A Life In Numbers

It’s a year since Lehman’s collapsed and threw the financial markets into turmoil.  And the last year has been an incredibly challenging period for many companies.  Whilst large corporates have been able to survive through budget freezes and cost reductions, although even this wasn’t enough for some, the SME sector has had even more challenges to face with the banks freezing access to finance, large customers pulling back their business, and cost cutting endeavours slicing to the bone.

There’s a big difference between a company of 10,000 cutting 10% of the workforce and losing 1,000 people.  It sounds a lot and can be distressing for all involved but it still leaves the company with 9,000 staff which can be plenty enough to take up the slack.  For an SME, there’s much more of a challenge.  The cuts have to be deeper to make a difference and for a company to reduce from 50 heads to 25, it means resources are stretched really thinly.  Sometimes to breaking point.

Any company who has lived through the last year or two and survived intact has something to be very proud of.  The challenges are by no means over yet but there are signs the worst may be over.

Building a business can be a challenge at any time but if you’ve survived through the current economic climate then it’s a a real sign that you have what it takes to succeed.  The key lesson is to remember what you learned through this period.  Actually companies can survive with tough decisions and the most useful asset in a business is not it’s resources but the resourcefulness of the management.

It’s also worth bearing in mind that there can still be more danger as we return to growth, especially if you don’t have a good understanding and control of the finances. 

So, if you’ve survived so far, well done.  If you didn’t quite make it, there’ll be other opportunities.  Whichever it is, make sure you look back and take some good lessons from the experience.

So, we have the much anticipated Pre Budget Review and the FTSE has it’s greatest day’s rise. Are the two connected or pure coincidence? Was the rise due to the budget announcements being better than expected or not as bad as the market feared? Or was it just Obama’s new finance chief?

For SMEs the most important elements were these:-

VAT changes (short and long term) - it’s debatable how much benefit the reduction will have. Many services companies rely on the VAT element coming in on their sales (and not paid out on salaries) to boost their cashflow in the month and this potentially reduces that element. If you’re spending a lot on stock, assets and general expense then it feasibly reduces your short term outgoings but again, if you’re profit making then the leveraged impact on less cash coming in from sales may hurt you.

For the accountants it creates a whole lot of extra administration and careful checking, especially in the transition periods. It’s going to mean a considerable number of tweaks to business models, accounting systems and invoice systems and there’ll be lots of errors to chase down. And certain companies will use the potential for error to justify delaying invoice payments. In some respects the worst element will be when the rates change back again and just when companies have got used to a lower payment then all the prices will increase again. And potentially up to a 20% rate.

Over time, for sizeable SMEs and companies, VAT is something of a wash through the accounts but it does interfere with the cashflow. It should ultimately benefit the small entrepreneurs and one-man-bands who are below VAT registration thresholds along with their customers, providing they can administer the changes.

Overall, I’m sure it looked good on paper and the economic theorists can wax lyrical about the macro-economic impacts but I remain to be convinced about the real benefits for SMEs.

Verdict - make sure you change your systems, invoices and models to reflect the new rate and check everyone else’s invoices carefully

National Insurance - Ouch! Of course, this isn’t a tax is it? Even the name tells you it’s a contribution. Your way of giving back. At least we have until 2010 but this still stings and adds an even greater cost to employment as the 0.5% is going on employees and employers. This will take employers rates to 13.3% on top of salaries.

Verdict - there comes a point when you have to question the costs of employment (with requisite recruitment costs, NI payments, benefits, pensions, administration, employment rights issues, notice periods and employment insurance) and consider whether it’s far better to simply bring in flexible resources which might seem a little more costly at first glance but end up as much better value when everything else is taken into account.

Corporation Tax - generously deferring the 1% rise for small businesses. So at least you’ve got something to look forward to if you can claw your way to profit in the current market. This doesn’t really do a whole lot to encourage entrepreneurship in the country and generate more employment opportunities.

Verdict - make as much profit as you can now before the rise comes in (simple as that!)

Finance and Lending - at least there seems to be some desire to get more funding into the SME sector. Unfortunately, there’s still the massive number of governement bodies advising and guiding SMEs through the maze of which they form an inherent part as highlighted by Doug Richards in his report last year. In reality this is likely to be an expansion of the existing Small Firms Loan Guarantee Scheme which is proving more popular than ever with the banks. They seem more keen on lending when they have a Government backed guarantee. If the promised Small Business Finance Scheme with guaranteed bank lending up to £1m (compared to the SFLG £250k) is introduced in the new year then this could present quite a useful line of credit. It will all depend on the qualification criteria and the application process.

