Bold Exec

Eliminating Waste

Eliminate waste; save a company! Quite often that’s enough. Although the benefits are finite, they can be significant if the elimination of waste is vigorously attacked. Over the next several weeks we’ll cover the waste waterfront, hitting on the big four.

The first, the waste of cash, is prevalent in almost every mis-managed company. A vigorous Priority objective can generate a significantly sized one-time lump of “free” cash in 90 days or so. Then on-going cash management is the next topic. Had anyone observing Enron, including the 100’s of employed auditors, checked into the relationship between ongoing corporate net cash balances and reported operating income, their fraud would have been uncovered much earlier. In order for me not to get fooled when I go into a new company, I developed a relatively simple but highly effective tool, which I named the Liquid Balance Sheet. It enables me to cut through all the vagaries and misleading possibilities inherent in accrual accounting, and see what’s really going on. Next week you’ll see how this works.  These next three categories will be covered in subsequent weeks.

Unions and Government: Oil and Water

We must decide that organizing government employees is illegal, and that public labor unions must be abolished. Why? Because balance of power, or balance of will, does not exist. In a corporation, if management gives in too often over an extended period and resulting work rules, wages, pensions, and benefits choke the company, there are several potential outcomes to adjust and correct. Management, recognizing the company's financial limits, convinces the union that there have to be changes and an accord is reached to keep all entities alive. Or a bankruptcy court mandates a diminishment of some provisions of the labor contracts, as well as hacking into the rights of secured debt, unsecured debt, and equity holders. Or the company fails and everyone loses.

Cash is the First Clue

  How did they miss it? Arthur Anderson collapsed because, despite 100's of full-time personnel doing on-site audting, Enron's publicly reported financial statements bore no resemblance to reality. Enron did a masterful job of obfuscation but that was no excuse. Then along comes Satyam who did nothing more clever than telling their auditor that they had way more cash than they actually had (currently only about a $1Billion discrepancy). Obviously this had been underway for quite a while.

Here's the opening statement from my 2007 entry found in category J; Eliminating Waste: "Are you a new potential investor, board member, or CEO of a company? Are you 100% confident that the accounting policies are valid and transparent, that no-one has taken some accounting liberties in the past that still lurk in the shadows, that the operating profit reporting you're receiving is correct?"

I went on to show how very easy-to-do cash flow analysis can verify that publicly reported statements based on accrual accounting are consistent with the true life-blood of any company--it's operating cash flow. Cash accounting was replaced by accrual accounting with good and sound reasoning, but following the cash is still and always the most clear and un-corruptible assessment. In the case of Satyam ongoing cash flow analysis (comparing operating cash flow to reported operating profits) is a simple procedure and should have been done along the way: but it was even easier--simply making contact with the bank where the cash was allegedly held, and getting bank statements. This takes about half a day of one person of an auditing team. How did they miss it?

Waste of Your Credibility

The greatest waste is that of your personal credibility. You can waste it in several ways.

First, attempting to tell different stories (even though you might just label this spin) to your different audiences. When there is a problem, identify it to the board, shareholders, managers; and yes even to all employees and to customers. All employees? Yes, you betcha. They know the problems all too Well anyway, and if you level with them you'll maintain your credibility and generate their help. Customers? Yes, you betcha. If you have a product problem, they already know it. If you tell them that you have it and you're fixing it, they'll stay. If you avoid that conversation, they'll avoid telling you, until its too late, that they have a new supplier. Use some diplomacy with customers, but not spin! Your credibility and honesty with every single constituency will make your job easier; and you won't have to remember which story you told to whom.

Second, as tough as it may be, don't fall into the temptation of sliding just one order from the next quarter into this one: Or hiding obligations: Or changing accrual policies without justification. This is the slipperiest slope there is. It's the beginning of the downfall. Keep you reporting straight and the temptations won't build. If you believe "it's okay", the next quarter is solid; let the next quarter be solid but, let me tell you, when there is an apparent need to cheat a little it's because there are factors at work that won't make the next quarter solid. Your company and your credibility will be decimated. What's the purpose in that?

Credibility, integrity, personal character, and all that stuff is so easy to lose, so difficult to restore. Don't ever risk losing it, whatever you think the benefit of your little transgression is, think through what it would look like on the news url of all your constituencies! Might as well contemplate it now, because the news of your downfall will be there eventually.

Management Capacity: the Waste of Distractions

Every LBO firm, venture capital firm, and most CEOs recognize and understand the importance of cash.  It should always be treated as a scarce asset for. Management capacity is even more scarce but frequently not treated so carefully.

Cash can easily be measured (even though measurement is frequently made less transparent by misused flexibilities available via accrual accounting). Many understand that it needs to be managed with scrutiny and allocated carefully to meet the company’s needs. But management capacity can’t be calculated, and is often squandered. When this precious resource comes up short, frequently the directive is, “just work harder and longer.” Boards and CEO's and general managers cannot see the damage to core business decisions, actions and results caused by management's time wasted on distractions.

