able to persuade the boss to stand back and empower his key people, the positive effect on the business has been substantial. However, when key members of staff are not empowered there is a tendency for them to become demotivated and cynical; and once this happens you really do have a problem.

My staff can’t do things the way I do them. Frankly that tends to be good not bad. A business needs a diversity of ideas. If the key staff are all clones of the boss, the business will go nowhere. The boss may be the key driver but he/she doesn’t have a monopoly on ideas, doesn’t know all the answers, doesn’t always have the best approach to problem solving and is often wrong. If key employees are empowered, bosses are much better able to develop their own strengths, whilst ensuring that their weaknesses are offset by the skills and experience of their key people. Running a successful business is about teamwork; it’s not a solo act.

My staff can’t do things as well as I do. In some cases this may be right. The boss will have skills that his/her key staff don’t have. But there will be areas where key members of staff have more skill and experience or perhaps greater aptitude or perseverance than the boss. It’s important to recognise this and exploit it. Again, it’s back to the principle of diversity of skills and ideas being the basis of a successful team. Where there are shortcomings in skill sets, you need to develop them through structured training programmes.

I can’t trust my staff. In many respects this is the real objection. The other three are often excuses for what is, in reality, lack of trust. And to be fair, all too frequently I hear stories of small businesses that have been ripped off by a rogue employee or damaged in some other way, by an incompetent one. But this opens up the much bigger question of how you actually manage and control your business.

The trust issue may be about not trusting people to complete tasks properly or take decisions appropriately; equally, it may be about the honesty and integrity of employees. In practice, most people are reasonably honest; but, unfortunately, a small minority is not. However, regardless of honesty and integrity, it’s important that no one, within the team, behaves as a lone wolf, acts outside their jurisdiction, covers up mistakes, works within a self-constructed silo or behaves dishonestly in any way. So how do you reconcile all of this with delegating responsibilities and losing detailed control of what your staff do and how they spend their time?

The answer is that you manage your business in a completely different way. And to do this, you need good management information that tells you, on a regular basis, how each significant element of your business is performing. In conjunction with that, you need to set targets, so you can see how each part of the business is performing against expectations. The type and level of information will differ depending on the type of business, its size and complexity and the markets served; but it’s likely to include data about sales, production and/or service output, productivity, costs, inventories, cash and all other key activities within the business. Some of this data will come through the production of monthly management accounts, some will require your IT systems to be set up to produce it. Some information will be most useful on a monthly basis, some weekly and some daily. When you have this data, you can identify areas of over and under performance, trends in both the right and wrong directions and aberrations that don’t, on the face of it, make sense. Whenever you identify anything that appears to be going in the wrong direction or otherwise out of the ordinary, you dig deeper until you have answers. If necessary you then take remedial action; but its remedial action based on facts not on gut feel or guesswork. You’ll soon find that you’re learning far more about what’s going on in your business than you ever did before.

This management information shouldn’t be treated as just yours and available to no one else. Headline data needs to be available to all your key players and each key player should have more detailed information about their own individual areas of responsibility. You can then meet regularly with your key players, both on a one to one and as a group, to set new objectives, report back on current issues, agree solutions to problems and establish strategies to exploit opportunities. This ensures that everyone is clear about strategies and objectives in general; and clear about their individual responsibilities and how these interface with the responsibilities of their colleagues.

As a result of this, you’ll start to build a real team that co-ordinates effectively, buys in to the core values and direction of the business and works with much greater enthusiasm and commitment. Under performance and lack of integrity then become a much smaller issues; but also much easier to identify because they’re much more difficult to hide.

Small businesses that make this leap are much more likely to grow and prosper than those that don’t. Sadly, many small businesses fail to reach their potential for no other reason than the boss remains a frustrated and stressed micro-manager. Some owners of small businesses do find it incredibly difficult to let go. If you’re one of these and you want to try and change, don’t try and do it on your own. In most industries, there are specialist business consultants, business coaches and mentors that understand this problem only too well and will be able to take you through a difficult learning curve far more quickly and effectively than you would otherwise achieve.

If you’d like to discuss any of the issues raised in this article, in more detail, please feel free to contact me.

The Importance of Having Good Management Accounts

In this day and age, most small and medium sized businesses (SMEs) use computerised accounting systems; and suppliers of accounting software, such as Sage, have made the bookkeeping process very straightforward, irrespective of whether your annual sales are £100k or £50m. As a result most SMEs now maintain a reasonable quality of bookkeeping that accurately records their financial transactions. However, many limit the regular use of their accounts systems to the processing and control of sales and purchase invoices, debtors & creditors, wages & salaries, the bank, VAT etc. And this means that they are missing out on one of the most important tools that is available to help them manage their businesses more effectively and more profitably. I’m talking about the production of monthly management accounts.

From the work that I do with SMEs, there seem to be two distinct issues. The first is businesses that don’t produce monthly management accounts at all. The second is businesses that do produce monthly management accounts but structure them in such a way that, at best, they are not particularly helpful and, at worst, are seriously misleading.

Let’s look, firstly, at those businesses that don’t produce monthly management accounts at all. Generally these are at the smaller end of the SME scale. They often don’t see management accounts as a priority; perhaps have some difficulty understanding and interpreting them; and may struggle to produce them. Realistically, if yours is a one person business with no employees and a very small number of transactions, monthly management accounts are probably not going to add much value because they won’t really tell you anything, you don’t already know or can’t work out in five minutes with a calculator or spreadsheet.

However, the business doesn’t have to grow too much, before the number of transactions increases to the point, where you lose track of them. At this point, many businesses then keep a close eye on the bank account and assume that, if there’s cash in it, they’re OK. And that’s the first big mistake because cash is not profit. A business can be making losses, whilst still having a healthy cash flow. It can also be making healthy profits, whilst having a cash flow problem (I’ve written another article about this, which you can access at Cash v Profit). You need a profit and loss account at the end of each month to tell you whether you’re making money or not and you need a balance sheet to show you whether you’re solvent and whether you have a liquidity problem or not.

Your management accounts should give you an accurate picture of where all your costs are and whether your margins are where they need to be. You can monitor where all your cash is tied up (stock, debtors etc.) and whether there is enough in the business to pay your wages and creditors. As the months go by, you begin to identify trends that may be developing; rising or falling costs; deteriorating or improving margins; increases or decreases in stocks, debtors and creditors; improving or deteriorating cash position etc. So you start to identify problems at an early stage and are able to take remedial action before those problems become acute. Similarly, you can see where you’re having increasing success; so you can then start developing strategies to build on that success. Finally, where you have a business plan with a detailed financial budget, you can compare your performance against the budget and take actions to get things back on track, when you’re falling behind plan; or build on your success, when you’re pulling ahead of plan.

Unless you have some form of accounting/bookkeeping experience, you may struggle to produce monthly management accounts yourself. Apart from ensuring that everything has been posted to the correct nominal account, a number of procedures such as stock adjustments, work in progress adjustments, dealing with prepayments and accruals are required. So you’re probably going to need someone to make all of these adjustments and to then produce the profit and loss account, balance sheet and any other reports that you may require. Obviously, some SMEs are big enough to employ a full time or part time bookkeeper and if so, the bookkeeper should be able to undertake all of these tasks. Some larger businesses will have accounts departments with a number of dedicated staff. These are likely to be producing monthly management accounts as a matter of routine. However, if your business is not producing management accounts each month, you’ll need to consider whether it’s possible to produce them, using existing resources or whether you need additional support. If you do need additional support, you may be able to employ a bookkeeper on a part time basis for a few hours a week; or there are many self-employed people and small companies offering bookkeeping services. Either way this doesn’t need to be a hugely expensive commitment and the benefits to your business are likely to be substantial.

The fact that you personally may struggle with accounts and may not have a very good understanding of them, doesn’t mean you shouldn’t have management accounts as part of your business processes. They’re just too important to ignore. In these circumstances, just be honest with yourself and your bookkeeper or prospective bookkeeper; admit it’s not your thing and ask your bookkeeper to go through the figures with you, line by line, explaining what each line is and what it’s telling you. You’ll need to invest some time in this; but, if you do, you’ll soon learn; and you’ll quickly discover it’s not rocket science.

I now want to move on to the second problem, I see all too frequently, and that is management accounts that are not appropriately structured and, as a result, don’t provide information that is helpful for the business.

Generally speaking, this problem comes about because the business owner/CEO doesn’t tell the person, responsible for producing the management accounts, what information is actually required. It’s just left to the accountant/bookkeeper, who may well understand the numbers but who, invariably, doesn’t understand the business.

The two most common problems are: –

1. A lack of sufficient breakdown between key business activities and/or product groups.
2. Classifying as overheads, entries that should be shown as direct costs.

Let’s look firstly at the breakdown between business activities or product groups.

If your business has more than one business activity, you need to understand the performance of each one. For example, let’s say you fabricate PVCu windows and doors; but you have two different market channels. The first is selling an installed service to homeowners; and the second is selling, on a supply only basis, to the trade.

Your production costs are likely to be more or less the same irrespective of the channel. However, the cost structures of the two channels are likely to be considerably different, as are the selling prices. Selling an installed service to homeowners is likely to involve sales commissions, advertising, survey costs, sub-contract installation costs, installation material costs and finance/credit card charges. Selling to a trade customer, is likely to involve different sales and advertising costs and may involve delivery or possibly trade counter costs; but it’s unlikely to involve survey and installation costs. Your management accounts need to pick all this up and provide a margin analysis for both market channels. If everything is lumped together, you just don’t know where you’re making money and where you’re not. So how do you know what strategies to apply to each channel? The answer is, “you don’t”!

A similar issue arises between different product groups. Let’s now say that you’re still a PVCu fabricator but all of your sales are based on selling an installed service to homeowners. However, this time you also sell conservatories. Your sales and advertising costs may be similar for both products; but conservatories require a roof, and also involve a significant amount of building works. So the cost structure of supplying and installing a conservatory is entirely different from that of windows and doors. Once again, if you lump these two product groups together, how do you know where you’re making money and where you’re not? And once again, you don’t.

Your accounts must be structured to provide a margin breakdown for all your key product groups and market channels so you have an accurate understanding of the true margin made by each one.

Moat accounting software can handle this type of analysis as a matter of routine; but it does have to be set up correctly to do so; and that’s where the main problem lies.

