Success - A Series of Strategic Moves and Sound Infrastructure

The other day I had the rare occasion to sit down and flip through the TV channels.  As I was flipping by one of the channels (I don't recall which) a graphic caught my attention. 

10% of a business' success lies in its technology, product, or service

Well, I can do the math.  Ninety percent of a business' success is about how the business operates and its internal structures. I have always believed this to be true.

Your business must have sound business management systems to enable it to maximize the opportunities that having a fantastic technology, product, or service provides.  Without the ability to manage your financial resources, people, and all the other aspects of your business efficiently and to deploy resources effectively - where they will get the best return, a business finds itself operating under ever increasing constraints.

Many businesses rely on lines of credit to offset cash flow issues.  Recently I read about an international banking accord that may just make those lines of credit more expensive or non-existent for businesses that are "risky".  I've hit the high points of the issue in the article "Adding Basel to the Debt Mix".

Other articles in this month's issue address the question of what obstacles organizations encounter and how they play a role in limiting success - both internal and external issues.

I hope you find the articles informative and timely.  As always, I look forward to hearing from you about your business issues.

From the e-Mailbox: What Is Holding My Organization Back? return to top

This question has several possible "answers".  Without more information on the outcomes you have been pursuing, it isn't possible to diagnose what is going on.  So the starting point is defining the issue.

Is your company operating at peak performance?  Do you seem to spend more and more dollars for less and less return?  When you invest in expanding the “capacity” of your business does it truly translate into more results (revenues and profits)?  If not maybe you didn't invest your resources in the right option - or if you did choose the right investment option, maybe something else is preventing you from getting maximum results.

There are a number of reasons a business can appear to be going full speed ahead toward success and not see results.  Some of the underlying causes span the issues alluded to in the preceding questions.  Here are some of those frequent constraints:

1. Lack of clear organizational objectives
2. Lack of specific performance objectives for functional groups, teams, and individuals
3. Misaligned performance objectives for functional groups, teams, and individuals – they don’t match the organizational objective
4. Compensation (tangibles and intangibles) reward the wrong behaviors
5. Lack of corrective action for poor performers
6. Lack of role definition in achieving objectives
7. Investing in the wrong places – not truly expanding capacity
8. Inability of the organization to pursue the selected strategy or tactic – skill sets, funding, internal structure inconsistent
9. External perception of company, product, service, or technology does not support pricing or positioning
10. Poor quality in product or service

Organizational alignment and consistency between the internal operations and external perception are critical elements of success.  How your organization selects its objectives, pursues its strategy, and gets the internal resources – people, money, and systems – structured are key determinants in generating returns on investment and profits.

Many organizations get caught up in growing revenues and fail to set gross margin and profitability objectives.  As a result, the business may see revenue growth, but steady or decreased numbers on the bottom-line.  Pursuing every sale regardless of cost of obtaining the sale (time and dollars invested, as well as missed opportunities for higher margin sales) and not taking into consideration the cost of servicing a high-maintenance customer may lead to a domino effect on the bottom-line.  Not all sales are created equal, so arbitrarily setting strategic objectives for revenues may lead to suboptimal strategy selection and poor business tactics.

Organizations also fall into the trap of continuing to use the same tactics in changing or new markets.  They also apply the “more is better” rule – through more people, dollars, and so on – without evaluating the effectiveness of existing approaches and processes.  For instance, one of the traditional approaches to growing revenues/increasing sales is to add more and more sales representatives.  Before taking this step, however, organizations need to determine how effective the current sales force is and whether or not they could generate more sales if

• They had more tools or information.
• They had a better quality product or broader range of product options.
• They were trained or better trained to identify, pursue, and get the sale.
• They were backed up with better customer service and after the sale support.

When sales are flat or declining, the solution isn’t to automatically add to your sales force, yet this is often the first step organizations take.

Another trap organizations fall into is investing in infrastructure and activity that isn’t revenue producing, capacity expanding, or organizationally necessary.  For example, an organization may be relatively new and establishing its technology and market presence.  All the investment is put toward technical staffing, sales and marketing people and activities, and other areas directly related to technology and product development.  Little to no investment is made in core business infrastructure – accounting, finance, human resources, and administrative operations.  Now these areas are not “revenue” producing, however, they are necessary and critical activities which enable the organization to build the business effectively, no what is going on, and control it (finance and accounting), to ensure the organization has the appropriate skills (human resources), to identify and minimize risk (finance and human resources), and to insure the organization doesn’t waste higher dollar capacity (technical staff) on administrative activities.  Sound business infrastructure investment enables the organization to grow effectively and to deploy resources efficiently (but don’t over do it!).

