BUSINESS PLANNING - FIT FOR BUSINESS IN UNCERTAIN TIMES
Article by Giles Murphy
Despite an uncertain economic environment, it's still possible to sow the seeds of future success. Good management and flexibility are key, says Giles Murphy.
Whether the UK economy is going to move into recession is difficult to predict, but we undoubtedly face a period of uncertainty. This will almost certainly have an impact on customers' purchasing decisions and therefore sales. A small downturn in revenue, coupled with increasing costs, can quickly change a successful business into one with poor profitability and prospects. So how can you ensure your business is in good shape to weather economic uncertainty?
Fundamentally, a business must be able to understand and monitor its financial dynamics. This requires up to date, relevant and accurate management information which can be compared to budgeted information and previous year comparatives. Of particular importance will be the key performance indicators (KPIs) that track future opportunities, such as sales orders, new contracts and enquiries.
Equipped with this information, management can identify trends and predict profitability. Where profits are under threat, the business should ideally look to increase revenue. If competitors are also struggling, the business could benefit from expanding its marketing activity to increase market share. However, the ability to increase sales or open up new income streams may be out of the business' control, require significant cost investment and/or be risky.
Curb The Costs
However, human nature is such that if a downturn occurs, there is a natural reaction to batten down the hatches'. If this is the preferred route, it is essential that the management team is in a strong position to carry out such a review. This will ultimately depend on the extent to which costs in the business are controllable in the short to medium term. These costs can be split into three categories: production, investment and overhead costs.
Production Costs
Key costs in this area, particularly in service-based businesses, often relate to employees. In most cases, these expenses are fixed in the short to medium-term. To manage this, it is vital that businesses have the ability to project future opportunities in the pipeline'.
Where possible, businesses should be flexible in the way they resource projects, for example considering transferring staff and/or projects between different offices and locations, or employing part-time or temporary staff to resource busy periods.
Staff communication is important at all times, but particularly so during times of uncertainty. Employers should ensure that they keep staff up to date with their plans and reassure them of the impact. Avoiding communication with staff during such times can result in low morale and inefficiency among the workforce.
Investment Costs
These include capital expenditure, marketing, training and recruitment costs. In the short term all of these costs can be controlled. These are often the first costs to be cut in a downturn. However, it is at this point in the cycle that spending in these areas can bring the most benefit if it is acceptable to cut them in a downturn, it is debatable whether they were necessary in the first place. An analysis of the effectiveness of this type of expenditure is fundamental to the success of the business throughout the economic cycle.
Overhead Costs
These costs include utilities, travel and subsistence costs, IT procurement, maintenance, insurances and professional fees. At all times, and particularly in times of uncertainty, it is important that businesses conduct audits' of the value for money they derive from these services. Improved terms can often be obtained.
In addition, businesses should ensure that they are operating efficiently. This should include a review of budgeting, authorisation and centralised purchasing procedures as well as the use of supplier credit terms. Firms often enter into unnecessary liabilities that only get identified once the invoice is due for payment.
Make The Most Of Quieter Times
Some businesses have been operating at near to or full capacity over the last few years. As a result, planning and reviewing longer-term strategic goals and options may have been neglected.
Think Strategically
A first step is to review your marketing strategy. Quieter periods give the business an opportunity to refocus, analyse specific goals and make sure its marketing strategy supports these aims.
Consider Pricing
Where costs are effectively fixed, at least in the short term, the ability to generate some revenue rather than none at all should be considered. In some cases this may mean lower prices to ensure that stock is shifted or staff are utilised (and morale improved).
This approach has proved to be particularly successful for some of the low budget airlines in the past. As the market has contracted, the differing approaches of these airlines compared to some of the more traditional carriers have provided dramatic results.
However, it may be difficult to raise prices back to more normal levels as the economy picks up.
Build Bonds
It is always important to develop relationships with existing customers or clients. If you are facing uncertainty, it is a fair assumption that your customers will also be feeling the squeeze. Building strong relationships with customers and clients should help you to reap greater rewards and loyalty when the economy settles down.
Finally, whether yours is a small niche business or a global company, you need to ensure your systems and controls monitor the performance of the business and provide the necessary decision making data. Increasingly, the more flexible the business, the greater its propensity to succeed in uncertain and sometimes volatile market conditions. Therefore the need for businesses to undertake reviews and potentially take difficult decisions in an ever increasingly competitive market is fundamental to their success. Your competitors will certainly be doing this, so be sure you do too.
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Keep Your Eye On The Ball
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GETTING THE BEST FROM YOUR BANK
Article by Greg Begley
With banks tightening their belts, Greg Begley explains how to get the financial backing you need.