I’ll now move on to the second problem I encounter, which is all about whether costs are classified as direct costs or as overheads. Direct costs refer to materials, labour and expenses, related to the production or supply of a product or service. Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product or service, and are, therefore, considered as overheads.

Many SMEs classify materials and direct labour as direct costs but almost everything else as overheads. And this can be very misleading. Let’s go back to the business selling windows and conservatories on a supply and install basis to the homeowner. Not only does this business have materials and direct labour as direct costs, but it has installation labour and materials, disposal of site debris, survey costs, sales commissions, lead generation/advertising, finance/credit card costs, warranty/guarantee insurance. All of these are directly related to the sale, production and supply of the product and its installation. So all should be classified as direct costs.

If you decide to classify only some of these costs as direct, you’ll end up exaggerating your gross profit, which is normally calculated by deducting your direct costs from your sales revenue. You’ll also overstate your overheads because some of your direct costs will be absorbed as overheads. The consequences of this could be quite profound.

Let’s say that the business is barely profitable and that you have to take action to improve profitability. One way of doing this would be to increase sales; you, therefore, put a sales plan together. You think you’re making some good margins so you decide to offer some additional discounts. You also need to spend some more money on advertising and, of course, extra sales mean extra commissions installation costs etc. Everything seems to hang together and off you go. You’re initially pleased with the increase in sales, but when you run your management accounts, the effect on the bottom line is shown to be marginal. You’ve added some volume but for little or no extra profit. So what’s happened?

The problem is that your accounts have mislead you about your margin. Because you’ve only included materials and direct labour as direct costs, you’ve been duped into believing that you’ve been making healthy margins. However, if you’d included all of the other direct costs as direct costs, you’d have found that your margins were in fact very poor; and, once you’d accounted for the additional discounts you offered, it would have been clear that there wasn’t much left.

If you’d known this at the outset, it would have been very apparent that additional volume wasn’t going to provide a solution. The only effective options open to you were (a) drive down your direct costs as a proportion of your sales, (b) increase your selling prices, or (c) a combination of both.

Let’s now look at another problem that can occur as a result of confusing direct costs and fixed costs. Many businesses seeking to improve their profitability, embark on a cost cutting exercise; but they cut the wrong costs.

If many of your direct costs are treated as overheads and you need to make cuts, staffing, process costs, administration, maintenance & renewals etc. are often the soft options that you go for rather than address the more challenging issue of high costs in sales and marketing, installation etc. However, the outcome of this can be catastrophic because, in reality, you still have a margin problem but you’ve cut the basic infrastructure that would have enabled you to address that margin problem by driving down your direct costs.

In the home improvement sector, which is where I focus most of my time, one of the most common problems I see is SMEs that under resource their processes, controls and administration and, as a result, suffer from direct costs that are out of control. Genuine overheads are relatively easy to control because you can make definitive decisions as to whether you proceed with something and spend the money or whether you don’t. Direct costs are much more difficult because they depend on operational efficiency, effective processes, quality control etc. In many SMEs, total direct costs are much higher than total overheads. So controlling direct costs provides far greater potential to improve the bottom line than controlling overheads. In fact, quite often, an increase in overheads is needed in order to provide the resources that are required to bring direct costs under effective control. In this situation, the bottom line may get worse, for a short time, before it starts to recover to the levels, at which it should be.

Once you have your accounts structured to give you really good information about your direct costs and overheads, you can start making these sorts of decisions with confidence.
Many owners and directors of SMEs find interpreting their management accounts quite challenging; so, if that describes you, don’t think that you’re on your own because you’re not. It’s, therefore, very important to have good accounting and bookkeeping support, the scale and structure of which will depend on the size and complexity of your business. It could range from a part-time bookkeeper or bookkeeping service to a significant sized accounts department. But wherever your business is on that scale, what you can’t do, is just let them get on with it, as they see fit, because they won’t understand your business as well as you do. You need to work with them to get the structure of your management accounts right and to ensure that it provides you with the right information in the right way at the right time. If you invest some time and effort in this, it will repay you handsomely.

If you’d like to discuss any of the issues raised in this article, in more detail, please feel free to contact me.

Why You Need a Business Plan & How to Prepare It

Virtually all businesses, within a corporate structure and the majority of larger private businesses, have well-developed business plans that incorporate clearly defined strategic objectives, detailed plans about how those objectives will be achieved and financial projections, including forecasts for sales, profit & loss account, balance sheet and cash flow. None of this guarantees success but it provides a road map, with a clear destination and a properly defined route for the business to follow. These types of businesses usually put considerable time and effort into the preparation of their business plans because they know it significantly improves the likelihood of building and/or maintaining successful market positions, strong balance sheets and sustainable competitive advantage.

By contrast, many small and medium-sized businesses spend very little time thinking through and preparing business plans and, in some cases, they spend none at all. As a result they tend to drift. The business is managed from day-to-day and goes from one year to the next, sometimes moving forward and sometimes going backwards but, in reality, making little or no progress.

Initially, many start-ups can show considerable progress, as they establish their market position but, more often than not, without a business plan as a blue print, they generally reach an early plateau, from which they find it difficult to progress. To be fair, this suits some business owners but, for many, it creates enormous stress, as they are continually living with a very uncertain future and less personal income than they require. And yet, preparing a worthwhile and effective business plan doesn’t have to be a massive project that distracts the business owner away from the action for too long; and actually, standing back for a short time to work on a business plan, almost always proves highly beneficial for the business and can be very therapeutic for the business owner.

So why don’t business owners stand back more? In my experience, the usual reason is that they think “no one else can do what they do” or no one else can do what they do as well as they do it”. So they micromanage everything and get increasingly bogged down and stressed out. In reality, many of the day-to-day activities can be done quicker and more effectively by their staff, if only the business owner would just let go. I’ve developed this theme in another article but, for the time being, let’s assume that the business owner has let go and is now about to work on a new business plan. How does she or he go about it?

The first thing is to look outside the business and see what’s going on in the market. For most small and medium-sized businesses, this doesn’t require a lot of detailed market research, it’s more about using suppliers, customers, competitors, trade organisations, trade publications and, of course, your own staff, who interface with customers. Using all these sources and any others that may also be helpful, try to establish what’s actually happening. Which market sectors and product groups are growing and which are declining? What’s happening with prices across those market sectors and product groups? What are your competitors doing? What quality standards and service levels are the norm? What technological developments are occurring? What legislative and regulatory factors are likely to affect you? In practice you’ll know much of this anyway; so it’s as much about standing back and putting everything into context and creating a balanced and objective picture, as it is about searching for new market data and intelligence.

The next step is to look at your own business and make an honest and objective assessment of how well it interfaces with the market. Are you capitalising on the sectors and products that are in a growth phase? Are you exposed to market sectors and products that are in decline? Are you under-pricing and giving away margin unnecessarily? Are you over-pricing and uncompetitive? How do you shape up against your key competitors? Where do you have competitive advantages over them? And where do they have competitive advantages over you? Are your quality standards and service levels meeting market expectations? Are you investing in appropriate technologies? Are you complying with all appropriate legislative and regulatory requirements? And are you running ahead of your competitors or lagging behind them?

You can now compare your business with the market by undertaking a simple SWOT analysis (Strengths, Weaknesses, Opportunities and Threats). You’ll very quickly see where your business’s strengths and weaknesses lie and you’ll clarify where the threats and opportunities, presented by the market, are likely to be.

Once your SWOT analysis has been completed, you can start to develop your strategy. Generally, you’ll want to build on areas, where you’re already strong. The more difficult decisions are likely to be around strategies for areas of weakness. How are you going to deal with these? Alongside this you’ll need to consider the threats to the business, from wherever they may come and decide how you are going to meet them. Then lastly, you’ll need to look at the opportunities the market is presenting and decide whether you should exploit any of them.

At this stage, you’ll probably have a lot of potential ideas, which collectively will be unaffordable and which, if you tried to implement them all immediately, would simply overwhelm the business. So you need to start establishing priorities and time frames; and as you do that, you’ll create the framework for your business plan, which would probably be built over a three-year period.

With the framework complete, it’s time to run some numbers, which would normally include projections for sales, profit & loss account, balance sheet and cash flow. The first year of the plan, which is your next full financial year, is likely to become the budget for that year. The second and third years will be increasingly aspirational. So this process needs to be undertaken on an annual basis, which means you’re always working with a business plan on a rolling three year basis.

It is highly likely that the first time you run your numbers, the projections will look completely unrealistic; unachievable, unaffordable etc. So you’ll need to adjust and refine; correcting errors; improving the accuracy of some of your assumptions; scaling some things down; scaling other things up; adjusting time frames etc. until you have a realistic and achievable plan. At this stage you’ll have your road map, with a clear destination and a properly defined route for the business to follow. As I stated at the beginning of this article, it won’t guarantee you success, but it will make success a considerably easier and more likely outcome.

If you haven’t been through this type of process before, you’ll probably need some help. If your business is big enough to employ its own management accountant, he/she should be able to run the numbers; if not, you may need to engage your external accountants. But, in a sense the numbers are the easy part. It’s the development of the strategy that leads up to the point where you can run the numbers that is important to get right. And to do that, you need to debate all the ideas, challenge all the assumptions and make sure that the strategic framework is realistic, robust and achievable. For many small and medium-sized businesses this isn’t always easy because it can be difficult for employees to challenge the boss’s ideas and there is no one else to do so. That’s where you need help from an experienced independent industry expert. Some small and medium-sized businesses have a non-executive director; and this is an area where he/she can play a very important role. If you don’t have a non-exec, there are invariably a number of independent business consultants who could be brought in. However, if this is something you are considering, do ensure that the person you select has had senior management experience within your industry and has a good understanding of your type of business and the market, in which it operates.

Once you have your business plan, it should become a key reference point for you and your management team. It should be the yardstick by which you measure performance and there should be regular monthly reviews to see how the business is performing against the plan. In areas where the business is under performing against plan you’ll need to consider what remedial action is required. Where the business is over performing, you’ll need to consider whether and how this can be further exploited.

Once you’ve started to use your business plan in this way, you’ll wonder how you ever managed before. It will provide focus for many of your management decisions; it will provide direction for your managers and staff; and it will help you to build a much more profitable and sustainable business.

If you’d like to discuss any of the issues raised in this article, in more detail, please feel free to contact me.

Better Times Ahead

Most economic indicators are now pointing to a recovery.

