Much of the art of negotiating is fairly standard and does not vary drastically. Notwithstanding this generalization, certain contracts like real estate leases or insurance policies require the assistance of specialists.
Traditionally, real estate leases are long term (i.e., only negotiated every 10 to 15 years) but are usually a material monthly corporate expenditure. Typically, a smaller enterprise has no internal expertise in negotiating such leases. Therefore, before entering into a real estate lease, heavy reliance should be placed on the enterprise's attorney, broker, accountant, and interior decorator. While the base rent is the major component of the monthly payment at inception, escalations (e.g., real estate taxes, inflation based on a CPI index or the standard porter's wage rate) and other hidden costs can become a large percentage of the monthly payment in future years. An expert's ability to slightly change a definition in the lease could save a company thousands of dollars over the lease term.
In addition, the expert might be very helpful in interpreting the lease's "gray" areas. Generally, landlords will appease contesting tenants and/or their representatives in exchange for the tenants not publicizing the contested discrepancies to other tenants.
Negotiating insurance policies can be unusually technical. Failure to employ an insurance expert knowledgeable in both your company and industry is not a good business practice. The chief financial officer must utilize the insurance specialist to:
* Determine coverage needed;
* Determine policy limits and desired deductible amounts;
* Evaluate the financial soundness and claim settling record of the potential insurers; and
* Negotiate the annual premiums.
A perfect industry to emphasize the need for an insurance specialist is promotional marketing. Companies in this industry manage numerous sweepstakes, and contests which require errors and omissions insurance. When I arrived as the CFO of a full service promotional marketing firm, it had paid $46,000 annually for $1,000,000 of errors and omission coverage with a $50,000 deductible. I utilized an insurance professional more familiar with the risks and nuances of the promotional industry to negotiate a new $1,000,000 errors and omission policy with a $25,000 deductible at an annual cost of $12,500. That was an immediate annual corporate savings of $33,500 or 73%.
Negotiating real estate leases and insurance policies are only two areas which require a high degree of expertise. The company's financial professional should utilize specialists whenever he deems it necessary. Do not be "penny wise and dollar foolish."
In my first installment of this article, I stated that the key reasons why the corporate profits have grown substantially in all of my companies during my tenures are passion and the use of my unique four-pronged approach. I am leaving the passion part to you, but have been discussing my four-pronged approach in detail.
Naturally, each prong works to different degrees in each company, but if you use all four of them, I can guarantee you will see amazing results. The first prong I discussed with specific examples was: “Understand fully an entity’s operations and develop the key financial metric that truly makes it ‘tick’.” The second was: “Educate the management team about finances and have them “take ownership” of their operations.”
Here is the third ingredient in my approach:
PRONG #3 - Create scalability in the Financial Department through automation.
In order to maximize profits, you have to scale the financial operations to handle an ever-growing volume with virtually no increase in manpower. The CFO has to concentrate on ensuring that the costs of the Financial Department are as close to fixed as possible. He or she can accomplish this goal by partnering with the organization’s CIO to look for additional ways to automate the growth in repetitive processing.
For example, during my five-year tenure at a NASDAQ distributor of medical supplies and equipment (in the late 1990’s), the annual billings grew from $120 million to over $380 million. By working closely with our excellent CIO, I kept the Accounts Payable staff constant at four employees even though they were processing over three times the number of vendor invoices. This was achieved through the use of electronic data interchange (EDI) as well as the automation of the “three-way” match process.
By having the our suppliers EDI their invoices, the invoices were automatically received and recorded in the accounts payable records without manual input. Besides consistently promoting EDI to all of the ongoing suppliers, we made it almost imperative for new suppliers to invest in EDI capabilities or we would not do business with them.
Once the vendor invoice was recorded in our system (either through EDI or manually), the invoice was matched by the computer to both the original purchase order and the quantity received in the warehouse. If all three of these records matched, the invoice was accepted for payment. Again, without any manual work, the check containing the approved invoice was automatically produced. The only manual steps in the process were to stuff the check in a window envelope and mail it. In the case of unmatched invoices (a small minority of the total invoices processed), manual research and additional work prior to payment were required.
Having to add additional clerical personnel to account for the tripling of the volume would have presented an unneccesary drag on earnings.
