Strategy

How Small-Biz CFOs Can Manage Uncertainty

Today’s uncertain business climate can make you want to shut the office door and wait until something, anything, changes. But smart finance executi...
Ryan PadillaNovember 26, 2012

Business today seems to be in a state of collective stasis.  Given continued economic volatility, small businesses are having difficulty seeing their next move and, understandably, are reluctant to start anything they’re not sure they can finish.  But temporizing is just as (if not more) detrimental than making decisions on less-than-perfect information.

Besides, it just doesn’t feel good to be reactive.

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Get back in the driver’s seat and mitigate uncertainty by managing what you can.  While financial models can’t solve the inherent lack of predictability embedded in today’s business climate, other solutions exist for CFOs to preserve margin and manage risk. You can control the key variables of your business and continue to drive financial performance regardless of current economic doldrums.

How to Manage Your Total Costs
Start by assessing the inputs you can control; namely, your costs. It sounds obvious, but far too few small-to-midsize businesses have an accurate understanding of their total costs. 

The foundation for developing an accurate view of your total cost picture is based on a demand-driver analysis. For each key functional area, categorize all the primary tasks that directly result in cost. Let’s use a courier business as an example. 

A core component of its operation is transportation. Its logistics department allocates time and resources to fleet maintenance (vehicle repair) and fleet management (Department of Transportation inspections, licensing, etc.), among a number of other tasks. Fleet maintenance and fleet management are two distinct demand drivers within logistics.

Once you develop a comprehensive list of tasks, assign a percentage of time employees should spend on each identified demand driver. Complete the exercise by capturing actuals using data from your human-resources system. Discrepancies immediately will become apparent, allowing for quick identification and vetting of cost-improvement opportunities. 

For example, let’s presume you or your logistics manager prioritize all the department demand drivers and determine that 10% of the staff’s time should be dedicated to fleet maintenance. The data, however, indicates that fleet maintenance is consuming 20% of department resource time. That’s not good. An inflated allocation to a demand driver likely means other priorities will be underresourced and that can affect service levels and the company’s reputation, and ultimately inflate costs as you try to fill the gaps, either with staff or new investment. 

With your demand-driver anomalies highlighted, identify improvement opportunities, both within and across functional areas. All options to streamline should be considered, with a particular focus on pinpointing quick wins. Quick wins produce immediate and measurable savings while also providing momentum to complete the restructuring and cost-alignment effort. 

So why was fleet maintenance taking up 20% of the department’s time instead of 10%?  There seemed to be a troubled relationship with a parts supplier. Vehicle technicians were charging more maintenance hours because they were wasting time waiting for parts and troubleshooting quality issues. By changing suppliers, you can achieve two victories: a reduction in part prices (through negotiation) and the elimination of nonvalue-added labor hours. 

Build out the total cost picture by applying this methodology to all your overhead. You’ll realize two financial benefits simultaneously: a reduction in waste and a more efficient design for your business’s future. 

How to Make Sales Contracts Work for You
Another component of total cost management involves sales contracts.  Many small-to-midsize businesses unintentionally give unearned breaks to their customers that result both in lost revenue and increased costs.  You can eliminate those breaks by using properly structured sales contracts.

Pricing, typically, is linear: the more you purchase, the less you pay, and vice versa. Fixed pricing, however, can dramatically change that equation and its impact to your bottom line. For instance, if your customer is guaranteed a price normally associated with 1,000 widgets but he now chooses to purchase 500 widgets, then you’ll miss out on potential revenue. Worse, if commodity prices rise while your customer’s order shrinks, and he continues to get the discounted rate due to a fixed-price contract, then your margin erodes even further.  

Now let’s say there’s a significant shift in either supply or demand. If supply shortages cause an increase in your cost of goods sold but your sales contracts prohibit you from passing on that increase to your customers, then your operating income deteriorates. Alternately, suppose there’s a shift in demand and retailers have the opportunity to increase the market price that their end-users pay. If your contracts don’t allow you to make a corresponding adjustment to your wholesale price, then you’re leaving revenue on the table. 

These scenarios in effect give your customers an open call, enabling them and your competitors to capitalize on changing market conditions while you can’t. One way to eliminate the open call is by placing language in your sales contracts that allows for a floating price based either on order quantities or dramatic swings in the supply and demand curve. Another way to minimize risk and maximize revenue is to negotiate some form of cost share or revenue share with your customers. This would allow you to pass on some of the costs or take a percentage of revenue above and beyond a certain threshold. 

Conditions are difficult enough already; don’t make your business even more vulnerable.  Eliminate the open calls associated with fixed pricing. 

CFOs can never afford to call “time out.”  Implementing these solutions and embedding a total cost-management exercise into normal business rhythms will keep your business systemically strong and financially healthy. The results will breed confidence in your team’s ability to manage in times of uncertainty and adversity. Be proactive. It feels better.

Ryan Padilla is a consultant at RAS & Associates, a Denver-based strategy and management consulting firm, with more than 10 years of experience advising financial executives on corporate strategy, scenario planning, and process-improvement initiatives.