“LIKE” IF YOU REMEMBER MYSPACE

MySpaceIs it just me, or has there been an explosion of people posting nostalgic photos on Facebook and asking you to click “Like” if you can remember a black and white picture of some fifties TV icon or a once popular consumer product from your youth? Time has a way of reducing our past to warm, fuzzy memories. Heck, show me a photo of a macho guy enjoying a cigarette on the back of a horse and I might even forget that three of the Marlboro Man actors died of lung cancer!

Digital media has done more than merely provide a medium to share the recollections of our youth. It has greatly diminished the time span during which products and services move from broad acceptance and popularity to distant memories. Allow me to offer two well-known examples.

Gutenberg’s 1440 invention of the printing press revolutionized communication. It made possible the sharing of ideas and information through the mass production of books. It took another 555 years, until 1995, for an upstart company named Amazon to start selling those same books using something that had been introduced just three years earlier. That something was the Internet.

It took another 12 years to popularize eReaders like their famous Kindle. Within four years, Amazon was selling three times as many eBooks as hard covers. Their success obviously does not include a plethora of competitors including the hugely successful Apple iPad. It seems almost certain the paper book will soon be a candidate for Facebook friends to ask you to “Like” if you can remember owning one.

Still, 600 years from invention to impending obsolescence is not a bad run! Now consider a more recent service life span.

MySpace was introduced in August 2003, six months before Facebook. Just two years later, it was the most visited social networking site on the planet. Rupert Murdock was so excited about its prospects that he paid $580 million for it in 2005. In 2006, it reached 100 million accounts, a level that required 1,600 employees to support.

Facebook over took it in April 2008.

In June 2011, Murdoch’s News Corporation sold MySpace for $35 million, a 94% loss on their six-year investment. With uncharacteristic understatement, Murdoch pronounced the purchase a “huge mistake”.

These examples illustrate three critically important points for all 21st century marketers.

  1. Communication trends change faster than businesses can anticipate. Most lack the resources to manage that change.
  2. Faced with a constantly expanding stream of free choices, your target audience no longer uses communications channels popular just a few years ago.
  3. Neither do your successful competitors.

The cost of failure is high. Even the most carefully designed marketing communiqué, be it a press release, an ad campaign, a newsletter, etc., will fail if it is not transmitted in the optimal channel.

The only way to avoid that mistake is to communicate a consistent message and single brand to over-lapping audiences across multiple channels. That is what successful digital media marketing is all about.

© 2013 by CFO America, LLC

Increasing User Buy-in of Financial Forecasts

Business HandshakeLet me begin with two assumptions: first, your primary modeling tool is Microsoft Excel; second, you share model projections with others. If both these assumptions are correct, I have two secrets of success for those new to financial forecasting.

The first is that everyone who sees your forecast assumes they know more about what the modeled results should be and better understand the impact of changes than you do. That you spent countless hours constructing the model, studying company and industry trends, back-testing formulas and validating every assumption will be quickly lost in their rush to point out what to them appears to be “obvious errors”.

I frequently develop complex models generating quarterly projections of full financial statements for a three to five year horizon. Models usually involve the consolidation of multiple entities and detailed ratio analysis. A typical model has 35 to 60 variables. Every variable is contained in named cells on an assumptions tab (immediately behind the title tab). All formulas utilize the appropriate variable name rather than a cell reference or hard coding.

For those not familiar with the use of named cells in Excel, go to the File Manager icon on the Formulas tab. Additional guidance is available online. One source is http://bit.ly/18tl7OP.

Typically, a client will zero in on one or two variables, insisting (as an example) that sales growth projected in year 3 is clearly wrong! He or she is so confident of their belief that the model has likely lost significant credibility with them.

Invariably, the impact of the user’s change is not as significant as they suppose. Sticking with the sales example, changing the growth rate has no impact on earlier years. Furthermore, the effect on future income is reduced by resultant increases in the cost of goods sold, inventory carrying costs, variable expenses such as commissions and shipping, borrowing costs and so on. Finally, income taxes further reduce the bottom line impact by another 35% to 40%.

Rational discussion and logic serve no purpose in this situation. You cannot change human nature! Your goal is merely to channel it in a productive direction.

I do this by simply asking what they think the number should be. I then take them to the assumptions tab and change the offending variable to their number. The model then recalculates, eliminating any guesswork on the impact of the proposed “correction”.

Seeing is believing.

The second “secret” complements the first. Without exception, even the most complex models come down to a mere handful of key variables. Since your goal is to redirect rather than change behavior, help users focus on those that drive projected results, rather than getting bogged down in immaterial detail.

