How To Make Better Decisions in Uncertain Economic Times

For some small and mid-size businesses, news of a weakening economy is met with cautious optimism rather than the fear and dismay we more often read about in the news. The difference in large measure comes from smaller, well-run businesses simply being more nimble and agile. They quickly adapt to changing needs and circumstances. But another cause for optimism stems from a view that there are always opportunities to be found, especially in difficult times. Three of those opportunities are:

• Taking top talent entering the marketplace from layoffs,
• Gaining customers whose previous suppliers are failing or have gone out of business, and
• Acquiring weak competitors.

Tapping into these opportunities requires that you have a framework to assess opportunities and effectively capitalise on them without weakening the fundamentals of your business. This article presents three areas to focus on and in to build a strong “opportunity assessment” process.

Focus on information, not data when making decisions (and watch for J-curves).
Most CEOs have no accurate way of determining the future impact of new initiatives on the financial health and strength of their company. They typically focus on data found on the P&L statement and to a lesser extent the balance sheet. These are historical accounts that are required for compliance purposes but do not serve as a reliable predictor of the future. Additionally, the majority of CEOs lack the level of formal financial training required to effectively analyse the data at their disposal and often miss the insights that are most critical to their company’s future success or sustainability. In the majority of cases, decisions impacting the future are made on gut instincts – and the impact is measured in the aftermath.

Investing in opportunities, such as a new hire, a new product, a new facility or an acquisition, all involve the investment of resources today for an expected future gain. These “risks” we take in pursuit of the rewards we seek can be described and represented as a “J-curve.”

We dive in, exposing ourselves to some element of risk, then quickly head upward until our heads are back above water and we gaze upwardly towards the blue-sky that seduced us to make the plunge in the first place. The problem is, few of us know how deep or how wide that plunge will be, or are aware of all the risks that are hidden beneath the surface. Moreover, most of us have little idea of how much of our resources are being deployed to the J-curves we generate. As a consequence we are unaware of all the risks associated with our endeavor.

Unchecked, J-curves can be the single most hazardous aspect of a business. Yet they don’t clearly show up as such on our routine financial statements, until they either contribute their intended benefit in profits, or undermine our ability to survive. J-curves impact businesses not only in dollars, but also in management’s attention and bandwidth.

Most entrepreneurs find J-curves highly seductive and become emotionally attached to them, too often at their peril. The solution is to develop a method to track and manage your J-curves. A basic tracking of J-curves includes taking the following actions:

• Assess the risks and rewards of the opportunity
• Set benchmarks and measure the investment in time and dollars, and
• Assign “Who, What and When” accountability to the progress and outcome. (Who is responsible, what needs to be accomplished and when is next phase or completion)

Tracking your initiatives will go a long way toward protecting your company and preserving resources.

Manage the future with more effective questions.
Measuring the past and simply keeping track of where you are today is not enough. Before you embark on a new initiative, remember that all decisions can be evaluated with two questions:

Should we? (Does this decision improve our reason for being?) All too often, when things have gone terribly wrong, the answer to why a decision to do something was made is simply “because we could!” The opportunity presented itself, and on the surface it looked good.

Can we? (Can we afford to do this?) The answer to this question is fundamentally about cash flow. Even if the initiative has the potential to successfully generate future profits, will it consume too much cash, or cash you have now but will need later on? Will it undermine your company’s sustainability?

One of the best ways to assess the “should we” question is to use a measurement called ROCE (Return on Capital Employed). ROCE measures the effectiveness of the management of operations. It is the equivalent of an interest rate that measures the return on the use of resources. Any action that improves a business will have a positive impact on the use of resources, and a corresponding increase in ROCE. ROCE is a measurement of input, or net operating assets versus output, or operating profit. (ROCE = Operating Profit / Net Operating Assets ) Most healthy businesses strive to maintain a return that is at least three times the interest rate charged on borrowed funds.

The “can we” side of the equation is all about measuring operational cash flow, or the cash-output result of operating your business. Look at your CAO (Cash After Operations) as a true measure of sustainability. This is the same measure your bank will generally look at, but not the number most CEOs or even their CFOs look at. This number is essential for analysing decisions and for managing your relationship with your bank and other lenders.

Gain a better understanding of the financial health of your business.
Maintaining and protecting the financial health and strength of your business requires a shift in thinking for many CEOs.

• To better understand how well you are utilizing resources and managing risks, don’t focus on numbers. Instead, think about measuring the effectiveness of the actions you take.
• Understand that cash flow is always more important than revenue and in many cases is far more critical than profitability: track and manage the variables that impact cash flow and make CAO one of your key indicators.
• Develop sensitivity analysis to weigh the impact of variables such as changes in sales volume, pricing adjustments, inventory turn and levels, collections and accounts payables.
• Use 24-month rolling forecasts of key indicators to watch trends and stay focused on the future.

Combining better ways of thinking and better tools for analysing information will provide an effective framework for companies to thrive. In good times and bad times, this framework helps a company effectively steer clear of trouble and find its way towards opportunities.

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