• The economy is growing
• Manufacturing and services are up
• Unemployment is continuing to fall
• Inflation is below 2%
• Living standards are beginning to recover, albeit slowly

Under these circumstances, business confidence is on the increase. However, over the last few years, small and medium sized businesses have had a tough time.

• Profits have been low
• Balance sheets have weakened
• Cash has been under pressure
• Investment in plant, equipment and infrastructure has been supressed.

So, it’s inevitable that many businesses remain very cautious. Nevertheless, as markets continue to recover, businesses do need to gear up; and being over cautious is likely to lead to lost opportunities and being left behind by your competitors.

So Think About Your Business

• Is your business model working effectively and still relevant to current and future market conditions; or does it need to adapt?
• Is your marketing strategy working; or have you been left behind by the fast moving on-line revolution?
• Are your products/services state of the art; or are they getting tired?
• Are your processes and systems as efficient as they need to be; or are they becoming cumbersome?
• Is your productivity as good as it should be; or are your direct costs too high?
• Are your quality standards under effective control; or are you getting too many complaints?
• Is your organisation structure fit for purpose; or has it become dysfunctional?
• Are you supporting your employees effectively; or are too many underperforming?
• Are your customers happy; or are they drifting to your competitors?

In all honesty, very few businesses can tick all of these boxes. Sadly, some can tick very few, whilst the majority fall somewhere between these two extremes and, therefore, have the opportunity to raise their game.

How Can You Raise Your Game?

As an owner, director or senior manager of a small or medium sized business, the first thing you need to do, is to be honest with yourself about the state of your business; good or bad. Then remember that you don’t necessarily have all the skills and experience needed to address the weaknesses your business might have, or exploit the opportunities that the market might present. Recognising that you aren’t superman or superwoman is a strength in itself.

Next, think about how you can spend more time working “on the business” and less time working “in the business”. That probably means more delegation of responsibilities; and remember that a failure to delegate is often more about your own inclination to micromanage, rather than the lack of competency of the people, to whom you should be delegating.

At this point, you can start to take a more considered view about the strengths and weaknesses that your business has, and you can be more objective about the opportunities and threats that exist. So you can now start to plan. Look at where you want to take the business and assess the resources you’ll need. Compare these with the resources you have. Then consider how, and over what time frame, you can acquire the resources you need but don’t have, as well as offload the resources you have but don’t need. This is all about developing a properly focussed strategy; and, once you have this, you can start to work on a more detailed business plan.

Now back to the point about your own skills and experience. For many owners, directors and senior managers of small and medium sized businesses, strategic planning and change management isn’t familiar territory; and if that is true for you, you have three options.

The first is do nothing, carry on as before and chance that everything will turn out alright in the end. It’s high risk but it might just work.

The second is to go it alone and to try and find your way through. If you do that, you may get there eventually, but the chances are you’ll take some wrong turns, get lost, have to retrace your tracks and end up taking much longer to reach your destination, whilst incurring substantially higher costs on the way.

The third is to hire a guide; a business advisor, familiar with the territory, who can steer you to your destination via the shortest and least costly route. Business advisors cost money; but the right business advisor will cost you a fraction of what it would otherwise cost, by the time you’ve taken several wrong turns en-route.

The changing economic climate means that small and medium sized businesses, which have battened down the hatches for the last few years, can increasingly start to take a more proactive position. But most markets are likely to remain highly competitive; so focused strategies, well developed business plans and ever increasing levels of operational excellence are essential to long term sustainability.

Cash v Profit

The UK economy is coming out of recession; that now seems to be the general view of economists, politicians and business. In fact growth in the July to September quarter was 0.8%, which equates to an annual rate of around 3.2% and is the fastest growth rate of all the G7 countries, over the last quarter. Even better is the fact that all sectors of the economy – services, construction and manufacturing – are growing.

This is all great news and let’s be thankful that, at long last, there’s some light at the end of the tunnel. However for small and medium sized businesses, it presents some new challenges and I’d like to highlight some of the more significant ones.

The last recession was longer and deeper than any other recession since the Second World War. But it has shown some very different and perhaps unexpected characteristics.

Consider employment and unemployment. The following tables show changes in employment statistics between August 2011 and August 2013. I’ve extracted all of the data from official figures prepared by the Office for National Statistics.

People in Employment

People in Employment

The number of people, aged 16 – 64, who in theory could have been working has risen by 101,000 (0.3%). But the numbers in employment will always be much lower than the total number in the 16 – 64 age group, which includes students, people who have retired early, people of independent means, people who are sick, disabled etc. However, the really significant factor is that the number of people, in employment, has increased by nearly 600,000, which means that many jobs have been created or existing vacancies filled; and there are proportionately fewer people, under the age of 65, who are economically inactive.

Economically Active & Unemployed

Economically Active & Unemployed

My second table shows that the number of people, between the ages of 16 and 64, who are economically active, has increased by 700,000 over the two year period; and yet, the number of people, who are unemployed, has fallen by 90,000. These first two sets of figures seem to disprove the suggestion that the unemployment figures have fallen, due to people being reclassified as economically inactive and in receipt of other benefits. The new jobs do seem to be real and the fall in unemployment does appear to have happened.

Full Time v Part Time Employment

Full Time v Part Time Employment

My third table shows that the number of people, working part time, has gone up by 269,000; so some of the new jobs have been part time. However, the number, working full time, has increased by 519,000. The notion that most of the new jobs are part time is, therefore, a myth. Most of the new jobs are, in fact, full time.

All of this has been happening at a time when public sector jobs have been cut by 437,000. So the private sector has actively created over a million new jobs, most of which are full time. And this has happened, during a recession, which is unprecedented. It also means that the wealth creating part of the economy has increased its capacity, which is now likely to be underutilised. But that, in turn, means the private sector should be able to support significant growth, as the upturn gathers momentum.

However, there is considerable evidence that salaries and wages have fallen and that living standards have been supressed. Furthermore, despite the loss of nearly 450,000 public sector jobs, over the last two years, public sector jobs now command a 6% premium over private sector equivalents, according to the “Policy Exchange” think tank. This all points to many private sector employees having had no pay rises for some considerable time and to people leaving public sector jobs and taking lower paid jobs in the private sector.

Understandably, the political focus is now moving from economic growth and unemployment to the cost of living. In reality, it is quite normal for real wages to continue falling during the early stages of a recovery. But it’s also normal to see pressure building up for wage increases; and realistically, there is likely to be a period of catch-up over the next two or three years. The challenge for business is to ensure that the higher wages that ensue, are paid for through productivity improvements and don’t just inflate costs. However, that should be possible due to the extra private sector jobs and capacity that have been created.

Another factor to consider is that the rate of business insolvencies has been considerably less, during this recession, than during previous recessions. And much of this is due to the banks, which have tended to leave struggling businesses to continue struggling, rather than calling in loans and appointing administrators. But the downside is that there are now a huge number of zombie companies that can barely generate enough cash to service the interest on their debts and keep their creditors at bay. The UK’s largest insolvency practitioner, Begbies Traynor has calculated that there could be as many as 432,000 businesses in this category.

If we now start to join up all the dots, a picture is emerging of a whole raft of businesses, particularly small and medium sized ones, which have weak balance sheets, high wage costs, upward pressure on wages, suppressed profits and cash flow difficulties. Add to this, a lack of investment in infrastructure, IT, R&D, plant & machinery and training and it’s clear that many of these businesses will struggle to invest and grow as the economic recovery gains momentum. Indeed, there is a developing school of thought that, because they will act as a brake on the recovery, it may be preferable to steer many of them towards administration, thereby releasing their employees to work for stronger businesses that can fully exploit the recovery.

I don’t want to get into the political arguments of whether this is right or wrong but I do want to emphasise, to owners of small and medium sized businesses, the importance of developing robust business strategies that take account of these very real challenges. I’ve written a series of articles about many aspects of planning and managing small businesses but, on this occasion, I want to focus on the difference between cash and profit because having a clear understanding of those differences is an essential part of developing a realistic and achievable growth strategy that is able to capitalise on the current recovery.

Depending on your type of business, it is perfectly possible to run a significantly loss making business, whilst generating a substantial cash surplus; at least for a time. It is also perfectly possible to run a profitable business and have a serious cash shortfall. So let’s look at this in more detail.

First of all consider a Business to Consumer (B2C)/retail business. It receives payment for its goods/services at the point of sale. In some cases it may have even taken a deposit prior to the point of sale. So it’s generating its cash very quickly. However, it may be paying its suppliers and employees a month in arrears. The following table is a very simple profit and loss account and cash flow statement for a £1m turnover business doing precisely as I’ve described.

B2C Business £1m Sales

B2C Business £1m Sales

This business has sold goods or services to the value of £1m and has collected all of the cash from those sales during the year; but it has made a loss of £50k because its total costs have exceeded its sales revenue. However because it is paying its suppliers on net monthly terms and its wages a month in arrears, it has only paid for 11/12ths of its costs; so its cash outflow has been less than its total costs. As a result it has generated £37,500 of cash, albeit, it still owes its creditors £87,500.

If the sales and expenditure figures, in the P&L, remain the same in the second year, the cash gain, in the first year, will have been a one off because the business will pay out 11/12ths of its costs for year two plus the final 1/12th for the first year. As result, it will have a net cash outflow equal to its loss i.e. £50k.

But now see what happens if, instead of remaining static in the second year, the business increases its sales by 20%, whilst maintaining its overheads at the previous level.

B2C Business £1.2m Sales

B2C Business £1.2m Sales

It still makes a loss, this time £10k. But it benefits from collecting all £200,000 from the additional sales but only makes payments for 11/12th of the additional cost of sales. As a result it generates £3,333 of cash. So over the two year period, it has made cumulative losses of £60,000, whilst generating £40,833 of cash

If, on the other hand, the business reduces its sales, in the second year, by 10%, whilst still maintaining its overheads at the previous level, a very different picture emerges; and this is shown in the next table: –

B2C Business £900k Sales

B2C Business £900k Sales

Not only do the losses increase due to the lower sales volume, but the cash drain is even greater. Cash in is reduced by £100,000 due to sales also being £100,000 lower, resulting in a loss of £70,000. However, payments related to the cost of sales, drop proportionately less because they include 1/12th of the cost of sales from the previous year, which were 10% higher. So the cash outflow is £76,667 i.e. £6,667 more than the actual loss. Over the two year period, this means that the cumulative losses would have been £120,000 and the net cash out £39,167.

