If you wait for your monthly financials to detect trouble, you may well be too late to do anything about it.
If you wait for your monthly financials to detect trouble, you may well be too late to do anything about it.
So you think you have problems! Back in 1982, the nearly bankrupt Wickes Cos. owed $2 billion to a quarter-million screaming creditors. And to make matters even worse, its managers didn't have up-to-date financial information to guide them.
Although Wickes's financial problems are in a different league from what you're likely to face, I'll bet your information problems are comparable. Most businesses depend on their accounting systems to provide the information they need; yet company accountants and bookkeepers typically take two to three weeks after the end of each month to find errors, assemble data, and produce financial statements. As a consequence, if a company-threatening trend begins, say, in early February, managers may not discover this fact until they receive February's statements in late March or early April.
When Sanford C. Sigoloff signed on as Wickes chairman, chief executive officer, and president in March 1982, he decided the company's turnaround could not succeed with that kind of delay. So his people developed a financial reporting system that collects financial information for managers weekly and distributes it to personal computers on each manager's deak.
"Every Monday by midday, the system picks up cash transactions through the previous Saturday," says assistant treasurer John Lesar. The company's divisions take 24 hours to add their operating data and explanations. By midday Tuesday, managers have an updated picture of the company's sales, budget performance, cash flow, capital expenditures, intercompany transactions, inventories, working capital accounts, and financial ratios. "At the end of the month," Lesar says, "companywide totals usually fall within 1% of the financial statement figures, which arrive several weeks later. That's good enough information on which to base decisions."
Even though you may not have access to the financial and computer resources of Wickes, there are several ways that your own company can produce much of the same timely data -- and at a fraction of the cost.
Most companies enter shipments into their accounting systems daily. Whether your company puts this data into a computer or on paper, you can easily summarize and report it as frequently as you wish. For example, I used to generate a simple graph each week that showed how sales were running with respect to our profit plan (figure 1). If the trend looked bad by the second or third week of the month, we still had enough time to react. I also maintained a similar graph of sales orders.
Each Friday afternoon, our sales manager, manufacturing manager, and I would go through every sales order, reviewing shipping dates and discussing problems. By the end of this "backlog meeting" we'd each have a list of tasks to achieve by early the following week. This meeting also provided the information I needed weekly to update my hand-drawn bar graph of order backlog and its estimated gross profit content (figure 2). As our company's sales rose and fell, this graph provided the most accurate early warning we could get about the changes ahead.
We also hung a small chalkboard on the wall outside our president's office. Each evening, we would update it with the bookings and billings for the month, as well as the order backlog. If bookings or billings weren't what we expected by midmonth, our employees did whatever they could to get us back on track by month's end.
Since expenses come from several different sources, and since there are so many expense categories, week-to-week spending performance can be a little trickier to monitor. The easiest way that I've found is to summarize the data by department and then divide it up by source.
For example, suppose that the accounting department is budgeted for $1,000 of this amount comes from depreciation and accruals generated monthly, $900 of actual spending remains to be tracked weekly. Say roughly $500 of this amount comes from the payroll system in the form of wages, taxes, and benefits, and most of the remainder comes from invoices entered daily into the accounts-payable system. These facts allow me to forecast and track what the accounting department should generate weekly in payroll costs and in other expenses arising from vendor invoices. We can track other departments similarly.
Wickes takes one extra step that you should consider as well. It monitors its outstanding purchase orders. Many companies, unfortunately, will find this difficult to do because they have no system for tracking purchase orders. In a similar position, I always felt the unknown mass of purchase orders hanging over me, like the blade of a guillotine hidden by the fog. I knew that someday, without warning, a shipload of goods and invoices would arrive at my door, the blade would drop, and the cash would be severed from my clutches. Therefore, one way or another, I always try to create a system for tracking and reporting the orders we place with our vendors.
Computerized accounting systems have many failings. One of the worst of these is their shortage of tools for managing cash flows. When I prepare a 12-month cashflow forecast, for example, I estimate the cash I'll spend monthly for inventory, administrative expenses, marketing expenses, and so on -- but only the rare accounting system can report actual cash spending in this detail. Or when I prepare a six-week cash-flow forecast for a small company, I estimate the cash we'll spend each week for CODs, for regular monthly expenses, for payroll, for accounts payable, and so on. And, again, few accounting systems can report actual cash flows in these simple categories.
