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Making the best business decisions – how to evaluate your opportunities

One of the questions that I get asked most often by business owners is how to decide between one or more options – when faced with path A or B, how do you know which fork to choose and what the potential outcome may be?

These sorts of question arise for businesses of all sizes and they’re just as important for the small business owner as for the large business owner. In the past three months, I’ve helped a painter/decorator decide if he should change his van and I’ve helped a large food manufacturer decide whether to outsource production, or keep it in house. For both of them, their decision was important and could have an impact on their business.

The value of good advice

I wasn’t long qualified as an accountant when an old school friend, now a dentist, asked me if he should refurbish his dental surgery. He’d already asked his accountant, who replied “that’s up to you”. That answer wasn’t very helpful. We know it was up to him to decide but his accountant wasn’t providing him with any advice as to how to make that decision.

To put it bluntly, he wasn’t adding much additional value as an accountant.

But (thankfully) times have changed, and most good accountants now realise that a large part of their role it to help with this kind of decision making – whether it’s supplying the right numbers, forecasting the potential outcomes or looking at the strategic implications.

So how do I go about making financial decisions?

I focus on the cash flows in your business and compare the different cash flow relating to all the options.

The simplest way to explain my approach is to imagine that the business has a large barrel of cash and ask what will happen to the cash in each of the scenarios. What money will come in and what money will go out? Once I identify the cash flows, I enter them into a table with three columns.

  • The first column is for the cash flows in the current situation.
  • The third column is for the cash flows in the alternative situation.
  • The middle column is for the difference in cash flow between the two options (I’ll show you an example of a completed table shortly).

Before you do that, you need to decide what sort of a time period you’re going to consider.  Its common to look at a decision over the life of the relevant item – so if it’s a van and you plan on changing again in three years, then you might evaluate it over three years. If you’re looking at outsourcing production, you might just look first at one year and then consider whether you need to review a longer period.

So, let’s look at the van example.

How much will a new van cost?

Let’s say John is currently running an 8-year-old van. His garage has a good 3-year-old van for €12,000 and will give him €1,500 for the old one. John wants to know if he should change.

The first thing I will ask is what the current van is costing him. He tells me his current van works up the following costs:

  • €3,600 a year in diesel to fuel the van.
  • €300 a year to tax and €500 a year to insure it.
  • Repair costs as the van had been giving him trouble which needed repair
  • €100 per day to hire a replacement van while his own was off the road – he expects this to continue and suggests that I allow 5 days a year for being off the road with maintenance work.
  • 2 days a year in lost earnings while he is dealing with the van – where he normally earns €400 per day on average.
  • Overall the van is costing John about €2,000 a year in maintenance, €1,000 of which is normal wear and tear, the other €1,000 is due to breakdowns.

Next, let’s look at the costs of buying a new van:

  • The new van John has his eye on will cost €12,000
  • We can then subtract the €1,500 trade-in on the old van.
  • John reckons he’ll sell the van on in 3 years for €4,000.
  • He estimates that it will cost him about €3,100 a year in diesel.
  • It will cost him €250 a year to tax it but €600 a year to insure it.
  • He’s not expecting to have any breakdown days or van hire.

So, overall the new van should cost about €1,000 a year in maintenance, which is all for normal wear and tear.

Note – these are not real numbers. They’re my best guesses to develop a reasonable example for you.

I put my table together, taking three years into account.

Current Van Difference New Van Comment
Investment 0 -10,500 -10,500 As I’m only looking at what will happen from now, I don’t consider the cost of the current van.
Fuel -10,800 1,500 -9,300 This is fuel cost over 3 years, based on the info supplied.
Maintenance -6,000 3,000 -3,000 Maintenance cost over 3 years. based on the info supplied.
Van Hire -1,500 1,500 0 5 days pa for 3 years at 100 per day
Lost Earnings -2,400 2,400 0 2 days a year for 3 years at 400 per day
Tax -900 150 -750 Info as supplied
Insurance -1,500 -300 -1,800 Info as supplied
Resale Value 0 4,000 4,000 Info as supplied
Net Cash In/(Out) -23,100 1,850 -21,350  

 

Positives in the cash flows are ‘cash in’ and negatives are ‘cash out’. In the difference column, positives show where the new option is better than the current option; i.e. cash in, or less cash out.

