- 10 steps to engineering financial success
- Risking failure in order to succeed
- The solvency and liquidity test in business rescue
10 STEPS TO ENGINEERING FINANCIAL SUCCESS
From working with many companies across various sectors, some that are very successful and others that are still a work in process, Louw Barnardt and his team have learnt that financial success in business can be engineered
Money is not a miraculous and independent mythical life force, but rather a completely measurable that can be tracked and utilised completely. Furthermore, finance is more than just compliance and handling accounts, where leveraging key insights with an active mind can create measurable growth. There is a golden thread that can be seen in each success story in our modern business environment.
I have sought to distill my observations and have seen three phases, which I will detail in ten critical steps. The aim is to (1) rethink current business and financial practices, selecting the best in light of the rapidly changing market for the future, (2) streamlining automatable activities so that (3) energy can be conserved to look at growth opportunities, navigate them, and succeed.
It begins with a change in mind-set (Steps 1–6). It’s made efficient by way of automation (Steps 7–9) and brought to fulfilment through scaling (Step 10).
Before we get started, I’d like to introduce you to OldCo and NewCo. OldCo and NewCo are both established companies operating in a similar industry to yours. They both earn product and service income and have both been quite successful to date. OldCo subscribes to the old-school way of doing business. They believe that if it’s not broken, then don’t fix it. Subsequently, they are not very interested in new technology and processes but instead focus on what they know best. NewCo, on the other hand, has had a change in mind-set. They believe that technology, innovation and access to the right information give them a competitive advantage in a fast-paced global business environment. These two companies will serve as our examples in the ten steps below.
To begin, let’s consider retrospection, analysis and choice. Looking back at what has been and what has not been working, choosing the best and looking to the global playing field for inspiration and direction.
ENTER PHASE 1: RETHINK
STEP 1– RETHINK FINANCIAL SYSTEMS AND CONTROLS
It is no longer the companies that have access to the information that hold power but rather the ones that are able to effectively sift through, analyse, interpret and execute on a magnitude of available information. This holds true when dealing with internal information as much as when looking at external factors. In rethinking financial systems and controls, access to financial information that is produced accurately, timeously and effortlessly yields huge decision-making value. A controlled environment that limits risks and standard operating procedures (SOPs) that leave no gaps will help you leverage two key drivers of your company’s value – profitability and risk.
OldCo sends a box of slips and bank statements to their accountant, who prepares financial records on a system that only works on one computer at the accountant’s office. Management reports are received every three months (or six months if they are busy). OldCo’s staff make out invoices – when they remember to – that are based on hand-written notes in their diaries of time spent.
NewCo has access to live financial data because their bank feeds are automatically updated to their financial records and matched daily. NewCo has a time-tracking system implemented that makes sure every minute of consulting work gets invoiced.
STEP 2 – RETHINK FINANCIAL REPORTING
To quote Karl Pearson: ‘That which is measured improves. That which is measured and reported improves exponentially.’ Only when identifying, tracking and reporting on the key metrics of your business are you able to improve them significantly. Traditionally boring management packs can be transformed into valuable decision-making tools when available for scrutiny at board meetings.
OldCo does not really look at management reports at board meetings. There is too much else going on. The packs received from the accountant are hard to read and make sense of anyway.
NewCo has access to accurate financial information neatly compiled three days after month end. Targets for key metrics allow the team to identify inefficiencies and actively improve ratios.
STEP 3 – RETHINK CASH FLOW
Cash flow is the lifeblood of every business. But somehow it remains an area that is not monitored on an adequate level by most directors. Rethinking cash flow means implementing the right tools and templates that enable you to plan ahead and proactively identify cash constraints early on. This way, rough seas can be effectively navigated and disaster prevented. Good habits around managing cash flow could often be the difference between survival or having to close your doors in times of tribulation.
OldCo checks their bank statements when they receive them to see how much is in the bank now. OldCo are frustrated with their bank, who can never assist fast enough when they need bridging finance. This has threatened the company’s continuity before. OldCo makes decisions that affect cash flow based on gut. Their credit rating is lower than it could be.