This is a classic problem for many B2C/retail businesses. They embark on a growth strategy funded out of cash flow rather than profit. Providing they don’t let their overheads expand at a faster rate than their sales, they can keep growing and maintain a positive cash flow, often for several years, whilst continuing to generate losses. However, at some point, the crunch inevitably comes. Growth grinds to a halt; sales decline for a period; the cash disappears and bang! the business goes bust. The home improvement market is an example of a sector that has a large graveyard of companies that collapsed in this way; and some of those failures were quite spectacular.

Now let’s consider the reverse problem.

Take our £1m turnover business but, this time, let’s assume it’s trading Business to Business (B2B); that it’s profitable but gives its customers ninety day terms, whilst paying its suppliers in thirty days. The next table shows simple profit & loss and cash flow statements.

B2B Business £1m Sales

B2B Business £1m Sales

Here’s a nice little business making a modest profit of £25,000 but, because it has only collected 9/12th of the cash from its sales and has had to pay out for 11/12th of its costs, it has had a net cash outflow of £143,750, which it has had to fund.

If its P&L was to remain unchanged during its second year, then it would collect £1m of cash from its sales (3/12th coming from the first year’s sales); and it would pay out twelve months’ costs (1/12th from the first year’s costs). It would, therefore, generate £25,000 of cash.

As with our retail business, the second year’s cash flow would match the profit or loss generated, providing sales and costs remained the same. But let’s see what happens to this business if it grows by 20%, whilst holding its overheads at the same level as in year one.

B2B Business £1.2m Sales

B2B Business £1.2m Sales

A sales increase of 20% would result in a profit of £65k (+160%). Cash flow would benefit from collecting three months’ cash from the previous year, as well as nine months from the second year. But cash from three months of the incremental sales, in the second year, would not have been collected by the year end, so the cash generated would only be £41,667.

The cumulative profit for the two years would be £90,000 but the cumulative cash position would show a net cash outflow of £102,083. It would, therefore, take several years of this type of expansion to recoup the initial cash outflow from the first year. And this assumes that overheads could be maintained at year one levels, which may be unrealistic.

Now let’s see what would happen if we go for a 50% increase in sales. In this case we’ll also assume that overheads would increase proportionately.

B2B Business £1.5m Sales

B2B Business £1.5m Sales

The net profit of £37,500 would be higher than in year one but would be suppressed by the additional overheads. But there would have been a net cash outflow of £6,250 because the cash from three months’ worth of incremental sales would not have been collected. So, in this scenario, there would have been two years of cash outflow, totaling £150,000 despite profits of £62,500, during the same period.

For businesses of this type, growth can be quite tricky. It needs to be planned and it needs to be controlled because, even though the business may be profitable, it may not have the working capital it needs to fund the growth it would ideally like to achieve. In a worst case scenario, it could fail due to over trading.

There are, of course, ways of funding the working capital needed to support growth; invoice discounting being one option. But however it is done, it involves a cost, which impacts on both profit and the amount of cash required. So there is a balance to be struck that keeps the costs manageable, the bottom line sufficiently profitable and the level of growth supportable.

For most small and medium sized businesses, the recovery shouldn’t be a signal for a mad dash for growth because rapid growth has its risks. For B2C/retail businesses, the risks tend to revolve around throwing money at growth because the cash is available in the bank. But costs then tend to get out of control, which hits profitability and ultimately leads to a crisis. For B2B businesses the risks tend to be around over trading, the inability to fund growth and the risk of running out of cash, which also ends up in a crisis.

Stronger businesses will obviously want to capitalise on the recovery and should of course do so; but it’s important that their growth strategies are properly planned, resourced and controlled. It’s also vital that funding is in place to support the growth plan and that the incremental sales make a real contribution to the bottom line. Whether you run a B2C or B2B business, both cash and profit need to be properly managed; and focusing on cash at the expense of profit or profit at the expense of cash is a road that invariably leads to a crisis. Get all this right and the business should grow and prosper; get it wrong and the business could be in trouble.

But what about the many zombie companies that now exist? Well, I’m afraid that some harsh truths may need to be faced. The first is that most of them are where they are due to bad management not bad luck. The second is that some of them are probably past the point of no return and just don’t have a viable future. For those that do have a chance of recovery, they really must address the underlying strategic, operational and management deficiencies that are responsible for their current predicament. Only when they’ve done this and can demonstrate a turnaround are they likely to get the support that they need, from suppliers, customers, banks and finance houses, to put in place even a modest growth strategy. But with the right approach and the right help, I’m sure that many of these zombie companies could be brought back to life.

Are your overheads too low?

If your business is losing money or making only small profits, the chances are, you’ll be under pressure to cut your overheads. Sometimes this pressure is self-generated and sometimes it’s applied by banks, accountants, financial advisors and financiers. But is it really the right thing to do?

In some cases, it most definitely is. If your overheads are disproportionately high relative to the throughput of your business, then you need to cut them. This is true whether you’ve let them grow too fast or whether sales have declined and you haven’t yet downsized.

But in many other cases, cutting overheads to address bottom line under performance is entirely the wrong thing to do; and I’ll explain why.

When comparing overheads with direct costs, overheads are usually much easier to control. You just say “No”. A manager wants an additional person in his/her department: you say “No”. An employee wants a pay rise: you say “No”. There may be a need for repairs or renewals: you delay them. There may be a requirement for investment in plant or equipment: you make do with what you’ve got. Your IT system may be past its sell-by date: you ignore it. So by just doing nothing you’re controlling many of your overheads.

In most businesses, there are some overhead costs that should be reviewed regularly, with a view to making savings; utility bills, outsourced services etc. This is simply good practice and should apply irrespective of bottom line performance. There are also some overheads that are difficult to influence in the short or medium term; rent and business rates being the obvious examples. So in practice, you’re stuck with them, irrespective of your bottom line performance.

When it comes to cutting overheads, there can be some difficult emotional, personal and personnel issues to address because it usually entails making people redundant. But predicting the costs that will be taken out through downsizing and achieving those predictions are relatively straightforward processes.

Now think about direct costs. In many businesses, the two major direct costs are raw materials and direct labour. So how do you control them?

Material costs don’t just depend on the price you pay for them. They depend on: –

• Efficient stock control, keeping losses and damage to a minimum
• Efficient utilisation that minimises wastage
• Getting orders right first time to minimise errors
• Quality output to minimise replacements.

Direct labour costs don’t just depend on the numbers of operatives or the rates they are paid. They depend on productivity and the level of output that is achieved. Furthermore, achieving the right balance between the number of operatives, their individual wage costs and their combined output isn’t just a question of how well they are managed day to day, although that is extremely important. It depends on the operational efficiency of order processing, planning, procurement and stock control. Well maintained modern machinery and appropriate levels of automation, as well as effective batching and efficient materials handling systems, are also essential in manufacturing businesses.

Effective control of direct costs is, therefore, much more complex and much less predictable than the effective control of overheads.

Now consider the relationship between direct costs and overheads.

In some businesses, such as professional services, overheads are likely to account for a much larger proportion of total costs than are accounted for by direct costs. So, in businesses of this type, where bottom line under performance is an issue, reducing overheads may be the only option.

However, think about a light manufacturing business or a home improvement service provider – windows, conservatories, kitchens, bathrooms etc. A typical profit and loss statement will show direct costs accounting for somewhere between 60% and 70% of total sales, whereas overheads may account for only 20% or 30%. In these situations, direct costs are much greater than overheads; and this is actually typical of lots of small and medium sized businesses in many different sectors. It’s also where the wrong approach to addressing bottom line under performance often occurs.

If the majority of your costs are direct and your business is under performing, reducing those direct costs, as a proportion of sales, is likely to provide far greater returns than cutting your fixed costs. But to many small and medium sized businesses, this is often perceived as a much bigger challenge.

In reality, most under performing businesses, in this category, are under performing because of operational inefficiencies. As a consequence, their direct costs are too high and that is why their bottom lines are under pressure. But few of them fully appreciate the extent of their inefficiencies; even fewer realise how much it’s costing them; and fewer still make any serious attempt to quantify that cost. So they focus on their comfort zone, namely overheads.

If you then look at why these businesses are operating inefficiently, it’s usually because they are under resourced. Their processes, controls and management information systems are often inadequate. Their administration often depends on too few managers and employees; and they put too little emphasis on the training and skills development of the people they employ.

Where businesses of this type are under performing, the right solution is, very often, to increase overheads to provide a more effective level of resource that can support greater operational efficiency. This will, in turn, reduce direct costs. So there may be a trade-off; for example, increase fixed costs by three percentage points (of sales) in order to achieve a ten percentage point reduction in direct costs, giving a net bottom line improvement of seven percentage points.

The problem with this approach, as perceived by many small and medium sized businesses, is that they need to commit to the increase in overheads with no guarantee that the direct cost reductions will be achieved. However, in reality, the risk associated with addressing the problem might be more immediate but the risk of not addressing the problem is usually much greater. Although, this can sometimes be difficult to reconcile, particularly when cash flow is under pressure.

There are several lessons to learn from this.

The first is not to get into this position in the first place. Always recycle a reasonable level of profits back into the business to invest in appropriate plant & machinery, automation, IT, systems & process, staffing and training. By so doing, you will have the best chance of maintaining effective control over your direct costs.

The second is that, if your fixed costs are starting to drift, either because they are going up or because those of your key competitors are falling, act sooner rather than later. The short term risk of an increase in overheads is much lower when you have a strong balance sheet and the ability to fund the additional costs reasonably easily.

The third is to recognise that if you have lost control of your direct costs, there will be an additional cost to regain that control. It’s unavoidable and the longer you leave it, the higher the costs will be and the less cash you will have available to fund them. It’s a vicious circle leading to a downward spiral; and the sooner you act the more chance you have of recovering the position.

The fourth is to understand the level of risk, to which your business is exposed. The earlier you recognise and address the problem, the lower the level of risk. If you don’t address the problem, the level of risk will increase, the number of available solutions will decrease and the risk of those solutions not working, when you do eventually try to implement them, will also increase.

Finally, if you’ve recognised that you have a problem but you’re not sure what to do or whatever you are doing isn’t working, bring in professional help. Yes there’s a cost; but it’s likely to be a much smaller cost than losing your business.

