A relevant case study

A building contracting firm which had been growing speedily for approx ten years from a stone-cold standing start, and with a turnover of approx £3m, and with approx 40 staff, has done it all absolutely wrong for x many years, and was now suffering serious long-term damage and major problems – and danger - as a result 

The Owner / Founder / Chairman / CEO, who had done an absolutely amazing job in starting and building this significant enterprise, found himself, even before the recession, in terrible cash flow difficulties, primarily as a direct result of his over-riding obsession, over that ten year period, with sales turnover  

He over-rode the advice of his fellow directors, (both of whom were full-time executive directors), and similarly of his internal accountant and external accountant professional mentors, primarily on the basis that he did not believe or in fact understand their figures, which showed that firm was in reality losing money month after month, and year after year, on the presented P & L Analyses

His contention was that he was hitting the accepted industry standard of X% Gross Profit Margin, and that therefore every thing would be / should be hunky-dory, given that his Fixed Overheads were under control, which, to be fair, they were, effectively

Truth be told though, he was, like many of his ilk, not very financially-literate, and the very real secondary problem which he was facing was that he was being presented with monthly management accounts from his internal book keepers and internal accountant which were structured in totally different ways - and the annual accounts from the external accountants were structured in yet a further different manner. It was a fact also that the monthly management accounts which were emanating for the internal accountant were hugely and quite unnecessarily over-complicated

At the point at which OMSG were asked to assist, the firm was having very real difficulty in paying its weekly and monthly wages and salaries, and similarly in paying its key suppliers monthly, notwithstanding the fact that it had in place very considerable overdraft facilities, and medium term loans, and debtor invoice factoring from its bankers

At that said point, the bank had said that enough was enough and that they were not prepared to assist any further, beyond their then-existing commitment        

The MD was still adamant that he was right and that the monthly and annual figures as presented were wrong, and he shouted again and again that the said presented figures did not reflect the true picture, , ,,,,,,,,,,,,,,,,,,  which he saw quite simply as being £3m turnover and 30% GP = £900k GP, and with Fixed Overheads at £500k = a Net Profit of £400k !

He was in essence, challenging the varying GP figures shown in the various sets of accounts which were being put in front of him

It didn’t take more than three or four sessions at the firm, for the appointed OMSG Senior business mentor, working in close consultation with the Internal Accountant and with two Operations Directors, to establish that the varying GP figure was indeed the key issue, linked of course to the driving obsession of the MD with Sales Turnover

After careful analysis by the OMSG Senior business mentor, focusing primarily it has to be said on challenging and simplifying the way over-complex, not to say contradictory, costing and accounting figurings, the outcome was that the MD was indeed proved to be ultimately INCORRECT in his assertions, ie the target of 30% GP was most definitely NOT being achieved, this largely because the Job Costing and Job Pricing MO’s used by the two Operations Directors were found to be at complete structural variance with the other three accounting calculations which were being used within the company

Or, put more simply, a number of key cost items were being put above and below the (GP) line in different ways in each of the four cases

The OMSG mentor had of course, as part of that process, tested the totality of the cost lines, ie ignoring completely for a moment or three, any GP break line

The final outcome ? – Absolute proof from the mentor, using a modified and consistent and vastly-simplified version of the monthly management accounts, which he generated himself using an OMSG template, that the real GP% figure which was being achieved, given a consistent allocation across Job Costings and Monthly Management Accounting of cost items above and below the line, was in fact only 8%, rather than the 30% GP figure which the MD was convinced was being achieved

So, there are two clear problems here –

1. The lack of financial literacy of the MD, linked to way over-complex management accounting and inconsistent treatment throughout the firm regarding the allocation of cost items, in Job Costing / Pricing, and in Accounting
   
   
2. The obsessive drive for, and over-focus upon, Sales Turnover by the MD 

So, did the MD know really what was going on, ,,,,,,,,,,,,,,,,  and that he was just choosing to look away, just because it suited his purpose to do so, ie for him to be able crack on with chasing Sales Turnover at pretty well all costs ?

Or, did he genuinely not know that he was achieving only approx 8% GP, rather than his much advocated 30%, given the placing of the cost lines in a consistent manner ?

Well, the answer is that we shall probably never know, ie Conspiracy v Chaos – but what we do know is that the owner and management there had a massive problem on their hands as a result of all these shenanigans having gone on for x years, namely to have to try to put through price increases of 10% to 20% on all new contracts, so as to replace monthly net losses at the firm of £5/10k, with monthly net profits of £10/20k, and to then have the discipline to leave those net profits in the business, in order to reduce steadily the working capital requirement of the business

The irony is that the top-line turnover dipped hardly at all at that time, as a result of the price increases that were put in to place, so there was in fact no real need at all to have priced low to gain work, over the years, if that is indeed what the MD had conspired to do, and no need at all to have imperilled so wildly his business  !

The moral of this story ? –

Well –

• It’d have been very different if there had been a strong-minded, independent detached and objective Non Exec on board – and Yes, I know, we would say that wouldn’t we ! – but it’s almost certainly true, nonetheless

• It’d have also helped had the roles of (Non Exec) Chairman and CEO been split

• (Management) Education, Education, Education, ,,,,,,,,,,,,,,,, and Experiential Learning of, and thoughtful business mentoring to MD’s / CEO’s, so that come the moment, they do not react and proceed in ways that are so hugely damaging and seriously-imperilling to their businesses  

• There is also the detailed and careful consideration, which might have been given to understanding more fully the very well-documented concept – and the respective strengths and weaknesses – of First v Second Generation Entrepreneurs / Business Managers – ie the former can not undertake with any facility the latter role, and the latter can not undertake usually the former role – (I think that I feel another quite separate Discussion Paper coming on ! )

More next month, on another topical issue for SME businesses.

March 2010

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