May you live in interesting times' is a Chinese proverb usually applied to global political issues, but it's just as pertinent in today's financial turmoil. In the current environment, we've seen attitudes to lending change. Banks now need to regain the trust of customers, while enforcing new, tighter lending habits. As banks seek to rein themselves in and re-build their weakened balance sheets, what does this mean for your business?
A Brave New World
The answer is simple and complex: simple in that banks must allocate a proportion of their own capital to every loan they make, and many don't have enough; complex because since January this year banking regulations have become more rigorous regarding capital adequacy ratios. For businesses this means tighter lending criteria, higher pricing, tougher terms and conditions, shorter lending periods and more restrictive covenants.
What advice can we give? Recognise the changed circumstances and follow the Scout motto: be prepared. Understand who you are dealing with. Your relationship manager/director, deal originator or whoever you meet on the front line' is not the decision maker. These people prepare and submit proposals, but it is the credit underwriters who need to be convinced and, in the present climate, it is safer for them to say no to any lending proposition that appears to be marginal.
The Winning Formula
So what can be done to win a bank's support for your business? Presentation and confidence are crucial. Poorly presented business plans can put a swift end to a proposition. It's important you include enough detail, support your confidence with realism, show an appreciation of risk, and be consistent and reliable with supporting numbers.
It's also important you take time to build belief and trust with your bank. On the practical side, this means being careful about breaching covenants and being conscious of the timeliness of financial information. With banks becoming more cautious, a lack of quality information may lead them to assume the worst.
Facing The Future
What does the future hold? In the short to medium term we expect to see more of the same: credit conditions will continue to tighten as banks go through their annual review cycle with business customers. The economic environment will be challenging and the days of relatively cheap credit readily available on light covenants is gone, if not forever, certainly for the foreseeable future.
Don't despair; banks still need to lend. But they will be more sharply focused on what they deem to be superior credit risks. Seeking bank debt finance is no longer purely down to a chat with your bank manager. Instead, a more professional approach is needed, one that can bring rewards in terms of consistency and ongoing support. If necessary, consider using specialists who can add value to the process.
RISK MANAGEMENT IN UNCHARTED TERRITORY
Article by Stephen Harvey
Market uncertainty brings risks, but for the well prepared it can open up opportunities, says Stephen Harvey.
For many managers, the increasingly volatile and uncertain business climate is uncharted territory. Plotting a safe course through an economic downturn is not something most people get to practise, so it's important to plan ahead.
Seize The Day
This is not just about minimising the impact of a downturn, but appreciating that tougher times also offer an opportunity to improve your competitive position. To take advantage of these opportunities, businesses need to take a long-term view and make some bold decisions.
The prudent executive will recognise that analysing the strategic risks and opportunities facing the business is now more important than ever. In the current climate, business plans and financial forecasts take on added significance. They should not only be used to measure performance, but play a key role in deciding what actions to take and when.
Plan Ahead
A systematic approach to risk management and scenario planning will help get the best from your business plan. This can be broken down into five main components.
- Identify a number of different scenarios for business
performance during the year ahead from worst case to
optimistic.
- Create some key milestones to benchmark your actual
results against these alternative scenarios and analyse the
impact on cash flow.
- Understand the business risks that may prevent you from
reaching those milestones, such as loss of key
suppliers.
- Determine the actions you will take if those milestones
are not met, and have alternative plans ready for immediate
action if required.
- Introduce additional key performance indicators and
reports that will provide management with early warning
signals.
Inspire Confidence
It's easy to forget that in a downturn, the way you and your company behave is under constant scrutiny from shareholders, banks, suppliers and customers. Furthermore, your employees will be looking to senior management to demonstrate clear leadership and give them confidence about the future of the business.
One way of exhibiting this confidence is to properly document and clearly communicate appropriate elements of your business plan. This enables senior management to demonstrate that they have well thought through plans in place and are ready to react, whatever the trading circumstances.
There are two good reasons for this approach to risk management. Firstly, those involved in the planning process will feel far more positive and confident in their ability to weather the storm. Secondly, there is far less risk of being caught off guard and there's always the chance that your competitors will not be as prepared.
ROOM FOR MANOEUVRE - MANAGING YOUR PROPERTY COSTS
Article by Nigel Grice
In uncertain times it pays to make sure you're getting the most from your property, says Nigel Grice of Drivers Jonas.
Whether your business operates from an office, a shop or a shed, it makes sense to get the best value from your premises. This is particularly true in times of economic uncertainty, when you may have worries about the stability of your income moving forward. Here are some of the things you should consider.
A Question Of Space
The golden rule that applies to all businesses is that the less property you occupy, the less you will be paying for it. So ask yourself the question do we really need all this space?' It may make sense to scale down, but often the property overhead unlike people is a fixed cost that is difficult to change in the short term. A bit like a super tanker: you can twirl the wheel as much as you like, but it takes time to change direction.
