In November 2007, an amazing piece of software from Australia called “Profit Driver“ was brought to our attention by CCH Canada. It’s an incredible tool that has allowed us to look at and help businesses in a whole new way. It gives us the means to really help our clients in ways that go far beyond “traditional” services provided by accounting firms.
We spent the next ten months or so learning about the software’s capabilities and how best to use it. We ran test trials with a group of select clients – the results of which ultimately became the basis of our “Business Compass Service” that we refer to on this site. Trust us – this development work is necessary – the software represents a radical departure from software typically used by accounting firms.
Fast forward to October 2008 – Our test trials were nearing completion when the economic climate as we knew it exploded. All of a sudden, we were fielding calls from clients, anxious to understand the potential impact this recession might have on their businesses. We knew we could help them with our Business Compass Service so we started booking and conducting sessions right away. The results and feedback to date have been awesome.
We’re going to chronicle our experiences with our Business Compass Service through this blog, so that interested business owners and others out there can see the lessons learned along the way. We’re hoping the dialogue is going to be two-way and that people will add comments and questions.
The press seems to constantly refer to the world-wide economic upheaval in progress as “just” a “recession”. Technically this may be true, as we’ve had the requisite number of quarters of negative economic growth to meet the definition. The press also implies that once this recession “ends”, things will go back to the way they were before.
I don’t believe this is true.
I think what’s really happening is that our economy is beginning a fundamental restructuring that will affect us for years to come.
Here’s why: The current recession was due in part to the high price of oil last fall. High oil prices have historically played a big role in triggering recessions and this one was no different. Oil prices are about to rise again and they have nowhere to go but up. World oil supply peaked years ago (in the 70’s I think) and demand is rising as millions of Chinese and Indians become car owners for the first time. I strongly recommend you read “Why Your World is about to get a Whole Lot Smaller” by Jeff Rubin for his compelling in-depth analysis of the factors affecting world oil supply and demand.
To date, our economy has been driven by the engine of cheap oil and that era is almost over.
So why am I blogging about this you ask? Because the restructuring will create business opportunities for those savvy enough to see them and because there will be plenty of businesses that will fall victim to these changing circumstances. We want our clients and readers to be winners, not losers, on the new playing field that is fast approaching.
If your business depends heavily on oil (directly or indirectly)- this is your wake up call. This includes those businesses that are importing things from halfway around the world on large container ships. International freight costs are about to go way up. Your cost structures are about to change drastically and you need to be ready to meet these challenges.
The flip-side of this coin is that opportunities will be created for astute manufacturers – these are the industries that saw much of their production move offshore in the cheap-oil era. Opportunities will now open up to create new manufacturing jobs again in North America. Here’s hoping they’re here in Ontario!
If you want to assess your exposure to changing cost structures or want to scope out windows of opportunity, contact us. We have the tools and the experience to help.
I apologize for the length of time since my last post – I’ve been so busy the time just slipped away before I knew it. A lot of my time lately has been spent working with people learning to adapt to a harsh new economic reality. Everyone seems to be saying pretty much the same thing – “Its been tough before, but NEVER like this….”
A quick review of their recent financials typically reveals operating losses, negative cashflows and messed-up balance sheets. That said, the first question out of everyone’s mouths when everything’s so messed up is “where should we start?”
Now that’s a question I can answer – Always start by addressing cashflow issues first.
You can stay in business with operating losses but you can’t stay in business for long without cash flow. Just look at the airlines and car companies – they’ve incurred billions in losses over the years and they’re still in business. In the longer term, you have to have profits to survive but your business can definitely survive a period of operating losses.
The trick is to improve your business’ ability to survive these periods. That’ll be the subject of my next post.
After a fall of virtually completely frozen credit markets, we heard yesterday that GE Capital is going to be back in the lending business in Canada beginning in January 2009. They’re the second lender (Royal Bank is the other) we’ve heard of this week who are getting ready to hang out their “back in business” sign in the new year.
Hopefully, these are the first of many like announcements that will help us keep our economy growing in the coming year. We’ve certainly learned from experience just how important it is to have the right financing in place to grow a business!
Is the Ontario government looking for the next Henry Ford?
We were introduced a few weeks ago to an interesting government grant available to Ontario manufacturers. It’s designed to help fund productivity improvements to allow manufacturers compete more efficiently in the Global economy.
This program is clearly a win for small to medium sized Ontario manufacturers faced with recessionary times and increased competitive pressures.
This post outlines some of the features of this program that may interest a reader to explore the finer details on the SMART website (which can be found at www.http://www.cme-smart.ca/).