So, what the above table tells us is that a new van looks like it will save about €1,850 over the three years. We need to be careful and remember that we’re making assumptions, albeit reasonable ones, about the performance and reliability of the new van. We need to be confident that we are aware of, and considering all of, the costs.

We’re not taking into account intangible elements like the effect on his business profile of driving in a newer van. Also, we’re not taking into account the effect on customers of cancelling work because the van let him down. And we’re also not taking into account the effect of having a reliable van and less stress and worry on John himself. We can allow for those in our decision but it’s hard to quantify them and put them in the table.

The bottom line is that the new van looks like it will save him €1,850 over the three years but there are some intangibles that might also be worth a lot to John and only he can put a value on those. I think most of us would change the van based on the info above.

The time value of money

Another factor to take into account is what accountants call the ‘time value of money’.

If I ask you which would you prefer – €1,000 now or €1,000 in 1 year – you’ll all intuitively know that if I get €1,000 now I could invest it somewhere and maybe make another €10 to €30, say €20, in that year. That means that €1,000 now is really worth €1,020 in 1 year. This is what we call the time value of money.

For some decisions, it can be worth taking this time value of money into account.  If you have high interest rates and two options with very different cash flow patterns then it may be worth looking at. But for most day-to-day investments, it’s not worth the additional work – and in any event it will involve other assumptions.

A systematic approach to decision-making

So, that’s how I recommend that you approach decision-making – by systematically breaking down those cash flows and seeing which scenario works out best for your business.

  • Identify the options available to you.
  • Note down the cash flows for each option.
  • Put them into a table and see which one looks best.

Put a little bit of time into challenging your assumptions and into thinking through the options to make sure you have considered everything that is relevant. And armed with your outputs you can be confident you’re making the best decision for the future.

Next time we’ll look at some more practical examples of how this can be put into practise.

If you’d like any assistance with your business decision-making, please do get in touch to see how we can help

 

 

Six elements that make an excellent finance function

Overview from PeakAs a business advisor, I get to see a lot of different businesses and their finance functions. At one end of the spectrum, the finance function just does the basics i.e processing invoices, managing cash and preparing the core reports. At the other end of the spectrum, the finance function is a key strategic partner to the senior management – whether that be an owner-manager or a full management team. And between those two extremes, there can be a range of options.

In this article, I will set out what I consider to be the key elements that make up an excellent finance function. No matter how the finance function is structured, it is essential that the management team have access to resources to help them understand, interpret and communicate the relevant data needed to support them in keeping the business on track.

In my experience, there are 6 key elements that come together to create an excellent finance function.

The elements

  1. A foundation made up of the core finance systems
  2. Insightful data that can be analysed as needed
  3. An excellent understanding of the business
  4. Outstanding Influencing Skills
  5. A supportive attitude
  6. Responding Resourcefully

1. The Foundation – Core Systems

Firstly, the basics must be in place and must work unnoticed. There will be appropriate systems that process the transactions – sales invoices, purchase invoices, receipts and payments – smoothly and efficiently. Key controls must operate to secure the assets of the business. The basic reports must be readily available within short timeframes. Essentially, we are looking at a lean operation – delivering what the customers of the function need with minimal intervention.

The one thing that can be guaranteed to cause the users of financial information to lose confidence is if the basic information is not reliable.

Pillar 1 – Insightful data designed to deliver required information

Next, consideration should be given to the type of information and analysis that will be useful. The systems should be designed to collect relevant data and be able to report easily on the data. Management should have considered what type of analysis will be required and the finance systems should be designed to capture that key information when the core transactions are being created so that the reports are available with minimal extra manipulation.

For example, if a distribution company has a goal of maintaining its sales to multiples while significantly growing its sales to independents, I would expect to be able to be able to quickly pull reports that show how sales are split between multiples and independents. To do that, each customer will be categorised and then finance can easily run a report showing sales by customer category.

Pillar 2 – Understanding the business

An excellent CFO will have a very good understanding of the business and will be always aware of what is happening. To be able to evaluate how events will impact on the profitability and on cash flow, the CFO will intuitively understand the relationships within the business.