Your flexibility depends on the terms under which you occupy your property. Is it a freehold? Or a leasehold at a market rent with that most user-unfriendly device: the upwards-only rent review. In other words, is it an asset or a liability?
Assets
If your business is run from a property it owns, you've resisted the urge to sell and leaseback in the good times, and you're not mortgaged to the hilt: congratulate yourself you have flexibility. You could sell it or part of it, lease part of it, or grant licences. All of which will bring in some extra income while allowing you to run a downsized business.
You may even find that your property is worth more for another use residential, for example. Provided you can get planning approval and there is demand for your kind of property you could take this route. Whatever option you choose, you are in control.
Liabilities
If your business space is held on a lease, things become more complex. Average commercial leases last for about seven years these days, and every one is unique, so much depends on what the document actually says.
A good place to start looking for savings is outgoings. Apart from rent, most leases oblige the occupier to pay rates and service charges. Look at the service charge clause and get hold of the last few years' worth of service charge records. Are they reasonable? Could they be challenged? And look at the rates: have they been appealed? Are there grounds for a reduction, such as neighbouring building works?
Steps To Downsizing
If prudence dictates that you should reduce the amount of space you occupy, or reduce your outgoings, here are some suggested next steps.
Read the lease. And not that unsigned draft floating around in the bottom drawer get hold of the signed engrossment.
Concentrate on understanding the restrictions in the lease, particularly those which deal with assignment and sub-letting. Can you sub-let part of the property or create licences? Can you let it at market rent even if this is less than the passing rent (the rent you originally agreed to pay)? Is the user clause restrictive? Are there tenant-only breaks coming up?
Get a local firm of commercial agents in: show them the space and give them a copy of the lease. Ask for a report on the following.
- Sub-letting and assignment prospects is there a market?
What will you get?
- What would you have to spend on the space to make it
marketable?
- Are there any wrinkles in the lease that you will need to
sort out?
- What will their fees be for advising you?
Your options are likely to include one or more of the following: assign the whole, sub-let the whole, sub-let part, create short term licences, or renegotiate the terms of the lease with the landlord.
Some companies tied in to a difficult lease have chosen to liquidate the company as an escape route. This is not recommended. It can damage the reputation of a business and, in any event, may not work if there is a parent company guarantee.
Liaise With Your Landlord
One option that is frequently overlooked is simply talking to your landlord. Things you could discuss might include:
- reducing the rent for a period of time, perhaps agreeing
to an earlier rent review
- paying monthly rather than quarterly, as most leases
stipulate, to help you with your cash flow
- widening the user clause if it is restrictive
- widening the alienation provisions if the restrictions on
assignment and subletting are restrictive
- trading up-coming tenant breaks for a lower rent
- extending the lease, again trading a longer term for a
lower rent or a rent holiday.
Ultimately, if you are anticipating cash flow problems, there's no substitute for dialogue. After all, your landlord really does not want your business to go under and should be open to options.
HARD TIMES? AN ASSESSMENT OF THE M&A MARKET
Article by Brian Livingston
Much has been written about current market conditions, but is the M&A market really dead? Brian Livingston investigates.
To paraphrase a line from Oliver!, who will buy (or sell) this wonderful morning? A cursory look at the market might suggest that it's in dire straits. An unholy trinity of higher taxes (an increase in capital gains tax from 10% to a flat rate 18%), uncertain prices and lower multiples on profits have led many business owners to conclude that selling now will only result in lower valuations and paying more tax.
But the results of a recent M&A International Inc. survey of the impact of the credit crunch suggest otherwise. Although the tightening of credit is having a significant impact on transactions valued at greater than $250m, most mid-market transactions are largely unaffected. As Murray Beach, president of M&A International Inc. comments: "We do see that the atmosphere has become more cautious, but the outlook for the market is still positive."
A Positive Perspective
There are good reasons for this continuing market buoyancy. The certainties of death, divorce and retirement will always generate a steady flow of privately held businesses for sale. At the same time, private equity houses continue to create significant activity by both looking for acquisitions and selling their portfolio companies.
The structure of private equity funds is such that they are required to generate returns for their investors by selling investee portfolio companies. These all-important returns (the crucial internal rate of return, or IRR) are often improved by selling now, rather than delaying for several years and selling at a higher price. When you take into account the time costs of money (such as inflation and interest), a £20m sale today may be more attractive than a £30m sale in three years' time.
The Corporates Cometh
Before the credit crunch, with the availability of cheap debt, private equity was able to pay more for acquisitions than corporates, a fact that is seemingly counter-intuitive. After all, corporates should generate value from synergies on acquisition to justify the highest price. However, the recent challenges in debt financing have seen prices fall back in certain sectors, providing opportunities for large, cash-rich corporates to re-enter the market and make acquisitions.
