When The Going Gets Tough, The Tough Cut Costs

According to Mark Zandi at Moody’s Economy.com (www.economy.com), the economy has probably been in recession since late 2007. Moreover, the firm’s weekly survey of business confidence has plunged over the past month, and expectations regarding the outlook for the next 6 months are as bleak as they have been in the almost 6 years of the survey. The question is no longer whether or not we are in recession, but how severe will it be. Mr. Zandi believes it will likely be the most painful recession since the downturn of 1980-1982.

Assuming the economy has entered a deep and long recession, managers need to focus less on growth and more on cash and cost cutting. That is not to say you should ditch your sales and marketing plan altogether, but instead, redouble your efforts to eliminate waste and maximize profit in your business. To be sure, the playbook that works during a healthy expansion is not likely to work through a period of prolonged economic contraction.

As a business owner or manager, look to your operations for opportunities to dramatically reduce expenses. But first, make sure your company’s accounting and financial systems provide the infor­mation needed to make good decisions. In this article, we discuss a few of the tools and best practices used by high performers. The silver lining: Most of these ideas work in good times as well as bad.

Let The Information Flow

First, let’s briefly review the basic sources and uses of capital, since your accounting and financial sys­tems must accurately capture these transactions for you to manage your capital and expenses effectively.

  • Shareholders and lenders supply capital to the company.
  • Capital is used to buy assets like inventory and equipment, which are deployed to create cash flow.
  • Inventory helps the company generate revenue, most of which is used to pay operating costs.

After paying its operating costs, the company can do three things with its cash profits. It can pay prin­cipal and interest on its debt; it can pay dividends to shareholders at its discretion; and it can retain or reinvest the remaining profits.

To determine whether or not your systems are functional, you need to answer the following questions:

  • Are your financial statements up to date?
  • Do you trust the accuracy of your statements?
  • Do you maintain a cash-flow model covering at least 13 weeks? Most companies only do this after they are in trouble.
  • If your balance sheet includes significant interest-bearing debt, does your model incorporate your bor­rowing base?
  • Does your cash-flow model help you manage the collection of accounts receivable and payment of accounts payable? These are key components of your working capital.

A functional system will help you mange your cash and other working capital and decide which expenses to trim. It will also help you determine which custom­ers and products are profitable and which are not. On the other hand, an under-performing accounting and finance system leads to a lack of control. During an economy when every dollar counts, it’s critical that your accounting and finance system can provide you with quick, accurate answers.

From Cost Cutting To Performance Improvement

Operations management focuses on the effective planning, scheduling, use and control of a manufac­turing or service organization. Traditional functions include design engineering, industrial engineering, management information systems, quality manage­ment, production management and inventory man­agement. If each is effective, together they turn capital into profits. If not, capital is likely wasted.

The following questions will help you determine whether or not you are getting the most out of your business operations:

  • Are your direct labor and material costs greater than 65 percent of sales? If so, either your prices are too low, your costs are too high, or both.
  • Are your purchasing and engineering departments obsessed with reducing material costs?
  • If sales are falling, are you reducing expenses, line item by line item, in proportion to the sales decline?
  • Do you use at least five or six key process metrics that indicate at all times whether or not you are meet­ing your production, quality, inventory and delivery goals?
  • Do you make use of a robust “clear to build” pro­cess that includes an MRP process, precise raw mate­rial counts and a sound production planning process?
  • Do you employ a daily cycle counting system for inventory?
  • Do you keep on hand more than ten working days of inventory? How much inventory is slow moving or obsolete?
  • What is your current product mix and how does it compare to your equipment capacity?
  • Do you perform multiple change-overs on certain machines or work cells while other equipment sits idle?

Now more than ever, ineffective operations can hurt sales, too. Customers are watching suppliers more closely, and many are installing risk managers to monitor vendors and help buyers make purchasing decisions on current and new pro­grams. They continue to measure the basics like delivery and quality, but more are requesting financial state­ments for the first time. If your bal­ance sheet is short on working capital and long on debt, and your operations are not delivering quality earnings, customers will likely start looking to other sources. In some ways, custom­ers are starting to think like lenders.

So, for now, cash and cost cut­ting trump growth. Leverage your accounting and financial systems to their fullest, and challenge your man­agement team, shift leaders and all employees to scrutinize every aspect of your operations. It will help you weather the current storm and ingrain best practices that will pay dividends well into the future.