Anthony Pratt
AP Management Consultants
May 2013

The Value of Business Advisors and Consultants to SMEs

I recently circulated an email promoting my services and amongst the replies, I received, was this one: –

Many thanks for your kind offer for ————.
Unfortunately X——— was recently placed in Administration but when I “resurface” I may well revert back to you.

Kind regards


I don’t know “Y” and I have no knowledge of either the business or the circumstances surrounding its demise. But, my immediate reaction was a sense of frustration. I would, of course, be pleased to help Y in the future, as he implied but, if I could have started working with him perhaps a year ago, we could have possibly turned his business around and prevented this tragic outcome. Y’s prospects would now be considerably better and his employees would still have jobs.

To be fair, Y may have brought in business advice and support and it may not have worked. But, in practice, many struggling businesses don’t or, if they do, they leave it too late. And that’s the basis of my frustration.

When an established business fails, it is very rarely a sudden event that comes completely out of the blue. It normally happens after a comparatively long period of decline that could, in some cases, take several years. In fact, it never ceases to surprise me how long some businesses hang on before they eventually succumb to the inevitable.

Businesses that are institutionally owned or part of larger corporates, generally have structures and processes in place that are better able to identify potential threats at an early stage; so remedial action can be taken long before any serious harm is done. If CEOs and management teams are found unable or unwilling to respond appropriately, they are replaced. It’s a fairly clinical process; albeit not very pleasant, if you’re the person being fired.

In the case of owner managed businesses, these structures and processes aren’t normally as robust and often don’t exist at all. So the identification of weaknesses and threats tends to be left to the owner manager plus, perhaps, a small team of directors working for him/her; and this isn’t always easy because their main focus is managing the day to day activities of the business, which can often obscure some of the more strategic and broader based issues.

However, irrespective of the ownership of the business, threats and weaknesses need to be identified and addressed at the earliest opportunity to prevent a crisis from arising. If this doesn’t happen, the number of options starts to reduce, profits decline, cash becomes tighter and the ability to fund the change programme, that is needed to achieve a turnaround, is undermined. The business then slides inexorably towards collapse.

Owner managed businesses tend to be more susceptible to this problem than institutionally owned businesses or those that are part of larger corporates. This is partly for the reasons I’ve already explained – lack of focus on strategic factors – and partly because owner managers can sometimes become overwhelmed and unable to find solutions.

There is also another factor that needs to be considered.

If a management team has been running a business that is either in crisis or which is sliding into a crisis, it is unlikely that the same management team, on its own, will achieve a turnaround.

There are, undoubtedly, exceptions to this but, generally, it holds true; and it is one of the main reasons why CEOs and other senior directors of institutionally and corporately owned businesses are replaced.

For the owner managed business, the position is, in many ways, more difficult. An owner manager is unlikely to fire him/herself; and even if he/she did, who is going to run the business in their place? However, if the owner manager has managed the business, as it has declined, the chances of him/her turning it around, on his/her own, are not great. If the skills and experience had been there to do so, the decline would have been arrested much earlier.

Let’s now consider why businesses get into trouble to start with. A successful business creates and maintains a sufficient level of competitive advantage in its market(s) to remain sustainable. The really successful ones develop strategies that enable them to build on this and increase their competitive advantage over the medium and longer term. A declining business may have created significant competitive advantage in the past and maintained it for a time, but its decline indicates that it is now losing whatever competitive advantage it may have created.

Competitive advantage isn’t just getting things like price, quality, delivery and service right; as important as those factors are. It is about creating advantages over competitors across a whole range of factors that are important to the market concerned. However, markets are continually changing; so something that provided a competitive advantage yesterday may not do so today; but something else might. So businesses need to be continually adapting in response to the market. It’s a journey without an end. For anyone interested in reading more about competitive advantage, I have written an earlier article, which you can read at: –


Markets go through their various cycles of growth, maturity and decline; economies go through cycles of boom and bust; and the time frames of all of this are often inconsistent and unpredictable. In the right conditions, when a market is buoyant, the strongest businesses will grow, prosper and make large profits; and most others will survive reasonably comfortably; but, even in these circumstances, there will be some that just can’t make it work and which fail. However, when market conditions become adverse, the strongest businesses will still grow and prosper but they will mainly do so by taking market share from the not so strong. As a result, for many that were previously surviving comfortably, survival starts to become more challenging and, for the weaker businesses, survival becomes very difficult and increasingly impossible.

Let’s now consider a business that has been reasonably successful and surviving comfortably but which starts to see its performance decline, as market conditions change. There are really only two possible outcomes.

The first is that it responds to the changing market circumstances, adapts appropriately and remains successful, albeit with a bit of a blip, while it grapples with the change that was needed.

The second is that it doesn’t respond or responds inappropriately and continues to decline.

For the first outcome to be achieved, there is a prerequisite that the business correctly identifies the changing circumstances in the market and that it then develops appropriate strategies to address those changes. Identifying the changes is often reasonably straightforward because there is usually plenty of discussion about it within the particular market and its trade press. Developing appropriate strategies to address those market changes is much more difficult and usually involves a degree of risk.

This is where institutionally owned businesses and those owned by larger corporates often have an advantage. The CEO and directors have access to external resources that can support the business financially through change programmes and provide a broader base of experience. This combination means that new strategies and change programmes are likely to be more robust and incur less risk.

For the owner managed business, the challenge can be much greater. Limited resources mean that you can’t afford to get it wrong. But there is often much less experience available, other than that of the owner manager and his/her team; and there can be a very limited capability of testing and challenging the strategies that are developed. So the risk of getting it wrong tends to be higher.

The risk of change can also lead SMEs to do nothing, which, set against changing market dynamics, can actually be just as risky or, in some circumstances, even more so.

When you start to think about all of this, from the perspective of an owner manager, it can all become very daunting and can lead to inertia, inappropriate strategies and panic, all of which, in the face of changing markets, leads towards administration.

This may all sound very gloomy; so we must remember that most owner managed businesses don’t fail and a minority remain very successful indeed; although it’s probable that the majority underperform and never achieve their full potential. But there are also a considerable number of owner managed businesses, for which the scenario I have painted is very real. So how can you prevent your business from being one of them? And how can you ensure that it achieves its full potential? I would ask you to consider the following points: –

  • Ensure that you have enough feedback from the market to know what is going on in it and the trends that are developing. This doesn’t necessarily have to be in the form of expensive market research. But most businesses have some form of sales function, which is out and about in the market; so listen to it. Similarly listen to suppliers. Read the trade press; attend trade shows and exhibitions. And network; keep talking to people at all levels and in all sectors of your market. Then bring together appropriate groups of your own employees, at regular intervals, and maybe invite an outsider or two, with relevant experience; throw everything into the pot and then distil out the facts from the fiction.
  • Make sure that your business is responding appropriately to the facts i.e. the changes in the market that are definitely happening; but maintain a watching brief on the fiction until it is either confirmed as a fact or is dismissed as being incorrect.
  • Be totally objective and non-partisan about the competitive advantages that your business has in the market place. How real are they? How important are they to your customers? How does each competitive advantage, you have, rank against those of your competitors? In each case, are you gaining ground or losing ground? Are some of the competitive advantages that you have declining in importance in the market place? Are you developing competitive advantages that are increasingly important to the market? Do the competitive advantages you have cover a broad enough spectrum or are they too narrow? Are you developing new competitive advantages that expose weaknesses in your competitors? If you have the answers to these questions and others like them, you can begin to understand the direction, in which your business needs to go.
  • Develop, a “Business Improvement Plan”. This should have short, medium and long term goals. The medium term goals should move the business in the direction of the long term goals and the short term goals should move it towards the medium term goals. It doesn’t matter how strong and successful your business may be, there isn’t a business in existence that couldn’t do better somewhere or somehow. And a business improvement plan is a template that will under pin progress. However, a business improvement plan needs to be dynamic; and if market conditions change or the business’s circumstances change, the plan must be adapted accordingly. Moreover, the plan should, at all times, guide the decision making process so that the business is heading resolutely towards the achievement of its various goals and milestones.
  • When things don’t go according to plan, as so often happens, face up to it sooner rather than later. CEOs, owner managers and directors all tend to put a lot of personal kudos behind the various strategies they implement; and it can sometimes be very hard to accept that you’ve got it wrong. I’m not suggesting that you should change course every time there is a hiccup but, as patterns start to emerge, don’t allow yourself to start tilting at windmills; if you do, your business will soon be on the slippery slope. When things start to go wrong, the sooner you act, the more options you have, on which to base a recovery and the more likely you are to turn the position around.
  • Think very hard about the resources and experience you really need; and don’t penny pinch. This is particularly relevant to owner managers, who all too often spoil the ship for a ha’porth of tar. However, don’t be over ambitious with your objectives and ensure that they are within your ability to resource.
  • Bring in external help and support to plug the experience and skill gaps that your business inevitably has.

The seventh point is probably the most critical because it is fundamental to the achievement of the first six.

For most SMEs, external help and support can probably be split into three types, namely: –

  • The outsourcing of specific services
  • Mentoring, coaching and training
  • Business advice and support

The outsourcing of services refers to such things as IT, HR, Health & Safety. In some cases, it may also include operational activities such as logistics.

There are arguments for and against outsourcing of this type; and there isn’t a “one size fits all” answer. But most businesses, in this day and age need efficient IT systems, good HR management and a keen focus on health and safety. But smaller businesses often struggle with the half person syndrome, where they can’t really justify a full time person; so outsourcing may be the answer, particularly if it can provide a much broader base of skill and experience. What is crucial is that these services are comprehensive, appropriate, efficient and cost effective. And my advice is to be open minded and objective about how this is achieved.

Mentoring, coaching and training are often overlooked by SMEs because they can’t afford them and they’re “nice to haves” not “need to haves”. However, as you build the skill sets within your business over those of your competitors, you increase your competitive advantage; and the bigger the gap in skill sets that you can create, the bigger the competitive advantage you develop. Many owner managers accept the need for staff training but relatively few think about their own training and development. Yet, this is actually at least as important, and probably more so, because the consequences of their decisions and leadership are likely to be much more profound than those of their employees. More owner managers are now beginning to engage business coaches and mentors to help them develop their own skills and competencies; and most who do acknowledge that it helps them enormously and adds real value to their businesses. However, if this is the case, the gap between the coached and the uncoached will open up giving an increasing competitive advantage to the coached. So like it or not, the pressure on owner managers to “up their game” is now increasing.