Yet another trap is spending on image and “I wants” rather than the “content” of the organization.  High-end real estate and luxury company cars, traveling first class, and sending the entire technical staff to conferences in foreign countries are generally not wise investments in growing your business.

Another issue that can arise is the too rapid growth of compensation and benefits.  Company founders are committed to providing quality benefit packages and time-off in support of work/life balance.  Be sure that you can afford what you promise!  High-end benefit packages – insurance, vacations, 401(k) matching, etc. – for a few people may be doable.  As you expand your operations and are required to extend the same benefits to everyone you employ, the price tag may just break your business.  Recognize that you can phase in benefit programs as your business grows and increases its profitability and cash flow.  It is very difficult to take them away.

For most managers and business owners, dealing with under performers is something that is avoided.  For the sake of your business, addressing performance issues has to occur.  Under performers drain your organization’s morale, financial resources, and return on investment.  Every dollar you spend on someone who doesn’t do the job well, completely, or at all is a dollar that could be invested in someone or something that moves your organization ahead.  Remember underperformance can be contagious, because it saps the motivation of other employees who see the “slacker” getting by and getting paid for not doing the job.

Perhaps a worse challenge than poor performers is situations where you have a valued employee who has performed well historically.  He/she is a hard worker, BUT the business has changed and you need a new skill set and experience this person doesn’t have.  It may be the organization can’t afford to invest time or training dollars for him/her to “grow” to fill the need or it may be the individual does not want to learn/grow.  Organizations tend to justify hanging onto this person.  For the good of long-term organizational growth and success, managers need to be able to address the situation.  That doesn’t mean walking into the office tomorrow and handing this valued employee a termination notice.  It does mean looking around the organization for options.  You could move this person to another part of the organization if your organization is large enough.  If you have no place for this person to go, then you can develop a transition plan that works for the person and the business.  If you value the person so highly you have had a hard time letting them go, then be honest with him/her and, as a team, identify new positions and opportunities outside your business – a client or vendor may need a great person, a friend or colleague may need or know of someone who needs a competent, valued employee – look for options and deal fairly with the person.  Current and former employees, clients, and vendors are usually your best (or worst) marketing message!

If your organization isn’t performing at its  peak and you aren’t sure why – invest both your time and dollars in identifying the issues.  You may be able to look internally and have your leadership team and employees point out the issues.  If you opt for this alternative, be open to the good, the bad, and the ugly news.  It is important to listen to the feedback; you don’t have to agree or disagree, explain or defend, challenge or accept.  You are undertaking a process to gather ideas, information, and perceptions.  Take it all in, and then analyze it.

If you opt to bring in an outsider to assist you in the process, commit to finding someone who will communicate honestly, with broad knowledge across many organizations, and seek out someone who has the ability to look across the spectrum of your business operations – accounting, finance, human resources, operations, and so on.  Every organization is an integration of people, systems, and functional activities.  To get a comprehensive picture of your business requires an understanding of internal operations and external market potential and perception.

Government Grants and Contracts return to top

While reviewing the award documents for a client SBIR recently, I noticed the following language was included:

“Failure to . . . may result in termination for default of this contract.  Contractor may be liable to refund all monies paid during the performance of this contract, receive an unfavorable past performance evaluation, an administrative assessment, or other adverse action.”

Whether this is stated in your grant or contract, the fact remains this is ALWAYS true.  Failure to comply with any aspect of the requirements for performing on a government funded project can result in having to pay back the funds.  Further, if the non-compliance is viewed as “willful and knowing” then additional financial and criminal penalties can be imposed on the company, its officers, executives, and agents.

Non-compliance with requirements includes not having robust financial and management controls systems.  The government gives flexibility in much of the “how” you run your business and document your processes and controls by saying you can use your regular business processes. If your business lacks or has inadequate controls, however, you may not continue to operate in that manner.  Lack of controls and processes is not an option.