Verdict - check to see if your company qualifies for any of the lending but be prepared to spend 3 to 6 months in the application process.

Business Tax repayments - a subtle but important change which essentially has the Chancellor telling HMRC to go easy on companies struggling to pay their tax bills (including corporation tax, PAYE & NI and VAT). This is actually an area that could be of real benefit to growing companies, especially on the PAYE and NI front which forms a huge (often 50%) part of their cost base and is usually expected within the month after salaries are paid. Obviously the intention is that the tax is all still paid but there is supposedly more scope for agreeing payment plans and terms.

Verdict - if you can afford to pay your tax then you need to pay it. If you’re struggling, then talk to HMRC and quote the budget review. It will be interesting to hear the responses.

Entrepreneurs generally - having previously taken away the Business Asset Taper Relief (replaced by the inferior Entrepreneurs Relief and Capital Gains changes) the chancellor continues to show a disinclination to support and encourage entrepreneurial risk takers. Increasing higher rate taxes, taking away personal allowances, reviewing offshore tax statuses (stati?), capping pension funds and increasing employment taxes all hurt those seeking to build businesses and generate employment. The whole point for many entrepreneurs is that they are willing to take a risk because they see a greater reward. And whilst there may be other non-monetary benefits such as the pride, excitement and challenge of building something against the odds and taking others on that journey with you, ultimately it’s the monetary gains (and what they can give you) that drive many entrepreneurs. Capping and taxing the amount they can make could potentially drive many overseas to friendlier economies or drive them to get proper jobs in other companies (potentially leading to the demise of those companies due to their disruptive natures).

It’s the entrepreneurs that can pull this country out of the jaws of recession if they are given the freedom to do so. This budget gives with one hand but takes away with quite a few others and it will be some time before the smoke clears and the mirrors reflect what’s really happening. Until then we’ll all have to pop a few nurofen and get back to studying the small print.

It’s good to see that there’s some consolidation in the market for part-time FDs. The recent merger of FDUK and FD Centre shows that there is more interest than ever in the use of flexible finance resources by large and small companies.

As the credit crunch bites and companies come under more pressure to manage their cash, more and more CEOs and MDs are finding that they have more than enough to occupy their time without having to look after the company finances too. Operations that could be handled in a growth market now become much more challenging. And it doesn’t take much of a shift in the finances of a business to take it from healthy and prospering to wounded and struggling.

The continued growth of companies providing the services of a part time FD or CFO, shows how a good management team can make a great decision when they bring on an experienced finance professional. And there’s lots of choice, from the independent providers to the multiple franchise services. And between those two there are specialist organisations, like us, which bring a very focussed service to their clients.

A recent survey showed that the majority of Finance Directors in the top UK companies are now being paid over £1m a year. And most good FDs in both public and private companies are now commanding salaries of over £100,000 a year. And those are being paid because of the value that they can bring to the companies. Of course not every one brings an equivalent value, but if you have the right person in the role then the worth they can bring will be many times their salary in terms of value created and costs saved.

For an SME, £100k or £1m is most likely a step too far, unless they’re very cash rich or extremely well backed. This is why the flexible and part time FD is becoming more popular. When you consider that a full time FD on a salary of £120,000 is going to cost you at least another £90,000 in bonus, pension, employment costs, NI and recruitment fees. Not to mention share options and notice payments. And after all that, they may not even stay if they get a better offer elsewhere. Also, they won’t be working on your finances all the time you’re paying them once you take into account holidays, sick leave, training, general downtime and all the time they spend getting drawn into matters other than finance.

So is a good FD worth the money? My friend Tony told me a recent survey said that 9 out of 10 of companies believe it is. And 100% of the top performing companies think so. When you consider a good FD can bring at least 10 times their cost in added value to the company then the answer becomes very clear. The biggest challenge for a business owner is really going to come down to the commitment to the cost and the risk that they may not need all the time, all at once.

Will we see a part time FD being paid £1m, like the ones in the top UK companies? If they can bring £10m of value then it still seems like a good deal. Would you pay £100,000 for someone worth £1m? It would be hard to see why not, if you could afford it. What’s it worth to see your business protected from ruin? What’s it worth to see your business sustained during a period of economic crisis? What’s it worth to have your business prepared for the growth that can be achieved both during the current climate and in the future? When you look at it this way, you can see why companies are turning to FDs they can trust.