The funding for this program is provided by the government of Ontario and administered by the Canadian Manufacturers & Exporters (CME) trade association. You don’t need to be a member of this association to apply. The SMART grant is intended for projects that have a primary focus on improving operational efficiency that can be fully implemented within 6 months from the application date (meaning the program is not designed for lengthy or complicated projects).
To be eligble for a SMART grant your business must satisify the following criteria.
- It must be manufacturing in Ontario
- It must have at least two years of operating history
- You must employ 10 to 500 people
The grant covers one half of the project cost to a maximum of $50,000. Approved businesses must initially fund 100% of the cost of their projects, then wait to receive their SMART grant money.
This money has some strings attached: grant recipients have up to 6 months after project completion to report back follow up measurements to see if expected productivity improvements were achieved.
While well intentioned, this program doesn’t go far enough to help Ontario’s beleaguered manufacturing sector. The $50,000 maximum and 6 month project limitation means that only small, short term projects may qualify. Major productivity improvements typically cost a lot more than $100,000, and if companies were having difficulty funding these projects before, its even worse now given the current financial crisis out there. The 500 employee limitation also means that Ontario’s big manufacturers aren’t eligible for the program at all!
If you have experience with the program already, please share your experiences by posting your comments here. We’d love to hear from you.
If you need help determining whether your project may qualify, please contact us at compass@macgillivray.com . We can also assist with the reporting requirements at project completion.
Are you one of their “good” customers or are you on the bubble, at risk of having your loan facilities cut back or withdrawn altogether?
The answers to these questions are more important than ever, as banks tighten up their lending requirements in response to the recent financial crisis and “freeze up” of credit markets. Your banker isn’t your enemy – they hate nasty surprises as much as you do. You’ll benefit greatly if you learn to understand how your bank looks at your business – this will help ensure you always put your business’ best foot forward.
Simply put, banks care about 2 things:
- Can your business afford to repay your loans plus interest as they become due?
- Can you provide adequate security for your loan(s)?
Its not enough to be able to meet just one of these requirements – you need to meet both in order to qualify for financing.
To measure your ability to meet the first test, banks rely on 3 main financial ratios – interest coverage, debt service coverage, and Debt-to-Tangible Net Worth.
Interest coverage is calculated as your EBIT (earnings before interest and taxes) divided by your interest expense. This measures whether your business generates sufficient income to pay your projected interest expense. Banks typically require an interest coverage ratio of at least 2.
Debt service coverage is calculated as your net cash from operations divided by your interest expense plus the portion of your long term debt due within the next year. This is a measure of whether your business generates sufficient cash flow to repay debt and interest as it becomes due. To obtain financing, you need to have debt service coverage of at least 1.25.
Debt-to-Tangible Net Worth is a measure of the risk of your business and is calculated as you would expect – Your total debts divided by your “tangible net worth” (“TNW”). When determining whether you have adequate security to support your loan, banks often require your business to have and to maintain a certain level of TNW. The definition of what constitutes TNW varies from bank to bank, but it generally means retained earnings plus any loans from shareholders that have been subordinated to the bank (this means that the loan can’t be repaid without the bank’s permission). To qualify for a bank loan, you need to have a Debt-to-TNW ratio of less than 2.5:1.
A bank may also require that your business maintain a certain level of working capital which is generally defined as your current assets (cash, accounts receivable, inventory, etc.) less your current liabilities (i.e. accounts payable, bank lines of credit, etc.) . This may be a specific dollar amount, or a specific current ratio (ie. current assets divided by current liabilities). We are aware that certain Canadian banks currently require a current ration of at least 1.25:1.
Your specific lending requirements are typically buried deep in the wording of your loan agreement. Too many people don’t pay attention to these covenants before they sign their loan agreements – They sign the agreement then tuck itaway in their desk drawer and forget about it.
This is a major mistake. It assumes that failing to live up to these requirements doesn’t carry significant potential repercussions.
Today, if your business is in breach of its covenants, you’re probably in a very tough spot – with your bank loan and operating lines subject to a repayment demand from your bank, or facing a requirement to inject additional capital into your business – funds that you might not have readily available. Even worse, they may reassign your account to special loans which is really code for “You need to take your business elsewhere and SOON!”. Worst of all, given the current financial turmoil, you likely won’t have new banks lined up, just waiting for the chance to fight for your business.
The bottom line here is – you need to pull out those loan agreements and figure out where you stand. Don’t wait until your year end numbers are in and you have no opportunity to deal with covenants you haven’t met. At that point, all you have to look forward to is a difficult discussion with your bank manager. If you act now, it might not be too late to for you to fix things before year end by focusing your efforts on the specific activities that drive your business.
If you’re not sure whether you currently meet your bank covenants or whether you’re on track to meet them at year end – we can help. Contact us at compass@macgillivray.com to arrange a no-risk consultation today. If you have any questions, please feel free to post them below – we’ll do our best to answer them.