But private equity houses still have plenty of funds to invest. And, while they may steer clear of sectors such as retail or general recruitment, which are more dependent on economic conditions, opportunities in areas that are seen as resilient to a downturn remain an essential addition to any private equity portfolio. Strong cashflow businesses with government or long-term contracts are perceived as more recession-proof and may generate super valuations' in an auction process.
Opportunities Remain
Transactions completed by Smith & Williamson at the end of 2007 such as Delamore, a plant propagator, and KV Pneumatics, a specialist engineering business, are clear evidence that the mergers and acquisition (M&A) market remains active. Here, the right combination of market position, management and deal structuring led to good-quality transactions being closed at high prices by both private equity and corporates.
We expect to see more transactions in the second half of 2008 as the market adjusts to changed economic conditions. Furthermore middle-market M&A should remain strong for quality businesses in resilient sectors. These businesses will continue to be of interest to trade, private equity and international buyers. To paraphrase the great Nat King Cole, there may be trouble ahead, but while there's synergy and market position let's dance.
TEN-POINT CORPORATE TAX HEALTH CHECK
Article by Andrew Wilkes
Feeling cost conscious? Andrew Wilkes offers some pointers to help manage your tax charge.
Tax is an important element in the financial health of a company. Businesses should make sure they are maximising the benefits of the tax reliefs available and that deductions for costs are accelerated where possible.
Ten Ways To Manage Tax
1. Review Provisioning Policies
Assess provisioning policies to ensure that provisions for expenditure of a revenue nature are made in accordance with FRS 12 and are allowable for corporation tax purposes. As far as bad debt provisions are concerned, there should be documentary evidence of action taken to attempt to collect the relevant debts. HM Revenue & Customs could seek to disallow a specific provision where no such action has been taken.
2. Watch Out For Discretionary Bonuses
Where discretionary bonuses are to be paid, directors should evidence by letter before the year-end the possibility that bonuses for the current year may be declared. These bonuses will need to be paid within nine months of year-end in order to be tax deductible in the period they are charged to the profit and loss (P&L) account.
3. Get Tax Deductions For Repair Work
If a company has a legal obligation to carry out future repair work (for example under the terms of a lease), it is possible to obtain a tax deduction for this, provided there is an appropriate provision in the accounts. If there is no legal obligation, a tax deduction is only available if the repair work has been carried out by the year-end.
4. Take Care Over Revenue Deductions
Caution should be taken to avoid capitalising costs which would be treated as a revenue deduction for tax purposes if charged to the P&L account. Relief will only be allowed to the extent a deferred revenue charge is made to the P&L account, such as by depreciation of the capitalised asset.
5. Maximise Tax Relief On Pension Contributions
Employers' pension contributions must be paid by the end of the year to obtain corporation tax relief in that year.
6. Plan For Capital Allowances
There are important changes to the rules relating to capital allowances that should be planned for. Annual writing-down allowances have been reduced from 25% to 20% and there will be an annual investment allowance of £50k for plant and machinery. Companies should consider specific timings of additions, for example deferring some capital expenditure to a subsequent period may benefit a company if it is able to take advantage of two tranches of the annual investment allowances.
7. Reclassify Expenditure On Industrial Buildings
The abolition of industrial building allowances (IBAs) means that taxpayers should consider whether expenditure could be reclassified as plant and machinery or building repair work. If it can, tax relief for periods to 2011 can be accelerated and will avoid the permanent loss of tax relief after this date when IBAs are abolished. Reclassification of expenditure from industrial buildings to plant and machinery is not possible once IBAs have been claimed but can be carried out in respect of open periods (at least two years). However, for reclassification as capitalised repairs it may be possible to reopen up to six years under an error or mistake claim.
8. Claim R&D Tax Relief
Companies involved in creative or innovative work in the field of science and technology may be able to take advantage of research and development (R&D) tax relief. As of 1 April 2008, the R&D relief rates increased from 150% to 175% for small or medium enterprises (SMEs) and from 125% to 130% for large companies. There is also a possibility for SMEs to claim a payable tax credit.
9. Look At Corporate Structure
In general, companies should also look at their corporate structure to ensure there are no tax leakages. This is particularly relevant for international businesses to ensure they are making best use of the differences in tax rates in each country and making sure they avoid double taxation. This may necessitate some group restructuring or changes to the group's financing arrangements or internal operating procedures.
10. Don't Forget Compliance
Companies should also look at the cost of dealing with their tax compliance obligations. Groups of companies could consider amalgamating the trades of various subsidiaries into a single company, which should reduce audit and tax compliance costs. In addition, companies should work closely with their tax advisers to look at ways of reducing professional fees, for example by undertaking more work in-house and working together to make processes more efficient.
Finally, companies should ensure that budgets and forecasts correctly reflect tax cashflow and factor in future changes in tax rules and planning. In these uncertain times companies do not want unexpected cash outflows.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