And that’s why I believe we’ll continue to see significant growth in the flexible and part-time FD market. Because smart CEOs and MDs can see the value they bring. And they like the flexibility and advantage of having an independent resource that can be called upon when its needed and dialed down during the quiet periods. And that’s definitely worth something.

It seems the government are digging themselves a deeper hole by intervening in the Lloyds/HBOS deal. As the HBOS shareprice falls the Lloyds offer could look less and less attractive for the Lloyds shareholders (and a 75% shareholder approval is needed) and there could become a point where the shareholders force the board to renegotiate or walk away.

And what does the Government do then? If it allows the deal to fail then what are the repercussions? If they give concessions to Lloyds to support the deal (which could be guarantees, underwritin of bad debt, future tax breaks) then what message does that give to the rest of the market. Don’t worry about taking on higher risk business because if you’re big enough the state will bail you out. The government has got itself into a very difficult position either way.

In an entrepreneurial market, investors and entreprenuers understand that there is risk in building and running a business. The extent of that risk is not always fully appreciated but most entrepreneurs understand that if they take too many risks in the business then they can lose their business, income and jobs. Unfortunately, directors and investors are not always fully aware of all the risks they are taking on but that’s another matter.

Until recently, the same was true for big business as well as the SME market. Now it seems the game may have changed.

So where’s the safest place to be?

I believe the SME market remains the more resilient, if it’s well managed and controlled. The challenge for large companies is that, especially in financial services, the devolved responsibility and increasing complexity of some transactions can have a massive impact on the business. In AIG, there was a solid, dependable, traditional business that had traded successfully in the same way for many years. They were ultimately undone by a small department set up to trade in derivatives, that brought only a small amount of overall income but exposed the business to massively disproportionate amount of risk.

The coming months may see many more SMEs and even large businesses fail. For large companies it will be those that have strayed into markets, industries and businesses that they don’t understand and those who are slow to adapt and change. In the SME sector it will be those who are carrying too high a fixed cost base and those who are not managing their cash. It will also be those who are too reliant on the cash flow from a few large customers who will be looking to reduce their spend and squeeze their suppliers. Ironically, due to much of the legislation supposedly in place to protect employees many companies may have to close due to the fact that they can’t afford to continue or bear the costs of undertaking a redundancy round, especially with all the costs and employment tribunal risks that now go with it.

Unfortunately, for many of these companies, they won’t be bailed out by the government and they will simply be allowed to fail.

I was having a discussion recently with a business partner of mine about whether the value of companies in the Web 2.0 sector is fully understood.

Back in the days of the dotcom boom we sold a company called Smartgroups to Freeserve for £60m. At the time we had very little revenues and certainly no profit. But we had a very good piece of software, a fast growing customer base and a great idea about how to generate revenues off the back of the service. Luckily, in Freeserve, we found a number of key individuals who completely understood what our company and service could bring to their business. Applying our software and service to their customer base could generate huge value for the business and that changed the way that the value of the company was viewed.

Now it would be easy to write off this deal as just another (for a change successful) example of internet euphoria. However, the priciples are still intact today and companies are still being valued and acquired on the basis of the future value they can bring to the acquiror.

If you read any academic or financial books on valuation of companies (and I’ve read a lot!) they invariably go down the route of valuing companies through variations on discounted cash flows (with or without terminal values), NPVs, revenue and profit multipliers (with much debate about the relative appropriateness of EBIT, EBITDA, EBITDAR, PBT or PAt), p/e ratios, betas and other more complex calculations involving variants of the Black-Scholes model or the Modigliani-Miller theorem.

However, in the past 20 years of working in this field, I’ve found there is a more fundamental valuation technique that seems to be known only to a handful of financial alchemists and some of the highest performing sales people.

A company is worth whatever the buyer is to prepared to pay for it.

All the financial analysis is generally used to justify the valuation (or at least give it some credence) after the event. Sometimes it stacks up, sometimes it doesn’t.

If you’re a large company, especially a quoted plc, who is looking to acquire a company that will simply add revenue and profit to your bottom line then looking at your own p/e ratio and applying that to the profit that will be added through the acquisition is a perfectly rational method of valuation.