“The bullet that kills you never takes you between the eyes,” says Jeff Wacker, the EDS futurist. ” It always hits you in the temple. You never see it coming because you’re looking in the wrong direction.”
I found this quote in Thomas L. Friedman’s latest book “Hot, Flat and Crowded“. He used it in the context of energy companies. He says “The traditional energy companies have never had to worry about a bullet coming out of the blue. When you finally see a few of them lying by the side of the road with bullets in their temples, you will know that we have finally created a change-or-die world in the energy business – and somebody didn’t change.”
This is a powerful metaphor for the need to be aware of changes coming our way. I mean, how many businesses out there are going to get hit in the temple over the next few months by economic bullets they never saw coming? From what I’ve seen so far, the effects of the economic downturn are likely to be far reaching, far worse than most people expect. It doesn’t take many real estate developments being shelved for lack of financing until the construction companies and structural steel suppliers start to feel the pinch.
Now more than ever, we business owners and advisors need to keep our eyes wide open to the reality of the current economic situation. Be sure to identify and develop contingency plans for your own “worst case” scenarios and you’ll never take a bullet in YOUR temple.
If you need help developing yours, please contact us at compass@macgillivray.com. If you have questions, please add a comment below and we’ll do our best to answer it.
We had a Business Compass session this week that I think readers might find interesting. We met with an existing MacGillivray client, the owner of a Canadian distributor for several international manufacturers of hi-tech instrumentation.
Her company’s financial health was excellent – when we reviewed her results together, we found that in the past year she’d managed to keep her fixed costs under firm control, her gross margins constant (despite changes in the US dollar and Euro exchange rates) and had increased her sales volume by several hundred thousand dollars over the prior year. Much of this increase had fallen to her bottom line. As you know, its pretty hard to do what she managed to do.
She had a very specific question for us though. “Can I afford to carry more inventory right now?”. It turns out that she’d made big efforts on the sales and marketing side in the past year that are now bearing fruit in the form of increased sales orders and an increased number of leads in the sales pipeline.
Unfortunately, delivery times from her suppliers in Europe have slipped to 8 weeks on some of her biggest selling product lines and some prospects have balked about waiting 8 weeks for delivery.
Together we looked at how she currently manages her working capital, including her accounts receivable, inventory and accounts payable. We noted that she had 60-90 day payment terms with her largest suppliers, which gives her plenty of room to manuever. We projected that she could increase her inventory levels to carry an 8 week supply of her top 10 product lines with NO additional investment required in working capital. She was impressed. Really impressed.
They won’t go “out of stock” on key products anymore and should be able to sell to those customers that had a problem with the 8 week delivery timelines. The long timelines also gives her the opportunity to cut her inventory levels back if her sales slow due to the economic downturn.
We’d gotten urgent calls from two existing MacGillivray clients asking for help understanding the potential impact a major financial downturn might have on their businesses.
After giving it some thought, we decided to approach their Business Compass sessions with the idea that we were going to ”stress test” their businesses against deteriorating economic conditions (including declines in revenues, changes in cost structures, and slowing cash collections, etc). We did this by projecting their potential effect on their businesses, then developed possible contingency plans that could be put into action if those conditions became reality.
The results between the two sessions couldn’t have been more different.
In the first case, a major decrease in sales actually improves their cash flows in the short term - because it frees up cash that had been tied up in working capital (specifically inventory and accounts receivable). That took us a while to get our heads around!
We were able to quickly establish that they were well positioned to withstand an economic downturn, though cash collections would have to be carefully monitored and inventory levels managed on the way down. By the end of 2009, we projected that their operating bank line would be fully repaid and they would be left with a couple of million dollars in the bank. We hadn’t even factored in any cost savings through layoffs or other cost cutting yet. Not a bad place to end up a year into a recession. I can tell you that there was a visible sense of relief in the room when when we were finished.
The second case was quite different – A decrease in sales had major negative financial implications for them. They were a company that had grown significantly over the past 5 years and had historically been able to maintain a high gross margin on sales. They had always counted on sales to “replenish” their bank account on a regular basis. We projected that the amount of working capital freed up with decreased sales was not enough to offset the lower cash flows generated from sales. We projected that they would be unable to unable to support their current level of debt within 12 months.The realization that an economic downturn could hit them this hard was a nasty surprise to them.
The truth of the matter was that this business was far more exposed to an economic downturn than its owners had realized. Armed with this information, they’ve begun putting plans into place to help them weather any storms that may appear on their horizon.
If you’re not sure how exposed your business might be to an economic downturn, we can help. Contact us at compass@macgillivray.com. You’ll sleep better.
David Straughan
Cherie Hruska