You can accomplish this by highlighting which variables have an individually material impact on the cumulative results of your forecast. Begin by deciding what the appropriate base or dependant result is. I find it is most often one of three things depending on the primary use of the model: net income, stockholders equity or the internal rate of return.

I then test every variable in isolation with a 10% unfavorable change. For example, a 20% sales increase is reduced to 18%. I note the impact of each variable on the cumulative base result. I then typically use a materiality threshold of 2% for disclosure. The less attention drawn to non-critical variables the better!

Rarely will a variable have a high correlation to the measured result. A typical scenario might be that a 10% change in each of my 35 to 60 variables produces four to six with an impact greater than 2%, with none exceeding 8%.

This sensitivity analysis is the third tab, immediately behind the variables. By quantifying and clearly presenting the impact of changes in this manner, you are inviting needed input (and therefore user buy-in), without having to debate or justify the majority of variables that will have minimal or no impact on your forecast. Users can then concentrate on achieving a comfort level with a relative handful of model inputs, saving everyone time.

As a closing note, while the focus is on the cumulative impact of variable changes, there are times and circumstances when individual period results are also important, regardless of the dollar impact. For example, loan covenant compliance is a constant requirement. If a change in an otherwise insignificant variable creates an incidence of non-compliance, the change cannot be ignored.

How I handle that situation is the subject of a future article. Here is a hint: conditional formatting!

CASH IS KING, LONG LIVE THE KING!

 

 

Today’s title is an obvious parody on the old phrase, “The king is dead. Long live the king!” It dates to thirteenth century England. It conveyed the immediate transfer of power between a deceased monarch and the heir to the throne. More relevant to our purposes, it signified the continuity of sovereignty, or the supreme authority.

Future articles will explore where cash comes from, and where it goes, two critically important issues for every small business. For now, I will discuss the more basic question of why cash is cash king in today’s business world.

First, allow me to quote the experts. A 2005 study titled Small Business: Causes of Bankruptcy by Don B. Bradley III and Chris Cowdery of the University of Central Arkansas explained the supreme importance of cash rather succinctly:

“A lack of cash flow is often the biggest failure indicator. A lack of cash flow could cause a business to fall behind on wage payments, rent, and insurance and loan payments. A lack of cash flow also could inhibit the company’s ability to reinvest for future profits such as the ordering of products or supplies and marketing execution. When a company is borrowing to pay off past debts, it is usually a sign of disaster to come.”

They also said, “A significant shortage of cash flow limits the company’s ability to respond to outside threats. This is critical for fledgling businesses since new threats seem to appear every day.”

The only thing you can be certain of in business is that things will never turn out exactly as you planned. Adequate cash allows businesses to survive extended periods when sales, profits and cash flow are running behind plan, whatever the cause. Every business requires some level of cash to serve as a buffer against this uncertainty.

You could say cash provides sleep insurance. Constantly worrying whether a large customer will pay their invoice in time to meet Friday’s payroll, or whether you will have to turn away sales during your busiest season because you cannot stock sufficient inventory to meet demand is too often part of a businessperson’s everyday thought process.

Adequate cash levels are especially vital during the initial start-up period of a business. However, while the risks and challenges change as a business grows and matures, cash is supreme during any stage of a company’s life cycle.

For example, imagine that a 120-year-old company generated $1.2 billion in net losses. My immediate reaction is they certainly won’t be around to celebrate their 125th anniversary. That company is Alcoa. They lost $74 million in 2008 and a staggering $1.1 billion in 2009. Yet, Alcoa is still the world’s third largest producer of aluminum, and still trades on the New York Stock Exchange.

How is surviving such staggering losses possible? It was possible because during the same two years Alcoa generated $2.6 billion of positive cash flow from operations. As the old adage goes, “You can survive almost anything if you just have enough cash.” Businesses close their doors when they run out of cash to pay vendors and employees, period!

Here is an even more dramatic and current example of why cash is king.

AMR Corporation, the parent company of American Airlines, filed for bankruptcy protection in November 2011. During the previous 15 quarters, the company accumulated over $4.9 billion in net losses. Yet industry experts seem confident the company will successfully emerge from bankruptcy. Why? AMR has over $4.3 billion in cash on its balance sheet.

Far too often, the immediate response to a cash crisis is to tighten up on expenses, cut something back, to make do with less! That may be an appropriate tactic, especially if you have not scrutinized expenses closely in the past, or do not have a good handle on your cost structure.

However, cutting back is not the only tactic.

Next week I will begin a discussion of how cash flow generated (or used) by any business is the net result of the inter-action and proper management of three related cycles. They are the revenue, expense and capital cycles.

Until then, long live the king!

© 2011 by Dale R. Schmeltzle

 CFO America: Your Cash Flow Optimization experts

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