Of course management capacity can be stretched in the short term. When crises hit or rapid-fire opportunities emerge, it’s amazing how much elasticity exists. But over the medium or longer term, management capacity is more finite. The wise CEO will keep the management team’s use of its available capacity in balance in several ways; by eliminating distractions, by making timely decisions, and by communicating clearly and decisively to all their constituencies. The latter two will be discussed in the following weeks.

Let's now look at the need to eliminate distractions. What exactly are distractions, though, and how do you ferret them out?  Simple: Define a distraction as any subject that continues to consume a significant portion of your day or your management team’s day; and that is a pain in the behind; and that brings no or limited added value when resolved and therefore by definition does not fit into the strategy of the company. Some examples:

·         Overhanging lawsuits or pending litigation not directly related to the core business.

·         Subsidiary businesses or product lines, typically acquisition related, that are in conflict with the core business strategy.

·         Subsidiary businesses whose performance has been and will likely to remain poor and “noisy.”

·         Slow-moving sku’s that require individual attention when the occasional order is placed.

·         Extra organizational layers that add no value, noted non-performers, average or below-average performers with a bad attitude.

·         Scattered locations, typically acquisition oriented, with their own cultural history that makes them difficult to manage.

·         Poor contracts or non-strategic business arrangements.

·         Peripheral or low-margin product lines.

The solutions are just as simple. Settle the lawsuits. Sell conflicting subsidiary product lines. Shut down poorly performing subsidiary businesses. Eliminate slow-moving skus. Delete extra layers and non-performers. Centralize or shut down scattered locations. Get out of non-strategic contracts.

Pruning product lines frequently opens the door to more major changes.  Pruning is counter-intuitive; after all, the products may apparently contribute positive gross profit.  However the extra processing, inventory, customer service, inventory management, purchasing, claims, warranties, and other administrative expenses may make them unprofitable at the bottom line. They are likely to clog up the system; preventing a more significant cut to expenses, soaking up the last bit of administrative capacity, and preventing the organization from fully attending to more profitable products. 

No matter what distractions you locate, they are all draining because they continuously appear on the day’s docket.  They are difficult to ignore and seem to get inordinate attention from the board; they’re just bad news. The longer they last, the more time you and your team spends on them. That means less horsepower for issues that create long-term value.

Removing Waste: processes and procedures

Many CEO's overlook or show little interest in tightening up processes and procedures; in fixing inefficient ones; or in removing unnecessary ones. It's minutae they say, i have much more important matters to tend to. Well...maybe so; or maybe not! Because they’re not so glaring, it’s easy to push off fixing them. But individual inefficient or unnecessary processes and procedures waste finances, waste work hours, waste management capacity, and frequently create damage beyond these simple categories of waste. I'm continually amazed at the cumbersome processes and procedures that grow like topsy or are mandated by "corporate", and the damage they cause.

In Paradyne, the previous owner AT&T had jammed in an engineering cost report. It was quite impressive, capturing every possible bit of data concerning engineering spending that one could imagine. The report itself was a 3 inch stack of paper each month. Just a few problems. #1. About 30% of the entire engineering personnel time was used in filling out time sheets, looking up charge codes, fixing errors, double checking entries and the like. #2. No one actually looked at it, and certainly no decisions were made on the basis of it. #3. It didn't really matter where people were spending their engineering efforts as the company had not launched a successful new engineering based product in the last 4 years. #4. The engineering managers and the engineers themselves got psychologically twisted to a belief that filing the report correctly and on time was their primary purpose.

The fix! No one would say any company should spend extensive monies on engineering research and development without some form of cost control. But i did; at least temporarily. During my fourth week at Paradyne, we scrapped the entire reporting system. In ther short term, there wasn't much risk as our costs were "controlled" within certain boundaries. The benefits were way, way beyond the 30% time we freed up. Combining this decision with some heartfelt "let's get at it team" presentations, within a week the engineers were semi-jogging to their benches, working extra time, and geared to meeting technical objectives. This one act was so meaningful to the engineers who had longed for real technical objectives and work but who had gotten numbed into report writing that our productivity probably tripled. What a waste that cost control program was.

You may not find such a dramatic opportunity, but remember, eliminating the waste of inefficient or unnecessary processees almost always has greater intangible benefits than simply the $'s saved.

Cash part 2

Are you a new investor, board member, or CEO of a company? Are you 100% confident that the accounting policies are valid and transparent, that no-one has taken some accounting liberties in the past that still lurk in the shadows, that the operating profit reporting you're receiving is correct? Given all the transgressions displayed by public companies in the past, it would be hard to be so confident, even with the Sarbanes Oxley bureaucracy loaded in. And, if its a private company; double beware. I was called into a situation several years ago when a very smart private equity firm got completely fooled by misleading accounting policies by a company I'll call Acme, leading to a bankruptcy six months after their major investment. More on that later!