NewCo has a cash flow tool that enables them to monitor cash flow closely. Checks are done weekly, even daily in periods when money is tight. NewCo forecasts cash flow months in advanced, enabling them to identify large cash flow needs like annual software licence renewal or asset purchases well in advance in order to secure finance for it.
NewCo can check monthly inflows and outflows before making big decisions like hiring a new management level staff member.
STEP 4 – RETHINK COMPLIANCE
The difference between passing an internal due diligence test and failing one could be the difference between getting a big new contract that takes the business to the next level or losing one that comes with material downside effects. Rethinking compliance means understanding the value of having all the boxes ticked so that business can flow unconstrained and provide a safe space for big thinking.
OldCo does not pay much attention to compliance. They omitted to take the new codes seriously and ended up as an L8-rated company, subsequently losing the 30% of their business that used to rely on government contracts. OldCo also did not set up or submit their last financials at CIPC or SARS. Supplier non-compliance on a short deadline caught them off guard, losing them their biggest corporate client. The list goes on …
NewCo takes compliance seriously. Up-to-date financials, tax clearance, good governance and a strong BEE rating is getting them new business from corporate and government.
STEP 5 – RETHINK RISK
An understanding of the unique risks of your industry, your business model, your leverage, the global business environment and a technologically advancing playing field is critical to business success. Risks are evolving. New York’s scrap yards are full of yellow taxis who never thought that their industry could be disrupted by an app. Banks are shivering because of the evolution of FinTech and BlockChain. That and many other business risks have made their lending policies to SMEs more conservative. The rand has plummeted, sending companies with predominantly foreign suppliers into liquidation. Cloud technologies are replacing slow, expensive hardware and software spend, making many older technologies obsolete. It requires a keen mind to stay on top of the new business and financial risks presented by our fast evolving business space.
STEP 6 – RETHINK OPPORTUNITY
As intimidating as risks and problems can be, if approached properly almost every one of them can be seen as an opportunity. New risks are creating unprecedented new opportunities in your industry, for your business model, around your leverage, in the global business environment and in a technologically advancing playing field. Those who can adapt fast and move effectively will reap the biggest reward.
NewCo has built an industry-first online platform that extends their reach to thousands of new customers overlooked by OldCo’s traditional model. They have broken into the UK market where they earn R22 to the pound.
This has significantly increased their profit margin. Understanding the trends and tools of brand building and digital marketing has seen their sales grow steadily despite a stagnant local economy. They have been accepted into a Dutch business acceleration programme, through which they have met an angel investor that has offered them a low-interest rate loan to serve as capital for their expansion.
Rethinking financial systems and controls, reporting, cash flow, compliance, risk and opportunities has given NewCo not only a breath of fresh air but serious direction too. With this in mind, there is now room to streamline and effectively grow the company.
ENTER PHASE 2: AUTOMATE
STEP 7 – AUTOMATE ACCOUNTING
Using the latest in cloud accounting software technology, there is no reason for this process to take up so much of your time. Implementing the right system could drastically decrease time spent on capturing transactions, and inadvertently provide you with more time and energy with which to tackle other things.
OldCo keeps a box of slips and some Excel spreadsheets. They will know the picture when they get management accounts from their accountant in a couple of months. Sort of …
NewCo uses Expensify to capture slips and costs. This automatically feeds through to their cloud accounting package, which also auto-allocates bank feeds directly to their accounts. Cloud payroll software automatically feeds payroll into their accounts.
STEP 8 – AUTOMATE DASHBOARDS
Creating high-impact, fully integrated live dashboard puts the information you need at your fingertips. NewCo’s directors can monitor key metrics live from anywhere in the world, enabling them to operate more wisely and efficiently.
