Market Report (2/3)
Written on the 17 April 2009
IN THE immortal words of Warren Buffett, ‘it’s only when the tide goes out that you learn who’s been swimming naked’. Well the tide is certainly going out in this financial tsunami. I say the tide is going out because as far as Queensland is concerned, many businesses are still relatively unscathed by the global financial crisis (GFC). But now is not the time for Queenslanders to be complacent.
As highlighted in my February column, over the coming months, I will take you through my business survival guide so you can deal with current and future economic conditions facing Queensland businesses. If you can tick these business survival guide items off, then you could not position yourself or your business any better.
The starting point is to revisit your corporate strategy and business model. There are a number of obligations imposed on all officers of a company under the Corporations Act (2001) particularly as they relate to ensuring an entity remains a going concern. The biggest challenge dealing with the GFC is predicting its next move. As Queensland companies become more exposed to significant financial pressure, boards will be forced to review the adopted business model and corporate strategy to determine its suitability.
A review of the business model and corporate strategy will inturn require boards to reconsider fundamental components of their business, namely, risk management and corporate governance, managing your company’s capital-base, how to approach acquisitions, buy-outs, mergers, takeovers and selling non-core assets, how you should handle potential insolvency issues, cash-flow management (short and long term), whether the company should be restructured, tax strategies available to it and how to handle stakeholder relations. By reconsidering each of these components in an honest way, starting with risk management and corporate governance, each business will, as a result of this process, realise whether their corporate strategy and business model is appropriate for the current and future economic conditions.
The massive corporate failures at shareholder and taxpayer expense (and those still to come) must bring right into focus well-designed risk management and governance systems. The risk management frameworks that failed did so because of weaknesses in supervision, regulation and accounting standards – a focus on wrong incentives and behaviours. Regardless of the size of the company, you should approach risk management in five key steps (as recommended by ISO/DIS 31000 Risk management – Principles and Guidelines on Implementation), noting that risk management is not about eliminating risks. Rather, it’s about how your business develops the culture, processes and structures that are directed towards taking advantage of potential opportunities while managing potential adverse effects (as suggested by the ASX Corporate Governance Principles and Recommendations).
Once your organisation understands the concept of risk, the executive team should then understand that there are predominately three types of risk: Uncertainty-based risk; opportunity-based risk; and hazard-based risk. In the context of the GFC, uncertainty based risk and opportunity based risk are most relevant as the GFC presents on a daily basis a high degree of economic and financial uncertainty, and similarly for those businesses with a strong balance sheet, significant opportunities.
Uncertainty risk includes (among other things) financial loss, loss of a vital supplier, unexpected loss of insurance or loss of market share. Opportunity risk relates to either taking or not taking an opportunity and includes (among other things) acquiring new business assets or diversifying your business, all very relevant issues in the current climate. And when broken down further into the business context, include the following subcategories, namely, financial, organisational, operational and strategic. In essence, these four areas are focused on risks around cash-flow, maintaining and retaining the right people for your business, development and delivery of your product or service and growth of your business. As soon as you can articulate your business objectives around these four key areas, you can then move to properly manage the risks relating to them.
PROFILE OF THE MONTH – Bradley Hellen – Pilot Partners
BRADLEY Hellen is a partner at Pilot Chartered Accountants in Brisbane, a fellow of the Institute of Chartered Accountants and an official liquidator. Brad’s areas of expertise include performance and recovery and forensic accounting. Brad regularly advises financiers and business operators from a range of industries on matters of financial risk management. He undertakes financial evaluation reports and develops strategies to help businesses assess risks and develop strategies to assist their return to financial viability or exit strategies as required. According to Brad, ‘cash flow management is clearly the key to a strong business undertaking at present. There is a high risk of debtors going bad due to business closures and insolvencies. There are however opportunities arising for investors and operators in businesses and property who are cashed up’.
CASE STUDY - SUPPLY CHAIN MANAGEMENT
COMPANY A is a coffee supplier and buys its coffee beans exclusively from Company B on a monthly basis. Under the terms of the supply contract between Company A and Company B, Company A prepays for coffee beans three months in advance of delivery. Company A makes its usual prepayments on January 1, February 1 and March 1.
At the end of March, shortly before Company B is due to deliver the coffee beans (paid for in January), Company A learns that Company B has gone into liquidation. Company B’s liquidators tell Company A that there is no chance of the scheduled deliveries taking place.
In order to recover the money that was paid in January, Company A will need to line up with other unsecured creditors and faces the possibility of getting none, or very little, of the funds returned to it.
What could Company A have done to prevent this from occurring? The issue essentially comes down to the negotiated terms of trade. Businesses who are reliant on key suppliers should consider adopting the following alternative payment arrangements at the time of establishing their supply agreement:
1. Company B holds prepayments on trust for Company A until Company B delivers the goods. Company A retains beneficial ownership of the funds until Company B delivers the goods, protecting it from exposure to the risk of non-delivery.
2. Company A makes prepayments into a special prepayment account held by Company B (separate from Company B’s usual trading account) which is not debited by Company B until it has delivered the goods. In the event that Company B goes into liquidation, Company A can make a claim on the funds held in this account without the need to get in line with other creditors.
3. Company A pays a deposit to Company B in order to secure the supply, and then pays the balance on delivery. This reduces Company A’s exposure in the event that Company B fails to deliver the goods.
4. Ownership of the goods transfers from Company B to Company A at the time that Company A pays for the goods, ensuring that Company A can obtain delivery. If this is adopted, Company A will need to ensure that appropriate insurances are taken out as the goods may be at their risk from that point.