Accrual accounting (vs. cash accounting) serves a great purpose; basically matching revenues with costs. But it provides many, many opportunities for unscrupulous or simply wishful accounting decisions that can lead to misleading operating profits reporting. When I come into a new company, I could do a search and destroy on every accounting policy but that takes resources and there are always other things to do. So instead I put in place a relatively simple adjusted cash accounting system, the Liquid Balance Sheet, to validate my company's accrual accounting reporting. You can, and should, too. This is rather technical but really easy. Here's how it works.

Just tell your CFO to fill out the following form every week, simply taking the data directly off the general ledger with no accrual adjustments, closing entries, or other adjustments, a process taking about 30 minutes max. It's basically taking the unadjusted current assets, subtracting the unadjusted current liabilities, and adjusting for non-operational financial transactions. The column headings are:

Week #
Cash - A/R - Inv. - Other - Current Assets total
A/P - Other - Current Liab.
Fin. trans. - Weekly Chg. - Cumulative Chg.

Obviously Cash + A/R + Inventories + Other assets ='s Current assets, and A/P + Other liabilities ='s Current Liabilities. The only heading requiring explanation is "Fin. trans.", which means any flow in or out of the company not related to operations, such as borrowing against a credit line, repaying a loan, or getting an equity infusion. These cash items do not relate to operations so you need an adjustment.

Then interpreting the results is relatively simple. If the Cumulative Change column over the course of several weeks or months is roughly consistent with your feel for the financial performance of the business and with the reported operating profits, then you can be at ease. This Cumulative Change column accurately measures the weekly flow of those items that measure your performance on a "cash accounting" basis. If the Cum. Chg. column over the course of several weeks or months is way out of line with the reported operating profits, sound the alarms. After the fact I put this process in place with Acme and found that, had it been done at the time, the investor firm would've easily uncovered this problem at least three months earlier when there still might have been time for correction. The company had reported operating profits during the period, but the cash accounting balances were spiraling downward.

Cash accounting is too simple for today's environment. But as a parallel check on the many, and many times mystifying, accrual accounting policies it can be invaluable.

Too often owners, investors, directors and even CEO’s don’t recognize unacceptable levels of cash consumption until it’s too late. A critical task is to know what the operating cash flow of the company is…not the cash on the balance sheet, not the cash flow calculated from earnings, not the cash flow after financing transactions, but the true operating cash flow. You can’t easily be fooled if you know that, and you can’t get into serious trouble if you manage it effectively.

Cash part 1

Aggressive gathering of cash is almost always the first action when a company is in trouble. Less careful watching of cash typically got the company in trouble in the first place. 

Even when not in trouble, initiate a crash cash Priority. Cash is almost always under-optimized. Squeezing every excess dollar out of the organization is the easiest source of funds you’ll ever find.  Obviously cash is always necessary and useful, and significant results from gathering it internally are usually not that difficult to achieve.

You can attack plenty of areas: excess inventories (sell off obsolete inventories and take the reporting profit hit but free the cash), unmanaged accounts payable processes (everyone pays “in the nick”, so you should too), soft collection policies (don’t think that your customers will like you better if you don’t push hard to collect), and capital expenditures (even if already authorized and some funds spent, tightly scrutinize the justification in today’s conditions). Attacking these four categories alone, you may accumulate “free” million$s.  Establish this as a top priority, put someone in charge (as mentioned in previous blogs, this might not necessarily be the CFO--this is a good time for a young, smart person to walk through the entire flow of procedures), and obtain rapid results. 

This initial attack with its substantial results is a one-time affair, and it should clean up most of the sloppy policies that led to whatever waste you’ve uncovered and cash you’re recovered.

Next week, part 2 on the subject of cash; the Liquid Balance Sheet, a simple but highly effective method of distinguishing between the operating profits reported via accrual accounting policies, and the realities of how the company is actually performing. Why is this important? Had this technique been used by just one of the hundreds of auditors at Enron, the company’s fraudulent reporting would have been uncovered earlier. Had this technique been used by a major LBO group on one of its earlier acquisitions it would have avoided the embarrassment of a bankruptcy. If you use this on your first assignment, you’ll sleep comfortably knowing you have put in place a fool-proof system that will either support the existing accrual accounting policies or expose them; either way you’re a winner.

Eliminating Waste Summary

Waste abounds in almost every organization in many different categories including cash, expenses, capacity, fixed assets, and organizational and personal credibility. Giant progress can be made by attacking each of these head on. Topics: From Cash to Capacity; The Liquid Balance Sheet; Management Capacity and Distractions; Inefficient or Unnecessary Processes; The CEO’s Guide to Eliminating Waste. to be published 4Q07