Besides using automation to keep an entity’s accounting and finance personnel costs fairly constant even though revenues and transactions are increasing rapidly, it can be used effectively to reduce other hard costs (like postage, paper, bank fees, interest expense due to improved cash flow, etc.) at the same time. Two perfect illustrations of major annual hard cost savings occurred when I became the CFO of a $1+ billion pharmacy benefit manager.
When I arrived at the pharmacy benefit manager, the pharmacy payable department had been processing and mailing over 20,000 checks per month along with a paper trail of the millions of claims being paid. Besides mailing a weekly check to CVS, the listing of the claims being paid by that disbursement averaged over 800 pages per check (that is over 40,000 pieces of paper per year). I redesigned the pharmacy payable system at an annual savings of $200,000 by eliminating the voluminous paper detail of claims paid (through a web enabled process) and by replacing the checks with electronic funds transfers.
Secondly, the Company had been mailing paper copies of the semimonthly invoices to their customers. Many of these invoices (listing every paid prescription) were well in excess of 1,000 pages. I quickly established more robust accounts receivable billing and collection processes (including the automation of the billing distribution process and creation of a reporting system to better prioritize collection calls). These changes reduced the average days an invoice was outstanding by five days. Besides saving tremendous amounts on postage, paper and printing supplies, increasing the cash flow by the five days amounted to an annual interest savings of greater than $500,000.
I think you can now see that there is plenty of “low hanging fruit” and annual expenses to be saved when you concentrate on creating scalability in an entity’s financial operations through greater automation.
Stay tuned for the fourth prong to profitability which will be published shortly.
In the initial installment of this article, I stated that the key reasons why the corporate profits have grown substantially in all of my companies during my tenures are passion and the use of my unique four-pronged approach. I am leaving the passion part to you, but have been discussing my four-pronged approach in detail.
Naturally, each prong works to different degrees in each company, but if you use all four of them, I can guarantee you will see amazing results. The first prong I discussed with specific examples was: “Understand fully an entity’s operations and develop the key financial metric that truly makes it ‘tick’.”
Here is the second ingredient in my approach:
PRONG #2 - Educate the management team members about finances and have them “take ownership” of their operations.
I am a great believer that in order to maximize a company’s profits and its enterprise value, the other senior managers must develop a thorough understanding of finance. Also, it is imperative that these key company officers fully understand how their “piece of the pie fits the entire pie”.
Many non-financial senior managers like the Chief Information Officer, the Director of Sales, the Director of Marketing, etc. have an amazing grasp of their areas of expertise but do not really grasp their company’s finances or understand the financial consequences of various transactions. Sometimes, even a CEO who comes from a heavy sales background does not have a complete understanding of the company’s net worth, enterprise value, etc.
In a public company, the financial knowledge needed is far greater. Besides understanding the entity’s finances, all officers must become conversant in the various SEC rules and filings, the Company’s stock activity, what one can say and not say to stock analysts or at public presentations, etc.
I have worked hard with all of my employers to provide the key managers with a general understanding of finances as well as the specific financial nuances of the company and its various types of transactions. This ongoing process includes both one-on-one and group training sessions. At most of my companies, we had top level monthly or quarterly management meetings. In addition to reviewing all the numbers, a major portion of each meeting would always be to teach additional facets of finance to the other key senior managers (e.g. fixed versus variable costs, contribution margin, leverage, scalability, etc.).
To assist the senior management team in utilizing their new appreciation of finance, I always create a series of important tailored reporting mechanisms. These reports are used by the management team to better understand the business trends and/or to quickly “stop any bleeding”.
The first of these specialized reports I call “flash reports”. They are produced as often as the company produces billings. In the case of a manufacturer or distributor, these reports are generally produced daily. They contain the previous day and month to date sales, gross profits, credits, etc. by company, country, division, and major product class. Where possible, I try to include, where possible, the entity’s key metric(s) which I thoroughly discussed in prong #1.