For many early stage companies, a grant or contract award may be the driver for beginning to structure and implement business processes, structures and controls.  Also, many experienced grant and contract recipients may find that, when audited, many of their processes and controls prove inadequate.

As a government funding recipient, you are expected to manage both the federal and non-federal funds received equally well.  The guidelines provided by the government cover cost principles, allowable costs, calculations, and property control requirements, but not the specific step by step processes, procedures, or controls that need to be in place to maintain and demonstrate appropriate levels of management oversight.

 The fact that the contract document you sign is only four pages long does not mean that is all there is to the agreement.  Both contracts and grants include requirements are incorporated by law, agency regulations, etc.  Many of these may be incorporated by reference, listing specific clauses and regulations, or simply through the proposal and acceptance process.

The first time you receive a grant or contract you need to begin the process of compliance.  The level and scope of compliance requirements depends upon the type and amount of funds received and the terms and conditions of the grant or contract.  As a prime contractor, you are also responsible for monitoring any subcontractors or subrecipients to ensure  they comply with requirements that pass-through to them and  they are capable – financially and managerially – of controlling funds, executing the technical aspects of the contract, and meeting other standards related to control and management of their businesses.

Here are some key areas that prime contractors and grant recipients may be required to have in place:

• Cost control and tracking
• Cash management
• Management control and oversight of expenditures and activities
• Subrecipient monitoring
• Accounting system and controls
• Human resource compliance
• Intellectual property tracking
• Fixed asset controls and tracking
• Compensation agreements

Each business will have specific needs that are unique to their business’s configuration of operation and funding.  Requirements vary across funding agencies, funding levels, and programs.  It is important that you approach compliance as a required activity and do so strategically.  Understanding the “what, when, and how” of your business needs  is key to ensuring  the right things get done, business is accomplished in an efficient and cost effective manner, you (and the business) are able  to continue to receive funds and exist..

If you are currently receiving funds either as a contractor or a grant recipient – as the prime or a subrecipient – understanding the requirements you currently have to meet, should have met under completed but not audited programs, and will be expected to meet under awarded projects is something you need to begin today.  Just as with tax compliance, ignorance isn’t a defense.  Saying you didn’t know you had to comply or couldn’t afford to comply doesn’t get you off the hook.  If you are receiving government funds, you must comply with the level of requirements placed upon your organization by the receipt of those funds.

Here are some steps to take to begin the process:

1. Identify all contracts and grants that have been or are currently being worked upon that have not been audited -any program/project that is three or fewer years old
2. Read each contract to identify
   • The type of contract – cost plus, fixed fee, time and materials, etc.
   • The awarding agency
   • Any clauses incorporated by reference
   • Any clauses that are incorporated in partial text but have requirements for compliance with the full clause
   • Any pass-through requirements to subrecipients/subcontractors
   • Amount of contract
   • Length of contract
3. Create a matrix of the closed and open contracts
   • Agency
   • Amount
   • Date Started
   • Date Closed
   • Rates used

As this matrix gets filled in, you will begin to see the cumulative levels and requirements that come into play.  Government funding isn’t looked at simply at a single award level; instead it is looked at across awards and cumulative dollars to determine how much funding you have received.  The higher the cumulative total, the more requirements the company will have to meet (in general).

Also be prepared for an audit.  Government contractors and grant recipients under new enforcement levels can generally expect to get some kind of audit/review annually.  One client recently underwent a pre-award audit.  As a new company in their first year of operation, they were being audited to determine if they could fulfill the role for the size of the business they will be when they receive the award.  If you are in the process of getting a multi-year, multi-million dollar contract, you can be required to put into place financial and management control systems, as well as subcontractor and subrecipient monitoring prior to the award.  Implement a compliance program is an investment in the future of your business.  Is it time you made that investment?

Adding Basel to the Debt Mix return to top

No it isn't a typo.  Basel refers to the banking accord addressing financial risk in lending that will be mandated for many banks (and their customers) in 2007.  Basel II requires certain banks to begin setting aside capital against short-term loans (lines of credit) and applying credit risk calculations for lending.

The capital set aside requirement essentially will increase the cost of these loans for banks.  As a consequence, line of credit users (you, for example) should expect these costs to be passed on to them ultimately.  For small and mid-size companies, this means that these "low cost" financing alternatives may be priced to reflect risk.

