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GOBBLE-ISATION

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A Chief Financial Officer’s response

Gobble-lisation is defined as “when billions of dollars of retirement savings are gobbled-up and destroyed due to the combined effect of globalisation and a couple of turkeys at some banks that decided to sell cheap credit mortgages”. OK, I may have made up this word, but I thought that the definition would be widely accepted. The question is, what were all the CFOs doing while this situation was developing? I suspect that they were doing some exciting marketing/business partner related work instead of fulfilling their traditional control related responsibilities. I recently attended a workshop with a number of industry CFOs where the changing focuses of the CFO were hotly debated. There was a strong indication of a trend and a need for CFOs to refocus on their traditional control responsibilities.

The impact of Gobble-lisation is likely to be an increased number of businesses facing a financial crisis in the near future. There is, however, surprisingly little literature available on how to handle a financial crisis. As CFOs, now is the time to really step up and guide businesses through these tough times. This article aims to share fifteen “Anti-Gobble techniques” to assist their business to survive during the current financial crisis. Some of the techniques may seem a bit reactionary in nature, but it is important to remember one of the classic quotes from the economist John Keynes: “The market can stay irrational longer than you can stay solvent.”

Offense or defence. Decide quickly what strategy is relevant for your business. There is often a thin line between greatness and bankruptcy, as can be seen from people such as Richard Branson. You will need to decide whether your business can afford to exploit aggressively the economic downturn, such as going on an acquisition spree; or whether it needs to take a defensive approach by conserving cash resources and trying to survive until the good times return.

Eliminate waste and cut costs aggressively. Find ways to change the organisation’s behaviour and become more cost conscious. A simple way is start looking at random samples of purchase orders, and then ask tough questions as to what the business really needs. However, this approach requires that the CFO at least has some understanding of the lean enterprise principles. Lean thinking can be applied in three distinct ways to the business:

1. Lean inside – as advocated by the traditional Toyota system.
2. Lean outside – synchronization of the entire supply chain. Think Walmart and Dell.
3. Lean business model – less brands, less customers, less suppliers, less machines. Less clutter means more cost effective revenue generation.

Understand peoples’ behaviour during troubled times.
Ray Immelman wrote a great book in which he described how an individual’s values and priorities change as the business results disintegrate. The six phase downward spiral is described as follows:

1. When the business is successful, people feel part of a winning team.
2. As the business results come under pressure, the team values start to disintegrate, but managers still try hard to restore profitability.
3. Once the board starts to blame management for the declining results, management loses self-confidence.
4. As the results continue to worsen, the focus shifts defensively to business preservation and individuals shift towards their own security.
5. When there are strong indications that the business may not survive, then the individual’s security becomes the number one priority, even at the expense of the company security/profitability.
6. When bankruptcy becomes a reality, then it’s “dog-eat-dog” in the workplace.
In a business recovery situation the sequence is reversed, except that phases 6 and 3 do not occur.

Cut those unprofitable product lines (but talk to the customer first). Activity based costing (ABC) will assist here. ABC was initially designed to identify the true cost of certain product lines or customers. ABC has had its fair share of controversy, especially from the “theory of constraints” supporters. However, it does provide an understanding of what the customer wants, quantifies the cost and therefore helps to support a transparent price negotiation process, which is useful during an economic downturn where the business really needs to cut unprofitable product lines.

Understand and exploit your constraints. The Theory of Constraints (TOC) developed and implemented worldwide by EM Goldratt (author of “The Goal”) proposes that every organisation must have a goal, otherwise it would not exist. For a business, the goal is ultimately about making a profit now and in the future. He proposes that every business must have a constraint preventing it from achieving infinite profitability. His five step process will assist the business to identify the constraint and to synchronise the business systems to maximize the through-put of the constraint. Ultimately, this will ensure the business optimises the often competing requirements of the various stakeholders (shareholders, customers, employees, suppliers, etc.).
Clearly defined roles, responsibilities and authority levels. In tough times people need more structure so tighten up those controls. Specifically focus on those areas of fraud risk and cost control.

Understand the fraud risk and look out for the warning signs. Understand which fraud risks are most likely to occur in your specific business, e.g. employees certifying receipt of goods that were never received, or paying higher than required prices in return for kickbacks from the supplier. Identify and look out for the typical warning signs of fraud, such as missing original supporting documents, incomplete key account reconciliations, unexplained credit notes and stock shortages.

Identify and eliminate financial reporting fraud. During the year, when the auditors are not around, there is the risk that various window-dressing activities could be occurring. In a weakening market, financial reporting risk increases and the monthly results may be overstated. These overstated results may keep the board in the dark regarding the true state of the business, thereby delaying taking decisive action. Be on the look out for pre-invoicing of sales, channel stuffing, delayed processing of credit notes, changed depreciation assumptions, overvaluation of inventory, use of accruals to smooth profits, delayed write-off of unused impaired fixed assets and delayed writing-off of bad debt.

Love thy banker. What is the difference between an investment banker and a pigeon? A pigeon is still able to make a deposit on a new Ferrari. There are currently a lot of jokes doing the rounds about banker’s job security and greed. However, the reality is that we need them (bankers, not pigeons). It is critical that you understand your cash requirements over the next 12 months, know your banker intimately and secure the access to the necessary lending facilities in advance of a cash crisis.

Identify a common enemy and identify a just cause. Make the time to communicate that neither management nor head office is the enemy. The competitors are the enemy. Tell people what the company is up against, and make the common enemy real in their minds. However, the enemy will not seem real unless your business has a “just cause” for its own existence, and people in the organisation understand what is the just cause .

Is your business model sustainable? A crisis, as the Chinese character for the word indicates, presents both a danger and an opportunity. A financial crisis tends to expose those businesses with fundamentally flawed business models. This could be an opportunity to take the knife to those divisions that just never made business sense and never will make sense. This approach may seem a bit short-sighted but in my defence another quote from John Keynes comes to mind: “The long run is a misleading guide to current affairs; in the long run we are all dead”.

Practise calm realism. Many leaders believe that it is their job to spread a positive message at all times, and that this approach will build their leadership stature. However, by not telling the truth about the situation the leader loses integrity and credibility. People fear the unknown and when a leader calmly talks about the realities and shares that there are solutions to most problems, they should feel less discouraged.

Risk management. Review the traditional risk management areas such as insurance cover, foreign exchange hedging strategies and monitoring of credit limits.

Evaluate your top team’s ability to handle the crisis. People in the team may have forgotten how to deal with the tough times (it has been a few years since the last downturn). In fact, some younger members of the team may never have experienced tough times. Consider changes in a few key positions if necessary.

Intellectual honesty. Top management is often the last to know that the business is facing a crisis. In a crisis it is important to get honest data to support decision-making. Firstly, listen to your customers, as they know the most about what is good and what is bad about your business. Secondly, create a climate where all employees are able to tell the truth no matter how scary it may be. Thirdly, make the time to step away from the chaos and think through the data. Having a personal sounding board can assist with putting the data in some perspective.

One last word in these tough times from a real cowboy,
John Wayne:
”Courage is being scared to death – and saddling up anyway.”.

References:
1. The Turnaround Kid – Steve Miller
2. Great Boss, Dead Boss – Ray Immelman
3. The Goal – EM Goldratt
4. The Confused Global State of Lean Presentation –
R Schonberger

Brendon Wood CA(SA) is the financial executive for a JSE listed automotive component manufacturer with customers, suppliers and partners in South Africa and around the world.