In many circumstances, while the monthly standard GAAP financials are useful to the financial department, the CEO, the Board of Directors, the commercial bankers, and the auditors, they might not tell the needed story to the senior operations officers. For them, I attempt to create tailored reports which give them important trend analysis to run their operations. For example at a distributor of medical supplies and equipment, the margin to several customer types was very thin and thus, it was of most importance to control overhead costs very closely and to keep these costs as variable as possible. On a monthly basis, I distributed a series of reports which showed detailed monthly, trailing three month, trailing six month and trailing twelve month fixed and variable costs by category and customer type as a percentage of sales. From these reports, one could clearly see trends as to the efficiency of the operations, whether the operations were becoming as scalable as hoped, etc.
Once I feel the other managers are gaining more of an understanding of the given company’s finances, I introduce a formalized “bottom-up” budgeting system in which the divisional and department senior managers become truly responsible for developing and meeting their annual budgets. The “bottom-up” process is tedious and while most companies say they use this process, they really do not do so. Rather, the budgets or the overall corporate targets are mandated by the top corporate officers and then, the detailed budgets are in reality built on a “top-down” approach.
The amount of cost savings and efficiencies from a “bottom-up” budgeting system have always been substantial once the managers truly “take ownership” of their budgets. Generally to reap the maximum benefits of this important corporate tool, the full implementation process takes at least two years.
In year one, I work closely with the divisional and departmental managers to teach them how to construct a budget and how to truly use historical data combined with the corporation’s current situation to project the upcoming year’s revenues, costs and expenses. Time after time, when undergoing this initial process, I hear from the CIO, the purchasing manager, the warehouse manager, etc. “I never realized all the overhead costs that were allocated to my department/division.” Then, they give me a list of services, employees, etc. that are either not necessary or duplicative. I would guestimate that this initial “bottom-up” process takes at least double the normal time and errors will still occur but it is certainly worth the effort.
At least quarterly during the first year of implementing a “bottom-up” process, I conduct budget-to-actual meetings with the entire group of departmental and divisional managers. Prior to the meeting each responsible manager must distribute a written report to all attendees explaining the major variances as well as a reforecast of the remainder of the year for major projected variances. At the meeting, each attendee is required to discuss his or her report and accept questions and comments from others. Generally in the first of such quarterly meetings, the CEO and I are usually the only ones asking questions or making comments. Slowly in future meetings, the other attendees begin asking questions and making suggestions. Once the “peer pressure” begins and everyone is making comments on others’ reports, the energy in the room grows to such an extent where you can almost guarantee that excellent revenue generating or cost saving ideas will come to light at each and every quarterly meeting.
In year two of the implementation, the managers become much more adroit in preparing their budgets. Once again, because of the “peer pressure”, they will work very diligently to prepare what they consider the most accurate budget incorporating many revenue enhancement and cost containment ideas (i.e. they will truly “take ownership” of their respective budgets). Then, the quarterly process will become an even more effective tool in maximizing profits and increasing enterprise value as each manager becomes more comfortable with this “bottom-up” process.
I hope you can visualize the huge additional profits (primarily from reduction of costs and expenses) that can be derived by educating the management team about finances and having them “take ownership” of their operations. The benefits from your efforts in this area will be appreciated by all. The senior management team will be especially happy come bonus time and the investors will be thrilled with the increase in enterprise value.
Stay tuned for the next installment and the third prong to profitability which will be published shortly.
I have been the CFO of numerous public and private companies of all sizes (from well over $1 billion in annual revenues to as low as $6 million in annual revenues). The companies have been in various industries (distribution, manufacturing, health care services, promotional marketing/ advertising and cable television installation). Some of these companies operated on a global basis while others only did business domestically.
I contend that knowledge of the industry, product or service while useful is not paramount or essential to assuring greater corporate profits and the maximization of enterprise value. The key reasons why the corporate profits grew substantially in all of my companies during my tenures are passion and the use of my unique four-pronged approach.
In this first installment, I will begin to explain in detail my four-pronged approach and cite specific examples of how it is a sure-fire way for a CFO to substantially increase his or her company’s profits. I will leave the passion part to you. Naturally, each prong works to different degrees in each company, but if you use all four of them, I can guarantee you will see amazing results.
PRONG #1 - Understand fully an entity’s operations and develop the key financial metric that truly makes it “tick”.
While some senior executives understand their businesses well, they sometimes do not understand the key metric that most affects their companies’ financial results. As the CFO, you must be an operational efficiency expert who quickly ascertains the keys to successfully managing the business and maximizing its operating results. Once you have realized the key metric (generally it is one metric but it could be two but not more), you must preach the importance of this metric to the senior management team. If the CFO is successful in motivating the team to make this metric a real focus, the improved results will be huge.