Risk calculation equations for companies without a formal credit rating have been recommended for banks to use when evaluating risk of default.  For many businesses the combination of assessed default risk and the additional requirement for the banks to hold capital reserves for risk will undoubtedly lead to higher interest rates.  While large banks will be the first to implement and the initial implementation will focus on larger companies, it is only a matter of time until all banks and the majority (if not all) companies will fall under the umbrella of Basel II practices.

Companies dealing with the larger, internationally active banks will feel the impact first because, by agreement between international banking entities, implementation of Basel II is mandatory for these banks.  These banks will be required to apply more precise calculations to the probability of default.  This probability of default calculation is called the Advanced Internal Ratings Based approach or A-IRB.  The A-IRB will be applied by banks when pricing loans to companies, including lines of credit (loans of less than 364 days).  The bank will then determine the capital reserve amount that is appropriate for the loan risk based upon other accord requirements.  All of this means increased costs of the loan to the bank, which inevitably means increased prices (interest) for your business.

If your business is heavily dependent on your line of credit, 2007 is just around the corner!  It is time to begin evaluating your alternatives.  Whether you are a large corporation or a small business, if you count on your line of credit as an expensive form of borrowing, it is time to plan your cash management strategy.

As the cost of borrowing increases, so does the pressure to improve your internal operations and cash conversion cycle – the time from acquiring the components of what you sell, whether it is materials or labor or both, to the time you have cash in hand from the sale of your product or service.  Credit terms from your vendors play an increasingly important role in leveraging your business.  The better your vendor terms, the more time you have to make the sale and collect the cash from your customer before you have to pay the vendor.

On the flip side, the terms you extend to your customers impacts how will quickly you are able to collect cash.  The risk associated with extending credit and the credit limits for each customer must be managed even more closely.

If your business is selling products, finding the right inventory levels, reorder points, and managing all aspects of your inventory will have an increasing favorable impact in your businesses need to borrow.  The right investment level in inventory combined with favorable vendor and customer credit terms will reduce the need to seek cash through your line of credit.

The impact of better internal financial controls and managerial oversight leads to less dependency on a day-to-day basis on the credit line.  In turn, this improved performance translates into reduced risk and better lending terms.

Now is the time to develop a strategy to decrease your reliance on short-term loans/lines of credit.  The improved financial management and operations will be reflected in both your risk rating (interest rates for borrowing) and in the performance of your business.

Here are several recommended actions:

• Review your cash conversion cycle including vendor and customer credit terms
• Analyze inventory levels and management policies to see if there are opportunities to reduce levels
• Analyze your business line (by product or service) to understand where your profits are
• Determine if there are opportunities to improve collection procedures for accounts receivable
• Analyze production processes to decrease quality issues – scrap and rejects

Reducing dependency on external lines of credit means improving the ability of your organization to generate and manage cash from operations.  Now is the time to begin, before you know it 2007 will be here.

Too Much Scorekeeping, Not Enough Results return to top

At a recent event the keynote speaker stated that the sales force didn't need to be bothered with or constrained by "those accounting measures".  It is a sad statement which is made too frequently and reflects the experiences (apparently bad) the speaker (and from their reaction, the audience) have had with the financial and accounting role in the companies they have worked for.

As a "numbers" person, I believe it isn't the perception that should predominant business.  The numbers are a reflection of what has and hasn't happened in a business, but they shouldn't be viewed from the "transactional accounting" perspective, which is apparently how many companies are still using them.

Transactional accounting is about recording the financial events of the business according to acceptable practices.  The accuracy of those records is important, even critical.  However, they aren't the managerial tool the organization needs or wants.  The purely financial representation and analysis of business results doesn't tell the full story.  While marketing is an "expense" under financial accounting treatment, managerially it is an investment.  There are other such examples of scorekeeping versus results measurement.

Businesses need both scorekeeping and results.  Businesses get results from gaining a managerial understanding and perspective on the numeric representation of the business.  Businesses also must recognize information beyond the numbers.  There are events, factors, and decisions that aren't captured real-time by the financial results.  The organization which has the capability to address the non-financial aspects of the business in the context of their ultimate impact on financial performance is the one that will be able to generate significant financial results.

