Business Effectiveness Analysis? (Case Study #1)

I’ve previously mentioned the Business Effectiveness Analysis that we offer to clients (in the last newsletter).  If I do say so myself, it’s a pretty powerful tool that provides an industry benchmark comparison and  ‘what if?’ scenarios to preview your businesses’ future financial performance and answer questions like these:

  • Do we have enough cash flow for next year to make my loan payments?
  • How do we compare to others in my industry on critical financial measures?
  • How much will it improve my cash position to collect receivables faster?
  • What would be the impact if we improved inventory turns by 10 days?
  • What changes could we make to increase profitability and growth?
  • If we increase sales by 5%, what does this mean to the bottom line? Cash flow?

I thought it might be useful to share an example of how this analysis can have a significant impact on your business.

Introducing DesignCo:  DesignCo is a fairly successful engineering design company with 46 employees. Last year they had sales of $5.4 Million with a net profit just over $200,000.  The owner enjoys long walks in the park, gladiator movies and yelling at the refs during his kid’s soccer games. 

We can use the Fintel Analysis tool to compare DesignCo to other Engineering Design companies of their size (there’s over 1300 in the medium size category in the database), at first glance they appear to be in pretty good shape.

Here?s a look at where they compare to their industry average (for their size) on their income statement.

DesignCo is a little more profitable than the average. However a look at the Balance Sheet comparison raises a bit more of a red flag:

They are carrying quite a lot more Accounts Receivable and they’re pretty low on cash. It’s not shown here, but the rest of the Balance Sheet indicates that DesignCo is also carrying more debt than the industry average resulting in a Net Worth of about half of the industry average for their size. 

The owner may feel a squeeze in the upcoming year – let’s take a closer look.

Cash Flow Concerns?

The Fintel analysis process uses something called Net Balance Position (NBP) to reflect the projected health of cash flow for a company. Essentially NBP is the working capital available for the year less the working capital required; a negative number indicates you’re likely to have a cash flow issue.

One of the inherent assumptions in the process is that you’re projecting forward using the current year’s financial statement, but unless you’ve made a significant change in how you do business, it’s a reasonable planning approach.

Below is a view of DesignCo?s Net Balance Position, which as you can see doesn’t paint a very pretty picture. They’re projected to be short on cash by $580,000 and they are off the chart (on the negative side) compared to their industry peers.

Identifying potential solutions for Cash Flow concerns:

Cash flow is primarily driven by:

  • How efficiently you manage your inventory,
  • How quickly you get paid by your customers and
  • How quickly you pay your vendors
    For DesignCo, inventory doesn’t apply, so the focus is really on the Accounts Receivable and Accounts Payable situations. Let’s start out by seeing what reducing the A/R Collection period would do for the NBP of DesignCo.

The current collection period for DesignCo is at 107.8 days (top left of previous chart)! That’s more than double the median collection period and obviously a big driver behind the cash flow issue.

If we could reduce the collection period by 40 days to 67.8 days (which is still worse than the median of 53.5) than the NBP goes from a ($582,000) to $9,000 ? a positive swing of almost $600,000!!!

Using a similar approach with Payment Deferral (how quickly DesignCo pays their vendors), we can also see some room for improvement.

DesignCo had been paying their vendors in 10.3 days, well below the industry median of 33.3 days. Improving that number by 15 days to get us to 25.3, drops the NBP from ($582,000) to ($369,000) an improvement of $213,000, not quite as good as the collections fix, but still well worthwhile.

Doing both improvements together results in the following – still not quite at the median for the industry, but a much more tenable position.

A projected Net Improvement of almost $800,000 in Cash Flow!

That?s interesting, but now what do we do?

Now the fun part starts: the Business Effectiveness Analysis will help you identify key areas that are impacting the future of your business.

Using that data we will work with you to brainstorm ideas and identify a high level plan on ways to address the biggest problem areas. For DesignCo, the priorities are fairly obvious, but developing a plan to address those priorities likely isn’t obvious (or it would have been done before this).

Also, a plan by itself isn’t going to solve anything, you actually have to implement change, which requires consistent action and follow-through (not always the easiest thing to do when you’re in the middle of running a business).

You can certainly make those changes on your own…or and I’m just spit-balling here, you could hire us to help drive you through and make sure you achieve the upside identified.

This is the type of thing that I started Aspire for in the first place.  My goal is to help you identify the changes you need to make in your business and give you the support and guidance you need to make those difficult changes and reach the next level of success. The 1 on 1 coaching/consulting service is designed for exactly this kind of support.

If you’re interested in getting a Business Effectiveness Analysis for  your company (or someone you know…) or if you’d like to talk about our 1 on 1 service, just give me a call at 913.660.9400 or contact me here.

Shawn Kinkade