STEP 9 – AUTOMATE OTHER SYSTEMS
Automation is key to ultimate business success. It allows the entrepreneur the freedom of continuing to create and innovate while their business is running successfully in the background with little to no personal and laborious inputs. Automation and systems integration adds significantly to a company’s efficiency and effectiveness, which NewCo values. They have implemented many systems and processes that make running their company easier, including ones where enquiries and communication automatically feed to their CRM system, building them a strong database for sales lead generation.
Retainer clients sign up online and their engagement contracts are automated into the process, as are their debit order systems. Retainer invoices go out automatically and receipts are matched accordingly. No one needs to make out invoices or follow up with retainer clients. NewCo has even created digital content of all their best practice approaches to business. E-books, audio courses and how to videos on a subscription model generate a passive stream of income that ups their bottom line.
With their systems carefully selected and their operations streamlined, NewCo is free to ideate innovative growth that can take their company to the next level, and help them add more value to South Africa.
ENTER PHASE 3: SCALE
STEP 10 – BUILD TO SCALE
The ability to scale is what takes a good company from success to significance. Rethinking your processes, finance, business model and opportunities to build a scalable company is key, not just for you but for South Africa too.
With automated systems, good margins, solid control over cash flow, multiple revenue streams, and a culture of innovation, NewCo is built for scale. A Dutch VC, a local enterprise development fund and a Clifton billionaire have all offered to give them access to the growth funding needed to go global. The limiting factors to uncapped growth were identified early on and eliminated. They are building a company that will employ thousands, make millions and sell for hundreds of millions. Less than five years from now, NewCo will likely be listing. At the same time, OldCo will likely be filing for bankruptcy.
These ten steps seek to challenge you to understand the value of rethinking finance and systems, automating processes and building for scale. For South Africa to make growth a reality, we need to build more companies that are better and faster and able to employ our people and create wealth for our nation.
We must realise that we are now operating on a global playing field. The speed of change is rapid and the use of technology is a necessity. Best of luck in your endeavour to build companies that are profitable, investable, scalable and successful.
AUTHOR l Louw Barnardt CA(SA) is the Co-Founder and Managing Director of Outsourced CFO, a financial management boutique of chartered accountants
RISKING FAILURE IN ORDER TO SUCCEED
The relationship between success and failure is paradoxical – you need to risk failure in order to be successful. By Allon Raiz
Samuel Smith – not his real name – and I met at an entrepreneurial conference about ten years ago. We’ve kept in touch ever since, each following the other’s business. He’s had some truly unique ideas over the years and his business has been very successful, hence I like to refer to him as Successful Sam.
When Successful Sam started his business, he wasn’t afraid to take risks and fail because he didn’t have much to lose. I watched as he became more successful and was less inclined to take a risk that would jeopardise everything he had worked for. He enjoyed being in his comfort zone where he ‘knew’ that money would always come in at the end of the month. He eventually became so comfortable that he no longer took any significant risks.
The trouble with success is that it plants the seeds of failure. I watched as Sam planted the seeds of his business, tended to the vines through the good times and the bad times, and harvested the fruits of his labour. Once he had these fruits, he became consumed with them and no longer felt he needed to continue planting new seeds.
THE TRAPPINGS OF SUCCESS
When Sam’s business started thriving, he felt he deserved to indulge in the luxuries he’d had his eye on for as long as he could remember. Suddenly that new Mercedes-Benz E-Class Cabriolet, six-bedroom house with a jacuzzi and tennis court in the best suburb, and luxury yacht anchored at Langebaan Yacht Club no longer seemed like a distant dream.
As he became increasingly consumed with these trappings of success, he lost sight of how he had reached a position where he could afford them in the first place. His priorities shifted from managing the day-to-day running of his business and focusing on clients to managing the trappings of his success, such as finding someone at the yacht club who could help with the repairs on his yacht’s motor.
Before he had his luxury yacht, it was very unlikely that he would have been thinking about a yacht motor instead of building his client base.