Every activity in the organization ultimately generates cash, uses cash, or both. The results are either direct or indirect from each activity.  For instance, manufacturing a product is a direct use of cash for raw materials, purchased parts, and labor. The ordering of the raw materials and purchased parts is not directly related to the conversion into a finished good - but is a necessary activity to the organization.  The purchasing and manufacturing processes both play a role in producing a product for sale.  Both use cash.  Both ultimately contribute to generating cash.  Either process executed poorly impacts the sales process and the bottom-line.

This becomes the question:  what is the measure of results for each group?  How is purchasing performance measured?  What metrics does manufacturing have to meet?  How are sales people evaluated?

Numbers should be incentives to perform and a means of identifying results.  The results measured must be meaningful to the business and to the performer.  When members of the organization view accounting measures as an obstacle and not as a tool for achieving results, setting priorities, and measuring performance, then it is time to reevaluate how the numbers are being used and determine how to generate relevant metrics which drive the organization forward.  Relevant metrics are necessary; merely keeping score doesn't benefit the organization.

Defining Conflicts of Interest return to top

Defining Conflicts of Interest and How They Impact Your Business

What are conflicts of interest and how do they impact you and your business?  Conflicts of interest occur when someone (an individual or a company) has multiple relationships or connections with another individual or company which could keep them from being independent in thought, action, or opinion.  One of the largest and most widely known conflict of interest examples is Arthur Andersen and Enron.  By having multiple roles as consultant, tax advisor/preparer, and auditor, the accounting firm could not be objective in its actions - too much of its livelihood depended on keeping the business.

Another type of conflict of interest occurs, for example, when a law firm represents Company A and Company B.  When Company A and Company B want to enter into an agreement to merge (or some other deal), they need their attorney’s advice. Because the attorney represents both companies, there is a conflict of interest for the attorney.  Can the attorney adequately and equally represent the interests of both clients in negotiating the deal?  Who knows?

While the Enron situation is an example at one extreme of the potential conflict of interest for a CPA firm, there are many more "small" conflicts of interest that can arise.  For instance, you may have asked a highly respected and well-known CPA to serve as your interim CFO and/or sit on your board of directors. This individual is a partner in a CPA firm.  His firm has been your audit firm for years.  With this new relationship, there is a perceived conflict of interest for the CPA firm.  Because a principal in its firm is now engaged in transactional and strategic decisions of the client company, the CPA firm is no longer unrelated and independent.  Independence, a key requirement in audits, has been compromised.

Another example involving law firms is the situation where lawyers become part of the board, accept ownership interest in a client company as partial compensation for services, or are somehow involved in the business.  Now that the law firm is an investor/owner in the business, the interests of the company may conflict with their role as an attorney - they are no longer unrelated to the business.

Return to the example of the law firm representing multiple companies:  by representing both parties, the degree of give and take, point and counterpoint in negotiations, etc. would most likely be impaired.  The attorney's interest in keeping both clients may come into play and the ability to challenge one's own perceptions and thought processes isn't the same as having another attorney (independent of the individual attorney or his firm).

Why should you care about conflicts of interest?  How do they impact your business?

If you are seeking objective, independent advice which is as free of self-interest as humanly possible, then it is important to make strategic decisions regarding who performs what tasks for your organization.  Having a strong transactional CPA or bookkeeper on your team will enable you to ensure that the day-to-day activities of your business are properly captured and recorded.  Identifying a CPA from a different firm to provide oversight through audit and monitoring enables you to have perspective and opinion that is objective.  If you are a public company, a company seeking investors, or a company that receives government grants or contracts this is may rise to the level of a mandatory requirement.

The same can be said for legal representation.  Having an attorney on your board or as an employee of the company can provide invaluable insights and opinions at the strategic level; complement that with independent external counsel and you are able to maximize the organization’s view of any issue.

This may seem unnecessary expense for your organization.  If you are a growing private company in the tech, biotech, or a complex or highly regulated industry, however, then these are wise investments to protect shareholder value and reduce operational risk.  Furthermore, if you are a private company with dreams of going public or merging with or being acquired by a public company, then at some point you are going to be required to comply with the Sarbanes-Oxley Act, which requires, among other things, auditor independence.