Even though your accounting system probably doesn't provide all the tools you'd like for managing cash, you can extract enough information if you work at it. At the very least, I recommend that each week you forecast cash flows for each of the next four to six weeks. Doing so is much like using weak headlights on a dark mountain road. Neither the headlights nor the forecast provides much warning of disaster ahead, but any warning is far better than none at all.
Of course, as Wickes does, you should also track actual cash flows weekly. Comparing actual cash collections and spending with your weekly forecast should help you improve future forecasts. And keeping a record of past cash flows may highlight trends that would not be apparent otherwise.
No matter how you monitor your cash flows, however, don't deceive yourself the way that many companies do with respect to accounts payable. When cash is tight, many companies extend their payables. Doing so often gives a false -- and temporary -- impression that they're generating positive cash flows. To produce a more accurate picture, subtract from your calculation of operating cash flows the increase in overdue payables your firm has experienced during the period. The resulting figure is what your operating cash flows would have been if you had had the cash or bank credit needed to pay your bills when they were due.
Wickes's inventories total $1 billion. Though yours are less, they probably represent 25% to 50% of your total company assets and so are well worth monitoring closely.
Unfortunately, many accounting systems allow you only to calculate the inventory balance monthly. (Even at Wickes, divisions must estimate inventory each week. The estimate is a careful one, however; managers are expected to be within 5% of the actual figure.) This lack of precise data makes it difficult for most companies to track the weekly inventory balance.
As an alternative, you might try to monitor inventory purchases, a number that will reveal much about the size of your inventory. Each month, you purchase enough goods to replace what you ship, plus or minus any planned change in your total inventories. Therefore, at the beginning of the month you should be able to estimate the amount of inventory that you will purchase during the month. Dividing this figure by the number of weeks in a month will give you the approximate amount of inventory that vendors will ship and bill weekly. If purchased goods arrive as expected each week, but shipments fall off, your inventory should grow proportionately. If this dangerous trend continues for several weeks, you have enough information to act on your inventory problem, even though you may not know your exact inventory balance.
As you know, working capital is equal to current assets minus current liabilities. Many lenders use this number and the current ratio (current assets divided by current liabilities) to indicate a company's ability to pay its obligations when due. Presumably, if a company's current assets are two or three times its current liabilities, its creditors are relatively safe in the near term.
There are many exceptions to this rule, however. Several years ago, for example, I responded to a projected cash-flow crunch by slashing inventories. Over several months I cut our inventory in half while our shipments increased. But cutting inventory also cut our current ratio to the point at which we were nearly in violation of a loan agreement. I never could make our banker understand that we became a healthier company by owning less inventory rather than more.
Whatever the merits of the discussion, many loan agreements limit a company's current ratio. This is often enough reason, therefore, to monitor that ratio during the month. This gives you the time to fix problems, if you can, before they hit your month-end statements and explode on your banker's desk.
Any fact that's crucial to your business is a candidate for monitoring on a daily or weekly basis. Some examples:
* Companies often hire and spend based on projected sales rather than actual sales, generating losses rather than profits. With these companies, I like to track the total number of employees each week and graph weekly sales per employee.
* Tracking measures of quality can reveal much, both about the quality of your product and about the time employees waste on poor-quality product. Some suggested measures: number and dollar amount of credits issued to customers for returned goods, number and dollar amounts of credits issued by vendors for goods you returned to them, dollars spent on scrap, labor hours spent on reworks, dollar value of rejected goods awaiting disposition, and so forth.
* Most companies have to do something to generate sales. They have to meet with prospects, mail catalogs, sign up dealers, submit bids, and so on. Often, each such action will generate a reliable volume of sales. Therefore, in addition to monitoring the results of these actions -- the sales -- I try to monitor the number of selling actions themselves, when possible. I also calculate the effectiveness of each selling action -- the dollars ordered per letter mailed, say, or the number of sales calls per order. By doing so, I can quickly tell whether a rise or fall in sales has been caused by a change in the number of selling actions, or by a change in the effectiveness of each selling action.