THE FIZZLING OUT OF HUNGER AND AGGRESSION
The well-known supermodel Linda Evangelista was once quoted as saying that she wasn’t prepared to wake up for less than $10 000. Sam woke up one morning and decided that he too would no longer get out of bed for smaller opportunities. He believed that he didn’t need to because he was successful and invincible, and the bigger opportunities would come straight to him. His hunger for pursuing new opportunities soon fizzled out. When he stopped ‘getting out of bed’ for smaller opportunities, other agile competitors jumped at the chance to get them and in many cases they reaped the rewards because these smaller opportunities often resulted in much bigger ones.
Sam forgot that these smaller deals are what got him where he is today, and helped keep his business afloat all these years. When he first started out he faced the risks associated with small deals and was excited to venture into the unknown to find new opportunities.
When a multi-million-rand deal fell through, and then another shortly after that, Sam had little to fall back on. While he was out organising the repairs on his yacht’s motor, his client base had atrophied to an incredibly unhealthy state. He’d turned down the smaller opportunities and they had gone elsewhere.
THE DANGER OF WORKING ‘ON’ YOUR BUSINESS ONLY AND NO LONGER ‘IN’ IT
Michael E Gerber’s world-famous entrepreneurial myth (e-myth) principle says that entrepreneurs should focus more on working ‘on’ their business than ’in’ it. After reading up on Gerber’s e-myth, Sam decided that that was exactly what he was going to do with his business. He also started using Gerber’s e-myth as justification for spending a fair amount of time sailing his yacht and working on his business instead of being in the office and attending meetings. ‘It’s more important that I work on my business only, rather than in it,’ he told me. ‘The time I spend on my yacht, away from everything, is productive because it helps me think about my business.’
While Sam was out sailing near the shore, he missed an announcement that the social media manager, who’d played a pivotal role in developing his business’ digital strategy, had resigned and left. He only found out that Tom had left when he read HR’s monthly report. Sam had sat in on Tom’s interview when he applied for the job and the two of them had hit it off instantly because their thought processes relating to business were so closely aligned. If Sam had been in the office more often, Tom would have most likely approached him and told him he was unhappy in his role. When an executive asked Sam why Tom had resigned and what was done to change his mind, he wasn’t able to give her any feedback.
In the space of a year and a half, Sam’s business had all but collapsed. He phoned me one evening for support and I asked him how this had happened. His response was simply, ‘I don’t know what happened.’
On the one hand, I agree that it’s good when entrepreneurs take some time off and spend a few days away from the office so that they can think about their business, but on the other hand, there is a danger to only working on your business and not in it, as Sam found out. He was not privy to many of the things that were happening in his office, and when his MD changed the sales strategy he was not around to tell him why he didn’t agree with the changes that had been made. In its ideal state, there should be constant ebb and flow of working on the business and in the business, creating fluidity between the two, particularly for a growing entrepreneurial business.
Monthly reports will never give an entrepreneur a true feel for what’s going on in their business or keep them updated in real time on the day-to-day running of it, especially when they’re sitting on the deck of their yacht and reading the report. There are times when it is crucial that an entrepreneur work in their business and do things such as attend sales meetings or write a new proposal.
At times, entrepreneurs misconstrue Gerber’s e-myth, especially when using it as an excuse to not have to be involved in the day-to-day running of their business, or as a reason for not knowing what went wrong in their business when it collapsed. Successful entrepreneurs more often than not have a fairly good idea of what is going on in their business.
THE PARADOXICAL RELATIONSHIP
I’ve seen many entrepreneurs lose their businesses, and a key observation is that they lost them when they became successful and stopped taking risks.
I believe successful entrepreneurs are successful because they have managed to find the correct balance between being successful and taking risks. They’re aware that if they only cling to success, they are destined to fail, and as much as they may not want to take risks anymore, especially ones that could cost them everything, they know that nothing great will come from staying in their comfort zone. They need to face failure again in order to grow.