Here are some suggestions for evaluating your current business operations:

• Are there professional service providers acting as consultants and holding equity securities (CPA, attorney, etc.)?
• What role is each of these advisors playing - transactional, strategic, oversight, etc?
• What are the expectations of compliance with Sarbanes-Oxley and other external audit requirements?
• Who is going to rely on the resulting advice or opinions that are issued - internal or external - to make investments, loans, etc?
• What are the risks associated with the perceived or actual conflict of interest if disclosed in a public forum (a newspaper article, etc.)?
• If the company has investors and debt holders, are they aware of the multiple relationships, do they have oversight?
• Does the person(s) with the potential conflict (real or perceived) have the ability to influence the decision or make the decision to give additional business to their own firm?
• Does the person sit on the audit or oversight committee of your company and are they involved in generating or approving the financial results?

Conflicts of interest can lead your organization to bad decisions, additional expense, and increased risk in operations.  Periodic overviews of business relationships, expert advisor roles, and business activity can decrease risk associated with potential bias.  Isn’t it worth the time and investment to keep your business as healthy and effective as possible?

How For-Profits Can Compete with Deep Pocket Not-for-Profits return to top

Many for-profit businesses – consultants, seminar and workshop providers, and a host of other businesses are finding their toughest competition is coming from “not-for-profit” entities.  Commercial businesses that provide services to other businesses (and individuals) are finding it tough to compete against the “free” or “discount” offerings being provided by the not-for-profit sector – including business associations, community colleges, and other organizations – both privately and government funded.

The not-for-profit status creates a two-fold advantage when it comes to positioning “products” like courses, seminars, and workshops and services that includes advising and consulting.  First, the not-for-profit offerings are often supplemented or paid for by private foundations.  So if a commercial business is competing on price for the same clients/customers, then they too must give away the goods.  The problem is that for the commercial entity, what they give away is truly given away – no one is reimbursing them for the costs.  Second, the not-for-profit organizations have the ability to use “incentives” to gain support for the programs – donations, contributions, in-kind services, etc. to build alliances; they can harness the spending power and recognition of more than their own operation.

How does a commercial enterprise compete with governmental agencies and not-for-profit entities?  It has to be based on content and results, differentiation and “branding”.  It isn’t easy and it isn’t cheap.

For the small enterprise that goes head to head for customers, it is an uphill battle to make sure the target market can see a clear difference between you and the FREE services.  It is also critical to recognize you will need to leverage every dollar spent to its maximum.  Getting the message right and delivered to your prospects is the make-or-break of your business.

If you have only recently started receiving competition from the not-for-profits, then the time is now to hone your weapons for the battle for customers.  When price erosion and increased supply begin to affect your business, there will be no time to waste to get back on track.

Here are some tips:

1. Don’t compete on price – you can’t win.
2. Reevaluate your marketing strategy and tactics
3. Consider establishing a referral relationship with the not-for-profit organization (if these are allowed under the funding and operating guidelines)
4. Volunteer or join the board (do so only if this doesn’t create a conflict of interest for your business)
5. Sponsor or exhibit at events held by the not-for-profit

From another perspective, not-for-profits are established to provide support and resources that foster economic growth and market expansion.  When you are competing with a government funded agency, state funded agency, educational institutions, or a private not-for-profit, understand that each of these entities have limitations and restrictions on the type, scope, and nature of the services and products they can provide.  Limitations may include amount of time or degree of involvement.  For instance, an agency may be able to review existing documents and advise where gaps are in the content, but they aren’t allowed to produce information to fill the gaps.

Understanding what your not-for-profit competitor can and can’t do will help you formulate your best strategy and possibly redesign or repackage your service or products to be downstream of their offerings.  If you compete strategically with the not-for-profit, you can continue to grow your business and leverage your competitor’s actions to your advantage.

FOCUS News: Grant Administration and Financial Management Workshops return to top

F.O.C.U.S. Resources is adding to its seminar and workshop programs a series of two hour programs that address specific compliance issues for SBIR grant recipients.  The workshop topics will include:

• Maximizing the Effectiveness of Your Accounting Software
• Understanding Allowable Costs
• Indirect Cost Rates
• Budget Development
• What Constitutes "Adequate" Documentation
• Cash Management

Sponsorships for these events may be available.

• The Five Key Compliance Areas

Additional topics will be added later this year.  Dates, time, location, and cost will be announced. For more information, send an e-mail to FIT@focusresourcesinc.com with Grant Compliance as the subject.

Copyright © 2005 F.O.C.U.S. Resource, Inc.