Business advice and support can be achieved through the engagement of non- executive directors, management consultants or a combination of both. The difference between this type of service and that delivered through coaches and mentors is that business advice deals with the development of strategies and processes for the business, whereas coaching is concerned with the development of the individual director or owner manager.

Businesses that are institutionally or corporately owned are monitored, supported and evaluated, in many different ways, by external shareholders. Wider external skills and experience are available by default, as is a significant degree of objectivity. Pressure can also be brought to bear on CEOs and management teams to address weaknesses and threats. None of this is true for most owner managed businesses; and it can undoubtedly give institutionally and corporately owned businesses a significant competitive advantage over them.

It is for this reason, that owner managed business should at least consider the engagement of some form of external support, of which there are probably three different types.

The first is regular advisory input to develop strategies, structures and processes; to monitor performance, identify threats and opportunities; and to provide general advice across a wide range of business and management issues. This type of advice will draw on broad based experience that is gained predominantly from outside the business concerned. It will be more objective and will act as a balance against the more subjective, more intense but narrower field of experience that exists within the business. If structured correctly, this will deliver more robust strategies, stronger financial performance, improved competitive advantage and greater long term sustainability. A good non-executive director or a competent business advisor should be able to provide this type of service on the basis of a few days per month; so the cost does not have to be high and the potential advantages are substantial.

The second is project based consultancy. This is where a business may have a particular problem or issue or wish to develop an opportunity that has arisen. There may be insufficient skills or resources to tackle whatever it is; so outside help is required. In these circumstances, the choice of consultant will be determined, to a very large extent, by the nature of the issue involved. A production related issue will require appropriate production skills and experience; a logistics issue will require appropriate logistics skills and experience; and so on.

The third is where the business is under performing and facing an increasing risk to its long term sustainability. Unfortunately, this is a far more common problem than many of us would wish and, in far too many cases, is not being addressed. Under these circumstances, a consultant would undertake a full review of the business, identify, quantify and qualify the threats and weaknesses and develop strategies designed to address those strengths and weaknesses, as well as strengthen the business’s competitive advantage. In many instances, consultants will also be able to help manage the implementation of the change programme.

In practice, a business review of an underperforming business or a project based consultancy may be undertaken on the recommendation of a non-executive director or business advisor. Similarly a project based consultancy, the appointment of a non-executive director, the engagement of a business coach etc. could be an outcome of a business review. So all of these means of help and support can be interlinked to produce the desired outcome. But this is where, for many owner managers, things can become confusing and appear to have the potential to run away with the cash. So I’d like to finish this article with a few words about how to select the support you need and how to keep control.

If your business is performing well, you’ve been growing and developing it successfully, you have good market feedback, you’re developing strategies to address market change and exploit market opportunities, then you have a great business model. So whatever you are doing doesn’t need fixing; just carry on and don’t be tempted to hire people that can’t add any more value. However, if you’re in this position, you’re almost certainly amongst a fairly small minority.

If, on the other hand, you could, with the right kind of support, build a stronger and more successful business or turnaround an underperforming business, then you would be well advised to consider the type of support you need.

Is there a particular part of the business that is weak and letting down an otherwise strong organisation? If so look for expert help in that area and bring it in.

If you personally feel out of your depth and are struggling, then perhaps some form of business coaching or mentoring would help. Or perhaps you should engage a business advisor or non-executive director to provide advice, act as a sounding board and oil the decision making process.

If the business is struggling strategically or operationally, perhaps a business review would help give it some direction and focus, particularly if this was followed up with the development of a business improvement plan.

However, the problem for many owner managers is that they know that they need some support but find it difficult to establish what kind of support would be best for them. If this is the case, a business review can be very useful because, it will take an objective view of the business, including the role and contribution of the owner manager. And one of the outcomes should be the type of support, from which the owner manager would benefit.

So in essence, if you’re clear about the type of support you need, go for it; if you’re not, consider an external business review and let that guide you.

However, whatever type of support you require, remember that you are searching in an unregulated market. There are some excellent practitioners, who will be able to help you but there are also some not so good ones. So do a proper search, make sure that the people or firms, you select, have the appropriate experience and track record; and it’s usually best if they have, at least, some knowledge and experience of your industry sector.

Finally, fees are normally based on daily rates plus expenses. What is important isn’t the daily rate; it is the added value in relation to the total cost of the service. If one consultant charges half the fee of another but takes three times as long to deliver and creates only half the added value, he/she will have ended up charging more money for a lesser result, even though the daily rate was much lower. It’s a bit of a minefield and, within reason, its best to make a judgement based on your confidence in the consultant to deliver the outcome you want, for a cost that is acceptable, rather than the headline daily rate.

I hope that you’ve found this article useful; and I’ll be pleased to discuss my own consultancy services with you at any time.

Should SMEs make more use of Business Advisors and Consultants?

The straight answer is almost certainly “Yes”. But I would say that wouldn’t I? I’m a consultant.

Let’s start with the rather well-worn joke about consultants.

“You engage a consultant, who then borrows your watch, tells you the time and charges you a large fee for doing it!”

I’ll be the first to admit that there is some truth in this. Business consultants & advisors can be engaged for many different reasons. In many large businesses and, particularly, in the public sector, consultants are often used to support or challenge strategies that have or are being developed. The reason for engaging them may be “political” in the sense that there are opposing factions for and against a particular strategy and the consultants become de facto adjudicators. Furthermore, if a well know firm of consultants is supportive, the strategy must be OK; mustn’t it? And, if things do go wrong, some or all of the blame can be offset. In these circumstances, the use of consultants is more about internal politics and minimising the risk to individuals’ careers rather than adding real value to the organisation; so there may well be an element of borrowing your watch to tell you the time.

However, this doesn’t tend to happen in the SME sector, which is generally much more resistant to the use of consultants for any purpose. So why are small and medium sized businesses so averse to the use of external advice and support?

In my experience, there are three main reasons: –

  1. Management dynamics
  2. Not fully recognising the added value consultants can create
  3. Cost

So what do I mean by “Management Dynamics”? Well I think that it involves several different threads. Many owners and directors of SMEs are charismatic, larger than life entrepreneurs, who have taken risks, often run by the seat of their pants, worked incredibly hard, overcome all manner of setbacks and ultimately created a successful business, of which they are justifiably proud. And they really don’t want outsiders coming into their business, picking holes in what they’ve done and trying to change it into something different. In many ways, it’s similar to an outsider trying to interfere in a relationship between a parent and a child.

However, in just the same way as a parent will sometimes overlook the shortcomings in their children, an owner or director of an SME can overlook the signs that not all is well within his/her business. But sometimes the issues presented by a child require some form of external intervention; this may involve developing strategies with the child’s school, perhaps with the GP or even a social worker. For parents, coming to terms with this can be very challenging emotionally, and acting on it can be very difficult indeed. But by not engaging in this way, the child’s future could be seriously compromised. It’s much the same with a business; and owner managers and directors of SMEs can find it very hard to accept the need for external advice and support.

For directors, who manage businesses that are institutionally owned or part of larger corporate organisations, it’s not quite such a difficult issue because the shareholder(s) will be monitoring performance, taking an external and broader based perspective and ensuring that the directors are taking appropriate action to meet the various financial targets and strategic objectives that have been agreed. The owner manager has no one to help keep him/her on track; and that can be both difficult and lonely. But it’s where a good independent business consultant can help. A consultant can’t act with the authority of a majority shareholder but he/she can bring considerable experience and a broader based perspective. Coupled with the drive and resolve of the owner manager, this can be a powerful combination that moves the business forward to an extent that could not otherwise be achieved. There are examples of where this happens very successfully, in many different sectors; it just doesn’t happen enough and, as a result, too many businesses under perform and struggle unnecessarily.

The second reason why owner managers and directors of SMEs don’t engage business advisors and consultants is that they sometimes don’t recognise what these people can actually do. Furthermore, they can often be put off by the image that consultants can sometimes portray.

At times, the image issue is not helped by consultancy firms at both the top and bottom ends of the spectrum.

At the top end, there are many stories, within small and medium sized businesses, about large consultancy firms engaged by SMEs, where the outcome is anything but satisfactory for the owners and directors. A partner, from the consultancy firm, may appear at the initial meeting, but most of the work is undertaken by bright young graduates with plenty of confidence and jargon, but little experience. In many instances this happens on the recommendation, or even the insistence, of a bank. Unfortunately, banks can add to the “borrow your watch syndrome” because, very often, all they are looking for, from the consultancy process, is reassurance; and the outcome from this type of consultancy process gives them the justification they need for a lending decision or even the appointment of an administrator. It’s not really designed to add value to the business; but the owners/directors are still faced with a large invoice, which they have no option other than to pay.

It would be entirely wrong to dismiss the large consultancy organisations as charlatans. Many of them are world class and at the cutting edge. Furthermore, many developments that benefit businesses of all types and sizes originate from these organisations. It’s more a question of horses for courses. The large consultancy firms are really geared to the needs of large projects for large clients. They are often less able to support the needs of SMEs, as effectively.

At the other end of the scale, there is a large turnover of people that move in and out of consultancy and never become experienced consultants. Very often they are people who are “between jobs” or people who think they’ll have a go at consultancy but don’t make a go of it and then go back into full time employment. However, it would also be wrong to dismiss all of these people as being bogus. Some newcomers quickly establish a niche position and grow from strength to strength, providing their clients with a first class service. Some people, who are between jobs, have great skill sets that SMEs can make use of for short periods; and, of course, some of these start by working on a consultancy basis and end up as full time employees. From both the employer’s and employee’s viewpoint, it’s a great way of establishing if there’s a good fit.

But, unfortunately, there are quite a number of people within this category, who are playing at consultancy for short periods, not delivering any real value and even pulling out of projects before they have been completed. Unfortunately, they can, and sometimes do, tarnish the reputations of genuine independent consultants.

On a much more positive note, between these two ends of the scale, there are some extremely good business advisors, mentors and consultants, able to provide SMEs with high quality and effective support that adds real and significant value to those businesses. Some work within small firms, others are individuals working on their own; but they all share a professional ethic and take their responsibilities to their clients very seriously.

You can probably classify these consultants into two groups. The first is those that offer a particular skill set, such as IT, marketing, production, logistics, HR, accountancy, etc. The second group provides more general business advice; it’s this second group that I belong to.