However, if a company is being acquired because it brings new technology or IPR, because it solves a problem that has been holding back sales or development or because it brings a business advantage that can be applied across a much wider customer base, then the value needs to be considered in terms of the additional value it can bring to the acquiror.

A company like Oracle, for instance, with a Market Capitalisation of over $100bn may see that buying a company with a technology or business application that could enhance their profits by 0.5% could add $500m to their market value. This means that, although there would doubtless be some shrewd negotiation, the value of that acquisition and the price they might be willing to pay could rise up to $499m and they would still come out on top. Of course in practice this would be unlikely given all the risk factors involved but it allows you to see acquisition values in a different context. And if you have a software company that is just breaking even then it might encourage you to think wider than just achieving a high multiple of your profits.

After all this, the conclusion we came to (following the discussion at the start of this post) was that many people, even experienced financial experts and business people, still don’t fully understand how valautions are achieved. And after last week’s episodes in the financial markets they might be even more confused.

I’m currently working with a client where there is much talk of “Critical Non Essentials”. These are those elements that can give a business or a sports team a significant extra advantage over their competitors or opponents.

The phrase was coined by an Australian Dentist by the name of Paddi Lund, who radically changed his approach to dentistry and his clients and created a very successful business and reputation on the back of it.

The idea of critical non essentials was also taken to heart by Clive Woodward as coach of the World Cup winning England Rugby Team. Clive explains in his autobiography how he used the idea of critical non essentials to give the England team that extra edge they needed when facing opposing team of equal strength and fitness.

In business there are many Essentials that have to be addressed in handling customers, dealing with issues, managing staff etc. These are the basics that every company should be focussed on, although there are still many that are not. Each industry has its own aspects that are taken for granted and you should expect that your competitors are seeking to provide the same level as Quality and Service as you are. That’s why Quality, Service and Price are no longer enough as a USP. Because everyone claims them they are largely ignored by customers unless they’re obviously missing.

Critical Non Essentials will set you apart from your competitors and are the things that you don’t need to do but when applied they will make a huge difference to how you’re perceived by your staff and your customers.

What are they for your business? Well that’s for you to decide. By their very nature they are not generic. If everyone’s doing them they become essential and expected.

Grab a copy of Paddi’s book or Clive’s. Then take a look around at your business, and your career, and select a few Critical Non Essentials that could really set you apart.

There’s something special about working with entrepreneurs. It can be challenging at times and it can also be extremely rewarding.

The biggest challenge for accountants working with entrepreneurs is that they don’t always follow the rules. In fact, it’s quite rare. This means that a large part of the job can be running around after them clearing up the apparent chaos they leave in their wake. Unfortunately, this can be equally true of both the good ones and the bad ones, and it’s not always apparent which is which (although you can often spot the really bad ones quite quickly).

If you look at successful entrepreneurs they have rarely followed a path of checking all necessary legislation and statutory requirements before setting off. And those that start up businesses trying to do everything by the book and do it all properly often find they fail before they even begin. They get so wound up in red tape and bureaucracy that they don’t have time to actually find clients and start the business. The ones that make it are more often than not those following the Richard Branson cry of “Screw it, let’s do it”. They’re the true entrepreneurs.

So what’s Entrepreneurial Finance? It’s really a way of making sure that the financial operations behind the entrepreneurs business really support what the company is trying to do. It means close management of cash and fast, effective reporting. It means understanding the value of expenditure and making sure that money is used as effectively as possible. It means being willing to speak out when things aren’t going to work (which can be a challenge when faced with a strong personality) and being willing to support the entrepreneur when they’re doing something a bit more risky or different.

You have to flexible and creative and ready to handle all manner of questions, challenges, ideas and curveballs. And you have to combine a “how can we make this happen?” mentality, whilst always keeping an eye on what could go wrong. You have to prepare for both the best and the worst scenarios. And one day you may be hiring and the next you could be firing. And you have to be willing to make decisions and stand by them.

Many people moving from the large corporate world into this environment find it all too much and quickly move back. And when entrepreneurs are looking for people to support them in the finance role they need to be aware of the challenges that will be faced, not just technically but on a personal front too.

If you’re looking for someone to fill your finance role in an entrepreneurial business (and if you don;t have anyone, you really should be) then you need to consider the personality and experience as well as the technical ability. Make sure that you can see the entrepreneurial element in the finance if you want to get the best finance support for your business.