Here are a couple of my personal experiences where veteran senior managers understood their businesses but not their companies’ key metric. By pushing management to become almost single-minded on the key metric, the company’s results changed “almost on a dime”.
My first example took place as an engagement partner with Tatum CFO Partners, LLP. My primary assignment was as the CFO for a cable installation company. When I arrived, the “angel” fund investor declined to provide any additional funds, and the Company was near bankruptcy (losing $300,000+ per month). The Company had no more than two months of funds before it would have to close its doors.
In order to keep their costs as variable as possible, the large cable companies outsource much of the installations to other installation companies such as the one for which I worked. Even though a technician would arrive at a customer’s home in what appeared to be a cable company truck, the technician was not really a cable company employee. My employer operated in the New York Metropolitan Area and had over 300 technicians performing television and high speed Internet installations for both Cablevision and Time Warner.
Through first hand observation of a technician’s work (I actually rode with a technician for an entire day), I realized that the technician was clearly not motivated to perform his or her work efficiently. The technician was paid hourly and averaged approximately four jobs per day. I realized the key metric to this Company should be daily jobs completed per technician.
When I returned to the office, I highlighted this problem to the veteran management team on one sheet of paper by showing them that the average revenue per hour was $25.00 while the direct costs (the technician’s pay, FICA, health insurance, worker’s comp, the total cost to operate the truck, the cost of the required uniform, etc.) was approximately $25.25. Thus, there was a shortfall of $.25 and absolutely no contribution to cover the corporate expenses (rent, office and management salaries, other office costs, etc.). I told them, the only solution was to dramatically change the method of technicians’ compensation.
I introduced an incentive compensation plan that was based on daily jobs completed plus revenues generated (since the amount of revenue earned by job varied somewhat based on the complexity of the work needed). Almost overnight, the average number of daily jobs completed per technician grew from four jobs to over nine jobs per day. While the number of assigned jobs did not grow, we were able to reduce the number of technicians by more than half. The tricky parts of the solution were negotiating successfully with the truck leasing company to return the idle trucks and with the landlords where the trucks were parked when not in use.
I did not stop there. I analyzed every technician’s performance to make sure that all technicians employed “best practices”. I noticed a few technicians were performing several jobs more than the 9+ average. They quickly explained that the job assignments were available from the cable companies at 6 AM, but the first appointment timeframe began at 8 AM. Instead of having a long breakfast, etc., these creative technicians did the pole wiring for many of their jobs from 6 to 8 AM without bothering the customers. Then, at 8 AM, they only had to wire the insides of each home and move quickly to the next assignment. Immediately, this became the new standard operating procedure.
Within six weeks, the Company began reporting consistent monthly profits because of my implementation of this incentive-based technician compensation plan and other cost reduction initiatives. This became a winning proposition for the motivated technicians as well. Historically, they had been earning about $400 per week but after implementing the incentive based compensation plan, the better ones were earning about $2,000 per week.
My next example was as the CFO of a $220 million NASDAQ manufacturer and distributor of flooring tools and adhesives that had been losing money. The Company’s senior management had used gross profit percentages by product and by customer to manage the business. While the annual sales and gross profit dollars had been increasing year after year, the Company’s profitability was not increasing.
After spending a good deal of time studying the profitability by product and customer, I realized that there were major variable costs below the gross profit line on the income statement (e.g. sales commissions shipping, interest costs to carry the receivables and dedicated inventory). In order to more accurately look at product and customer profitability, I quickly introduced and educated the organization as to the concept of product and customer contribution margin (instead of their traditional gross profit analysis). I define contribution margin as gross profit less direct costs. By eliminating certain products and re-pricing others (due to poor but previously unknown contribution margins), the domestic contribution margin dollars increased by 64% within one year. Even though the sales volume did not grow (in fact, it decreased by a small amount), the Company’s results went from an annual loss per share to over $1.00 of EPS within eight calendar quarters.
As these examples demonstrate, determining the key metric is imperative to maximizing corporate profits and enterprise value.
Stay tuned for the next installment – the second prong to profitability – that will be published shortly.