Sam is currently working on rebuilding his business and applying the lessons he learned, the good and the bad. He’s being extra vigilant of the trappings of his success so that he doesn’t become consumed with them; regaining his hunger for landing new opportunities, big and small; becoming far more pragmatic about working more in his business than he did last time, and taking significant risks again. He’s confident in his ability to rebuild his business and is making a concerted effort not to become overconfident again about his success.
Do you have the seeds of failure that were inherent in Successful Sam? If you do, it’s probably time you took a risk again.
AUTHOR l Allon Raiz is the CEO of Raizcorp
THE SOLVENCY AND LIQUIDITY TEST IN BUSINESS RESCUE
The Companies Act has at its heart the solvency and liquidity test as the primary protection for creditors and shareholders. When the test cannot be met, the directors are obliged to consider business rescue under Chapter 6 of the Act. By Robin Nicholson
The 1973 Companies Act has as a central tenet the maintenance of capital. This tenet informed the basic approach to the way share capital was structured and was the reason why shares could not be subscribed for at a discount and why a company could neither acquire its own shares nor provide financial assistance in their acquisition. The primary purpose was to protect creditors of the company by preserving share capital and reserves and restricting distributions to situations where assets exceed liabilities.
Without thin capitalisations rules and with the permitting of no par value shares, the tenet was undermined even before the Act came into force. This was done by issuing shares of no par value with low capital value and financing the business through shareholder loans. Creditor reaction was often to insist that such loans be subordinated and to insist on specific loan terms that sought to preserve both balance sheet solvency and operational liquidity.
The Companies Act of 2008 seeks to replace this ineffective regime with the introduction of the ‘solvency and liquidity’ test, the ‘business judgement’ test and the codification of the duties of directors and advisors. It also introduces the concept of ‘business rescue’ for periods of distressed liquidity should the directors invoke the provisions contained in Chapter 6 of the Act.
This series of articles considers the inter-relationship of these measures. The most important of these is the solvency and liquidity test set out in Section 4 of the Act. The test provides that for a company not to be considered financially distressed:
‘1 The assets of the company (fairly valued) equal or exceed the liabilities (fairly valued), and
It appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months after the date on which the test is considered or In the 12-month period following a distribution
Interestingly, the solvency and liquidity test appears to cover a combination of the two types of insolvency – the first being technical insolvency whereby the company’s assets (fairly valued) are exceeded by its liabilities. The second type of insolvency, referred to as commercial insolvency, is referenced by a company’s inability to meet its debt requirements as they fall due, irrespective of the nature of its balance sheet.
In applying the solvency and liquidity test a board of directors or its advisors must consider all reasonably foreseeable financial circumstances at the time of performing the test. Therefore the board would consider the company’s financial information based on accounting records that comply with Section 28 and financial statements that comply with the requirements of Section 29 of the Act.
This creates a difficulty in that none of these records and statements are forward-looking and the Act is silent on what reasonable information would be required to support the business judgement test when considering whether or not the company is in financial distress.
The board, in applying the solvency and liquidity test, would need access to the forward-looking budgets, cash flows and funding plans that reflect the future forecast of the business. If these are absent, how could the requirements of the solvency and liquidity test be met?
There are no standards that guide the preparation of the financial forecasts and or the reasonableness of the assumptions used in compiling these forward-looking statements. Therefore the board will need to bring to bear high levels of skill and care in the evaluation process.
The board, or any other person applying the solvency and liquidity test to a company, must consider the fair value of the assets and liabilities including any foreseeable contingent assets and liabilities. It may also consider any other valuation of the assets and liabilities of the company that is reasonable in the circumstances.
The recognition and valuation of assets and liabilities must conform to any of the standards set by the Act. Often intangible assets such as brands and trademarks are not recognised on the balance sheet or taken into account in the valuation of companies but they can have a profound effect on the solvency element of the test. Thus, the valuation of the intangible, unrecognised assets may be appropriate in the circumstances. In particular, self-generated assets, prohibited under International Framework Reporting Standards (IFRS), may be considered in the solvency and liquidity test.