It’s probably easier to categorise the services that the first group provide because what is written on the lid is generally in the box. In other words, the services that, for instance, an IT consultant provides, are fairly obvious. However, a potential client needs to bear in mind that many of these small consultancies may be operating within specific markets or sectors, for which they are extremely skilled but they may have less to offer businesses, in different sectors.

In practice, SMEs use consultants with specific skill sets quite routinely; but these consultants tend to work on clearly defined projects under tight control. Furthermore, the boundaries, between consultancy and outsourcing, often become blurred. For example, an IT consultant may be engaged, initially, to address a specific problem or issue but, once this has been resolved, on-going IT support may be outsourced to the same consultant. It is the consultants that provide more general business advice and support that tend to be kept at arm’s length by many SMEs. So let’s examine what it is that these consultants can provide?

The simple answer is: “Experience”. Most consultants, in this category, are likely to have had senior management experience, at an earlier stage in their careers. They understand the fundamentals of running a business. They’ve had successes and failures. They’ve seen different ways of approaching problems. They understand the pressures that business owners and directors are under and they can empathise with them. They are realistic about the restrictions imposed by limited finance, resources and skill sets. They understand the need to carve out practical strategies that can exploit market opportunities, within the limitations that exist. In addition to this, the very fact of being a consultant means that they see many different businesses, working in a wide variety of ways and can, therefore, bring a much broader perspective to the development of solutions and strategies.

Let me give you a couple of examples, with which I’ve personally been involved.

I was called in by a client, who had a sales and marketing problem. The strategy they were pursuing wasn’t delivering the level of sales they expected and they wanted some help in deciding what to do about it. I analysed, in detail, the various activities, in which they were engaged, the results they achieved and the costs they incurred. There was actually very little wrong, except that the whole process was being significantly under resourced, for the level of sales they were targeting. However, there was no cash available to address that problem; so I looked at other areas of the business and identified significant under performance in production. Both direct labour and material consumption was far too high and, if this could be addressed, it would release the cash they needed to support sales and marketing more effectively.

I was not the right person to work with this client to sort out the production problem; but my experience was sufficient to enable me to show them that this is where the route of their difficulties lay. They were then able to take appropriate action and, by introducing improved production systems, they gradually resolved their marketing problem.

My second example also starts as a sales and market issue. The client, a home improvement business, was struggling with low margins. They had screwed down their costs as much as they possibly could but their margins were still much too low. They tried to increase their selling prices but, every time the price went up, volume fell back significantly. And yet their market intelligence was telling them that their unit selling price was well below that of many of their competitors. So they were stumped. I undertook a profiling exercise of their customer base and found that their core customer profile was younger couples in their first homes. These customers were not interested in buying top of the range products but were looking for bargain basement products that would tidy up their homes, make them better to live in, in the short term, and easier to sell, when they moved on, in a year or two’s time. However, the product, the client was supplying, was premium not budget.

There were only two possible solutions. The first was to reposition the brand in the market, targeting buyers of premium products, prepared to pay premium prices. The second was to maintain the existing brand position and selling price but supply a budget product that was cheaper to produce.

On the basis that changing market position is very difficult, very expensive and would, in any case, take a long time, the solution was to change the product. This is what they did and, ultimately, it meant changing supplier.

Would these two companies have reached the solutions without my involvement? Possibly; but nothing like as quickly and the costs of delay would have been considerably more than the fees they paid me.

These are practical examples of ways, in which a business advisor can help. They are both project orientated, where the consultant (me), was engaged for a specific project, at an agreed fee, went in, did the work and then withdrew. However, business advisors and consultants can often be retained to provide on-going support on a regular basis; a day or, perhaps, two days per month. This enables them to maintain an on-going involvement with the business, review performance each month, help identify problems, develop the best solutions and look for opportunities and ways of exploiting them. All of this can be very difficult for owner managers and directors of SMEs because they tend to be immersed in the day to day activities of the business with very limited opportunity to stand back and take a wider and objective view. And this is why so many SMEs fail to optimise their performance and why some eventually fail. The consultant provides much of the external perspective and objectivity that an institutionally owned business or a subsidiary, within a group, would gain from its shareholder(s).

Another advantage of retaining a business advisor or consultant is that, if specific projects emerge that require a consultancy input, the consultant is already there and has no learning curve to go through. This means the project can be completed quicker, more effectively and at a lower cost.

We’ve looked at one off projects and on-going support. But there is a third area, in which a business consultant can help. Remember that these people have invariably run businesses in the past; so they can step in, where necessary – short term – in an operational role to manage the introduction of a change programme or stand in for a senior manager/director, who may be sick, have resigned etc.

In my view, the best and most effective consultancy, of this type, derives from building relationships, based on mutual trust and respect. A consultant, who is retained for a day or two a month, builds up knowledge of the business, which steadily increases the value of his/her work and provides an additional skilled resource that can be deployed, as and when required.

The third and final reason for SMEs resisting the use of business advisors and consultants is cost.

Consultancy costs vary enormously from a few hundred pounds a day for the casual consultant, at one end of the spectrum, to a few thousand pounds a day for a partner of a large consultancy firm. So it’s fairly meaningless to talk about average costs. However, most good independent business advisors and consultants are probably positioned at £1,000 per day or below. My own fees are significantly less than that.

Because you only engage a consultant for a one off project or for just a limited number of days each year, your annual consultancy costs should be modest, predictable and controllable. Furthermore, most responsible consultants will not try to leverage up their fees to a level that becomes a burden on the business. Most will structure the consultancy so that it is affordable. After all, they have no interest in giving you a cash flow problem and not getting paid!

So the issue really comes down to whether you think you are getting some value in return. I would argue that an effective business advisor or consultant, working two days a month, in most SMEs, would add considerable net benefit to the bottom line.

The problem for most owners and directors of SMEs is that, at the outset, the costs of a business advisor or consultant are defined, whereas the benefits are, to some extent, speculative. In addition, most business owners and directors become more risk averse in tough times. So a speculative punt on a business advisor becomes much less likely.

The irony is that the skilled business advisor or consultant can often make a larger positive impact on the bottom line, when times are tough, than when they are buoyant. And to illustrate the point, I’ll recount a piece of work I’ve done recently.

For obvious reasons, I’m not going to publish any clues as to who the client may be; all I’ll say is that it is a £5m T/o business that has been trading for about four years. So it’s done well to achieve that level of growth in a comparatively short time. Its directors are intelligent, skilled and very industrious people, with high levels of integrity. I was approached by them in the last quarter of 2011 because they had cash flow problems. They were very open and honest, with me, about their position and I worked, with them, to establish why they were in their current predicament.

They had never made big profits because they had been funding their impressive growth. However, during the latter part of 2010 they started making losses and during 2011, they implemented a cost cutting programme to try and stem those losses. But it didn’t work because, although their overheads fell, their margins came under pressure and their gross profit declined, by more than the reduction in overheads.

I undertook some detailed analysis and found that the margin erosion was due to two factors. Firstly, they had started chasing volume. They cut their prices and took more risky work. As a consequence, their margins fell and their bad debts increased. Secondly, by cutting their overheads, they had taken away some of the key controls in the business, without replacing them with automated or more efficient systems. Consequently their procurement process was out of control and material costs increased significantly.

I worked with them to review, restructure and properly resource their systems and processes in order to regain control. We also introduced more effective credit control and stopped chasing volume.

When I first became involved, the business was, in all probability, heading towards administration. It’s now back in profit and starting to generate cash. There is still a long way to go; but it’s out of intensive care and the prognosis is now for survival and long term sustainability. Without my involvement, that would not have been the case.

My total fees and expenses amounted to a little over £6,000 plus VAT. I leave you to consider the added value that this expenditure created.

The directors of this business took a leap of faith by engaging me, I ensured that the fee structure was manageable and, between us, we got the result we wanted.

It goes without saying, that you must be very clear about why you engage a business advisor or consultant and that you are careful about whom you appoint; but if more SMEs would take the leap of faith, taken by my client, there would be many more strong balance sheets and considerably fewer casualties, particularly when market conditions are tough.

Market Share – One Critical Leg of a Three Legged Stool

Here’s a quote from BBC Business News on 31st January 2012: –

“In the 12 weeks to 22 January 2012, Tesco’s market share dropped to 29.9%, the lowest since May 2005, research firm Kantar Worldpanel said. Tesco has described its Christmas trading period as “disappointing”, after like-for-like sales fell 2.3%. In contrast, Sainsbury’s and Iceland both gained market share. Sainsbury’s edged up from 16.6% a year ago to 16.7%, its strongest hold since March 2003. Iceland’s share rose from 1.9% to 2.1%, its best share for 10 years.”

One of the key measurements of success for supermarkets is market share. In this quote, we see Tesco under pressure because it has lost market share during the last Christmas trading period; and Sainsbury’s and Iceland glowing because they’ve gained market share.

Supermarkets allocate large budgets to researching market shares and they have very sophisticated data capture systems to provide them with detailed market share information. They look at market shares by product, by time frame, by region, by store and probably by many other criteria as well.

They don’t do it for fun; so why do they do it?

There are, no doubt, a myriad of reasons ranging in importance; but there are really three key measurements of business performance and sustainability. These are: –

  • The Profit & Loss Account (P&L)
  • The Balance Sheet
  • Market Share

The P&L tells us how much money was made or lost over a specific time frame; a month, a quarter, a year etc. By implication, it tells us how effective and efficient we are as a business and it helps us identify areas of operational strength and weakness.

The balance sheet tells us how strong we are financially; our working capital, our gearing, our net worth etc. If we’re making profits our balance sheet is building and we can use it to help us make decisions about future investment, growth, development etc. If we’re losing money, it helps us understand how long we can sustain those losses and what financial resources we have to help achieve a turnaround.

Market share tells us how well our business strategy is working. If we’re losing market share, we lack competitive advantage, our competitors are outperforming us and our strategy clearly isn’t working. If we’re increasing our market share, we have created competitive advantage, we’re outperforming our competitors and our strategy is working.

Sales growth or decline and market share should not be confused. If the market is growing and your business is also growing, you will still be losing market share, unless your growth is equal to or greater than that of the market. If you’re growing but losing market share on a rising market, you’re benefiting from the growth of the market, but you’re still under performing, relative to your competitors and, as soon as the market turns and starts to fall, which it will do at some stage, your rate of decline will be greater than that of the market; and, as I’ll show later, this could be catastrophic.