For example, if sales in the business are switching from high labour products to low labour products, the CFO will have a sense of the impact of this and this would likely trigger an analysis of the specific impact on headcount enabling the business to respond proactively.

To develop this awareness, the CFO will spend time walking around the business understanding what happens within the business and talking to key people whether that be operators or management. This CFO will have good relationships with the other managers and will keep himself or herself informed of what is going on in the business. I would expect the CFO to run projections a several times a year and then to compare the projections with the outcomes. In this way the CFO will be testing and developing his/her understanding of the business.

Pillar 3 – Outstanding Influence Skills

The third pillar for an excellent finance function is to be able to influence key people. These key people can be management colleagues, direct reports, funders, customers or suppliers. To be a key influencer you must know what is important to the audience and you must be able to communicate simply and clearly.

Pillar 4 – A Supportive Attitude

A great CFO will understand that Finance is a support function and that its role is to help operations and the other departments to deliver the product or service. Because everyone will not have financial acumen, the CFO will be alert for opportunities to help the other functions and to use finance constructively for the benefit of the business.

It is also important to be able to nurture that attitude throughout the finance staff. The CFO can’t do everything and needs to have a like-minded team around him or her so that the CFO can delegate well while focusing on what’s important. This is done by hiring well, by managing well and by being an excellent role model for how an excellent finance professional operates.

The Roof – Responding Resourcefully

When a finance function has the basics right, curates key information, understands the business, operates supportively and is a key influencer, the function can then respond resourcefully for the business by evaluating the events that are happening so that opportunities can be grasped and problems can be anticipated.

It’s probably true to say that for a really great CFO, technical ability is less important than the CFO’s ability to influence strategic discussions with useful analysis of timely, relevant and accurate data. This ability comes from understanding how the business works, understanding what’s important to the business and to the management colleagues and then being able to use that understanding to make a difference to how the business addresses the key issues that it faces.

Conclusion

Having read this article, what are the elements you need to focus on in order to improve your finance function? Why not rate each element as it is in your organisation. Then prioritise the elements you need to work on, preparing a one-page plan with attachments around specific action plans if required.

If you need help developing your one page action plan, feel free to contact me.

Finding time for Strategic Thinking

This blog update comes from Mindshop Colleague, Paul Hopwood. (http://www.paulhopwoodconsulting.co.uk) Paul is a longtime Mindshop Member and is one of the Support Coaches for Mindshop members.

Very often, the biggest constraint for business owners is their time. Those who make time to think strategically tend to punch above their weight. We know this intuitively, but operational issues can easily get in the way.

“Strategy is the great work of an organisation. In situations of life and death, it is the Tao of survival or extinction. Its study cannot be neglected – Sun Tzu “The Art of War”

“Plans are useless, but the process of planning is indispensible” – Eisenhower

If you are guiding your business or a customer on their strategic agenda, it’s your job to isolate the right quantity and quality of strategic thinking time.

Here are 10 tips for doing so:

1. Split board meetings between strategy and operations. This could potentially be done in separate meetings, possibly with a smaller steering group
2. Schedule the dates for the entire year ahead and never cancel the meetings
3. Use the One Page Plan as a framework. If you are discussing something that isn’t on the plan – either the plan is wrong, or you probably aren’t being strategic
4. Get the administrative protocols right – E.g. agenda in advance, circulate papers a week in advance, start and finish on time, bullet point minutes of actions and follow up action progress between meetings
5. Be aware of where the conversation is leading while keeping a balance between strategic and operational issues
6. If there are some short-term, burning issues, factor them into the One Page Plan, but don’t get bogged down – decide how they should be tackled outside the meeting (e.g. project team) and move on
7. Be conscious that you don’t spend too much time managing exceptions (i.e. actions not completed and excuses). This is a total waste of everyone’s time
8. Ensure someone is responsible for keeping the meeting strategic. Usually this will be the chair or facilitator
9. Make your planning process iterative. Don’t put all your effort into the annual away-day, but evolve the strategy as you go along
10. Define the rules for each meeting – E.g. ego-less, listening, not interrupting, allowing everyone a turn to speak.
Do this well and everyone will get good value from their strategic time and be able to reduce the time they waste fighting fires.”

As always, if you have any questions on this blog post, feel free to contact jim (at) accountsplus (dot) ie.