Chapter 6 of the Act (Business Rescue) introduces the concept of ‘financially distressed’ in Section 128(f)(i). This builds on the principles of the solvency and liquidity test as set out in Section 4. The test requires directors and advisors to consider financial distress when it seems reasonably unlikely that the company will pay all of its debts as they become due and payable in the immediately ensuing six months or it is reasonably likely that it will become insolvent in that period.
The section implies that the solvency and liquidity test must be continuously evaluated by the board and the officers of the company. It must therefore be a key consideration of the risk and finance committees of well-governed companies.
In considering the voluntary commencement of business rescue, Section 129(b) requires that there must appear to be a ‘reasonable prospect’ of rescuing the company. The impact of a voluntary commencement of business rescue proceeds is that a business rescue practitioner is appointed by the board of directors and all claims against the company at the date of commencement are held in abeyance. The intention here is that the practitioner and the existing board are provided with ‘breathing’ space during which to administer the operations of the business to the best advantage of the creditors and shareholders.
The business rescue practitioner (BRP) is expected to present a plan that maps the route for the company’s return to solvency and liquidity and the rescue of the business. Alternatively, the plan may allow for an outcome better than liquidation. At all times in the process, the BRP needs to keep the solvency and liquidity test foremost in his or her mind while navigating the complex business, legal and financial issues that arise in business rescue.
The precise meaning of this phrase will be considered in a future article but the wording is, in my view, incorrect and the BRP must consider the likelihood of rescue of the business contained in the company through a range of corporate actions. The shortcoming of judicial management was the focus on the saving of the company and not the business. If the objectives of rescue are to be met, then the wording should be revised. In simple terms, judicial management sought to preserve the cup and business rescue seeks to save the content.
Where the board recognises the likelihood of imminent distress and considers there is a reasonable prospect of rescuing the business but chooses not enter into business rescue, the company is required to provide the notice of distress to creditors and affected parties. The board must also provide reasons for not entering into business rescue. This is a new level of protection for affected parties and allows creditors an insight into the affairs of companies before they default on payment.
It is unusual to see this notice of distress and directors may well be at risk in these circumstances even if they have very good reasons to believe that the company will overcome its solvency and liquidity challenges within the ensuing six months. The Act does not allow elective compliance and the wording of Section 129(7) is mandatory.
It is in applying the ‘business judgement’ test to determine whether there is a ‘reasonable prospect of success’ of the corporate action proposed in the business rescue plan that directors, their advisors, and the business rescue practitioners face their greatest challenge. Their reputations, careers and personal liability are exposed unless due care and diligence are evidenced in the decision.
The meaning and interpretation of these key elements of the Act will, no doubt, be litigated. That litigation is most likely to arise in the course of business rescue. In court initiated business rescue good practice already insists on an independent expert to give their opinion on the reasonable prospect of success before granting the application. The introduction of a special court could almost certainly anticipate that creditors and affected parties will challenge both the commencement of business rescue or liquidation on this test on a more frequent and timely basis.
BRPs need to carefully assess the information provided to the board that informed their opinion that rescue had a reasonable prospect of success; that the basis of the valuation of assets and liabilities used in the test was appropriate; the quality of the financial records and financial statements; and the forward forecasts. The forward-looking work papers that identify the distress should also conform to some agreed standards and some standardised formats.
Section 150 of the Act specifies details of the information expected to be included in the business rescue plan along with the time horizon required. It does not, however, specify a format for this information. Accountants would expect that the cash flow statement should conform to IFRS, but IFRS allows two formats in which cash flow information may be presented. In practice, it is more often the simple cash payment plan that is provided. This may be an area where accountants can play a meaningful role in business rescue by supporting practitioners who may not have the skills set to produce plans that comply with IFRS. I would submit that the professional bodies need to apply their minds to providing guidance on these matters.
AUTHOR l Robin Nicholson CA(SA), BCom LLB, BAcc (Wits) is a business rescue practitioner and director with Corporate-911