Similarly your sales could be falling but, if the market is falling even faster, you’re still in a position of having competitive advantage; and this could put you in a strong position, when the market stabilises or, in extreme circumstances, it could give you more time than your competitors to develop a diversification strategy.

Strategically, the relationship between the P&L, the balance sheet and market share is all important and the messages coming back from each need to be considered together, if you’re going to make the best decisions for your business.

If you have a strong balance sheet, your P&L is showing very healthy profits and you’re gaining market share, then your business is in pole position; but realistically only a minority of businesses achieve this and maintain it for very long. At the other extreme some businesses have very weak balance sheets, are incurring significant losses and are losing market share. Realistically, many of those are heading for collapse. Most businesses lie somewhere between those two extremes; but in tough trading conditions, businesses are pushed down the scale and in buoyant conditions, they are pushed up the scale.

Consider a few scenarios.

Scenario 1: Take a business that has a strong balance sheet and is very profitable, but which is losing market share on a rising market. Its P&L suggests that, operationally, it is efficient and well managed. Its balance sheet suggests that it has plenty of resources for investment and development. However, its loss of market share suggests that its strategy isn’t delivering; so, despite a strong financial performance, all is not well. No business can survive indefinitely if it continues to lose market share. But because it has a strong balance sheet, this particular business can afford to invest in a detailed review of its strategy as well as the development and implementation of a new or reconfigured strategy. And that is what it should do.

Scenario 2: Let’s take an almost identical situation except, this time, let’s assume that the balance sheet is much weaker. The problem is the same. The strategy isn’t working; but the ability of the business to fund a major strategic rethink and change programme is much more limited. If no strategic change is brought about, the business will ultimately fail; that’s inevitable. But the weak balance sheet means that the resources available to fund the change programme are much less, as is the room for error within the change process itself. The rate, at which change can be achieved, is also likely to be much slower. So the risk to the business is much higher than is the case in scenario 1; and, although it doesn’t mean this business can’t be returned to long term sustainability, it’s going to be much more difficult than it will be for the business in scenario 1.

Scenario 3: Consider a business that has a reasonable balance sheet, is gaining market share but is delivering very low profits. Is this the “busy fool syndrome”? Is this business buying business? Is it simply selling too cheap? If it didn’t know what was happening to its market share, how could it answer those questions with confidence? The answer to this last question is that, “it couldn’t”.

These three scenarios illustrate how the P&L, balance sheet and market share data can be used together to understand the performance of a business and help identify if and where strategic change is needed.

I now want to describe two real examples. These are based on fact; although I am not identifying the businesses for reasons of confidentiality.

I’ll call the first business “Company A” and will describe it as a significant player in the home improvement market. It was very profitable and operationally well managed. It also had a strong balance sheet. I undertook a market share analysis and found that, for a number of years, it had been gaining market share on a rising market; so during that period its strategy was working well. However, its increasing market share then reached a plateau, after which it started to fall. But, for a time, the decline in market share was masked because the market continued to grow and Company A also continued to grow, but at a lesser rate than the market. During this period, the business continued to make healthy profits; but the warning signs were there. The strategy that had worked so well in the past was no longer providing the competitive advantage that the business needed to stay ahead of its competitors. At this point there needed to be a fundamental strategic review and the development of a new strategy, capable of recapturing the lost market share and then gaining further share beyond that. This didn’t happen; the market then started to fall and Company A found itself losing market share on a falling market. Despite its operational efficiency, sales volume fell, to the point where there was insufficient critical mass, and the business eventually went into administration.

The real point of this story is that the main focus was on the P&L and balance sheet, both of which remained strong for a considerable time, while market share was declining. The business was balancing on a two legged stool that eventually toppled over, rather than sitting on a three legged one, which would have had a much greater chance of remaining upright.

My second example is another home improvement company, which I’m calling Company B. Company B is a successful and profitable regional player. The business had been using local radio as a means of advertising for several years. However, its trading area didn’t fit easily into any of the broadcasting areas of the available local radio stations. This meant that it had to utilise several local radio stations rather than just one or two; and furthermore, there were large gaps with no radio cover at all. The costs were high and the cover not complete; as a result, Company B decided to analyse the sales that it could attribute to local radio advertising. Its conclusion, based on this analysis, was that local radio advertising wasn’t cost effective. However, before the business withdrew from radio advertising, I was asked to consider whether there might be other ways of measuring the results.

I used published market data and found a way to calculate Company B’s market share, based on relevant postcode delineation. I then overlaid this with the local radio stations’ broadcasting areas. The results were interesting because, whilst the original sales analysis showed relatively few sales directly attributable to radio advertising, Company B’s market shares were much higher in those areas covered by radio advertising than those that were not. In principle, this wasn’t unexpected but the differential between the hotspots within local radio broadcast areas and the cold spots, where there was no radio advertising was substantial.

In this example we see market share information being used more tactically than strategically; but without it, the wrong decision could have been made. In the event, Company B continued to use radio advertising.

Now let’s go back to the supermarkets. They put so much resource into market share analysis because they need to be able to measure the effectiveness of their strategies and tactics at very regular intervals. They can then make informed decisions at an early stage and, by so doing, optimise their financial performance and identify problems at the earliest possible opportunity.

Most large FMCG organisations rely heavily on this type of analysis and research. But as businesses move away from FMCG, there tends to be less emphasis on market share research and analysis. In the SME sector there is often very little. However, for the reasons I’ve outlined, most businesses need to have a reasonable fix on their market shares and, if they are to optimise their financial performance and remain sustainable in the medium and long term, they need to respond to the messages that are conveyed.

In many markets, where market research is much less sophisticated and much less frequent than is the case in FMCG markets, it is usually possible, with a little thought and ingenuity, to use published market research data to provide a reasonable basis for market share calculations. It won’t be as detailed or as sophisticated as that used by the supermarkets, but it will be enough to keep the business secure on a three legged stool rather than falling over on a two legged one.

Is your business obese or anorexic?

Few people maintain their ideal weight for very long. In the West, we are predisposed to being overweight and in many third world countries malnutrition is the more immediate concern. But either way, the effect on health can be serious; and it’s the same for businesses.

If a business becomes overweight or obese with bloated overheads, its processes tend to become over complicated, its organisation bureaucratic, its decision making convoluted and its focus introverted. Internal politics and posturing also tend to take precedence over customer service and operational excellence. As a result, profits are not only depressed by the cost of the excess fat but also by the health problems that the excess fat creates.

Generally speaking, it is larger businesses that tend to suffer from this affliction and, of course, it is at epidemic proportions within local authorities and the public sector. Smaller businesses are less susceptible but by no means immune.

At the other extreme, when businesses become seriously underweight, their overheads may be very low but their general health is poor, as their vital processes and controls are undermined by the lack of resources. This often occurs because necessary investment is treated as unnecessary expenditure and is perhaps the equivalent of anorexia rather than famine.

It is smaller and more isolated businesses that tend to show these characteristics; although larger ones sometimes do as well.

Against this background, if we’re faced with a business that’s underperforming or losing money, how do we know whether it needs to slim down or build up its infrastructure?

The simple way is to benchmark against a similar type of business that is optimising its performance. The table below shows simplified P&Ls for three fictitious businesses, within a particular industry.

Company A is considered to be optimising its position; so each of the others can be benchmarked against it.

The percentage columns show each line of the P&L for each company as a percentage of that company’s sales. So for example, Company A’s gross profit of £925,000 is 37% of its sales of £2,500,000.

The key comparisons are, therefore, the percentage columns.

If we compare Company B with Company A, we see that: –

  • Material costs are running at 42% of sales compared with A’s 40%
  • Direct labour is running at 22% compared with 20%
  • Transport is 4% compared with A’s 3%.

In total, B’s direct costs are 68% compared with A’s 63%, which means that B is either selling at significantly lower prices than A or is operationally less efficient. It could of course be a combination of both.

If we now look at overheads, we see that B’s are 36% of sales compared with A’s 25%, B’s salaries and indirect wages are significantly higher (5 percentage points) but its other overheads are also higher.

Company B has bloated overheads, which, on their own, have led to a small loss. But the loss has been increased by the lower percentage gross profit. So not only is the fat adding unnecessary cost, it is also undermining the performance of the business.

If we now look at Company C, we can see that the gross profit is only 14% of sales, which is substantially less than Company A’s 37%. Material, direct labour and transport costs are all running at much higher rates than A’s. Whilst C may well be selling at lower prices than A, this is unlikely to account for such a large difference in gross profit. Poor operational performance will almost certainly be a key factor.

If we now compare the overheads of the two businesses, Company C’s are running at 15% of sales compared with A’s 25%; and they are lower across all of the cost centres, but particularly staffing. So C has saved 10 percentage points compared with A; but the lack of control, operationally, has meant that its direct costs have increased by 23 percentage points. It is, therefore, 13 percentage points adrift of A.

Here we have the classic anorexic business. Presupposing there ever was any, the fat has long been cut out and the lack of sustenance has eaten in to the muscle.

The turnaround strategy for Companies B and C will be entirely different. Company B will require a substantial overhead reduction and the introduction of more efficient process and controls. Company C will require investment in resources to give it the capability of operating efficiently and effectively; and this will mean that overheads will increase.

The examples I have shown are both fictitious and extreme in order to demonstrate a principle. In real life it won’t necessarily be that simple; and because of that, businesses often apply the wrong strategy. In particular they cut overheads to compensate for low margins rather than introduce appropriate resources to address the margin problem. In many ways, cutting overheads is the easy option; and in some cases it is the right one; but not always.

For many small and medium sized businesses benchmarking presents some difficulties because they don’t have reliable figures for their competitors. However, most industries have expert consultants, within them, who know what the ideal P&L structure should look like. I have that expertise for the industries, in which I have specialised; so when I review management data from businesses, within those industries, I can identify the key issues very quickly and can advise whether the business needs to be slimmed down or strengthened. And whilst I couldn’t do that for businesses, within industries outside my experience, there will be others who can.

In view of the risk of getting it wrong, it is always advisable to bring in expert opinion before embarking on a turnaround strategy, even if all it does is confirm that the basic strategy is right. The costs of this tend to be comparatively small; the costs of getting it wrong can be enormous. There are no prizes for being a business anorexic.