Traditionally, business intelligence tools were reserved for well-established businesses capable of affording such solutions. But Creative CFO believes that SMEs should have access to this service too.

Bringing this Business Intelligence to the SME sector in an accessible and value-generating manner is crucial to the development of the sector. Improving decision-making can further ensure that the world we live in is one where more SMEs succeed.

What Is Business Intelligence?

Business Intelligence (BI) is a strategic approach to utilising data analytics and automation principles to assist organisations in making informed decisions.

In the context of BI software, the concept is elevated to drive decision-making and provide bespoke solutions for SMEs, marking a departure from conventional approaches. For example, the concept of business intelligence allows the user of data-driven decision-making to tailor relevant key indicators to their own business, rather than relying on traditional metrics that are not adjusted for relevance.

In simpler terms, BI is not just about analysing data to guide choices; it’s about crafting unique solutions for businesses. Imagine it as a personalised consultant for SMEs, stepping away from the usual ways of doing things. It’s like having a bespoke advisor, leveraging the power of data and automation to give businesses an edge in decision-making and problem-solving.

Using Business Intelligence To Unlock Business Potential

During the past few years, the world has undergone substantial changes. We have experienced changes in where and how we work, and the technologies that support this new world have also changed with things such as artificial intelligence even joining most people’s day-to-day list of software they use. These changes have all impacted the operational landscape for businesses. Now, considering that SMEs operate in industries with intrinsic risks, these external factors have added pressures, creating additional challenges within the business world.

While business intelligence solutions can’t predict the landscape of the world, the right partner will strive to build tools that help solve the intrinsic challenges your business faces, while also bringing the right data into your strategic reports. The evolution of BI from a series of technologies to a platform which supports strategies is what has made the applicability of these tools ever more present.

3 Ways Business Intelligence Can Transform Your SME

Business Intelligence presents a transformative opportunity for small and medium-sized businesses across various dimensions. These include:

1. Automation of Data Collection and Processing

This automation liberates valuable time and resources for SMEs, allowing them to redirect their focus to critical aspects of their operations.

2. Generation of Accurate and Timely Reports

This empowerment enables businesses to make informed decisions and identify trends and patterns within their data.

3. Collaborative Aspects of Business Intelligence

SMEs can seamlessly share data and insights across the organisation which fosters communication and collaboration.

KPIs and Competitive Drive with Business Intelligence

The greater the level of BI and Analytics integration is, the greater the extent to which an organisation can transform its business processes, which results in the business being more competitive. The reason for this increased competitiveness is that they understand the data which underpins their key business metrics better, allowing them to make decisions faster and react to market changes in a more agile manner.

This process of automation and efficiency generation helps ensure that businesses that adopt BI in their business decision-making processes are more competitive in the markets they operate in over time.

Therefore, the impact of business intelligence on a business is that it acts as a catalyst for information exchange and the development of business and market knowledge within an organisation. Knowledge becomes the core focus, knowledge of customers, suppliers, market conditions, and underlying financial information which helps businesses make wiser, faster decisions in the medium to long term.

Business Intelligence Solutions with Creative CFO

Creative CFO has always operated at the confluence of finance and technology, with a vision to see more SMEs succeed. We are a team of talented professionals who use and develop the best technology to solve the challenges facing SMEs. This evolution in our service offering involves providing SMEs with the best financial support built on cutting-edge technology for financial clarity and peace of mind.

Our dedication to excellence is more than just a business philosophy; it’s a recognition that the SME landscape necessitates agile and responsive solutions. We’ve integrated this ethos into all of our work, aiming to exceed the continually changing requirements of SMEs. We take pride in setting ourselves apart when servicing the industry.

Our commitment to your business is fueled by a deep understanding of the problems faced by SMEs. Our deep understanding of solving sector-relevant problems has been developed over time due to our relationship-oriented approach and our identity as proactive problem solvers. We are driven by a passion for agility, foresight in anticipating challenges, and a commitment to providing solutions that genuinely make a positive difference for SMEs.

Work with Creative CFO.

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Death is one of those inevitable life occurrences that affect everyone yet still catches one off guard. In the event of the passing of a loved one, having a will in place provides certainty, security, and clarity of who should be the beneficiaries of your estate.

It could be so that you already have a will, but when last was it revised? It is critical to update it regularly, especially after a significant life event such as a birth, death, marriage,divorce, or any major asset purchases.

Furthermore, who have you entrusted with the power of fulfilling your last wishes? The administration of an estate can be as challenging as navigating a maze blindfolded. Therefore, it is important to appoint a trusted person, preferably a professional, to lead this process in ensuring that your property is divided according to your wishes and settling any outstanding debts.

If you need assistance with the drafting of a customised will, codicil, or living will, please get in touch with our team here.

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Cape Town, South Africa

Business advisory firm Creative CFO has recently launched Creative Growth Capital, its very own investment vehicle to meet the high demand for flexible funding solutions that are better geared toward SME business models. Creative CFO has coupled its longstanding expertise in working with SMEs with making flexible investment capital available to SMEs to unlock sustainable growth opportunities and consequently create a positive and measurable impact in more communities in South Africa.

Creative Growth Capital will offer growth capital to SMEs by way of tailored deal structures using an array of investment instruments including debt, equity and combinations of these instruments to craft bespoke deal terms for these businesses.

 

“SMEs are largely underserved by capital markets, specifically in emerging market territories. Traditional financiers lack the flexibility and risk appetite to provide the right type of capital to support SMEs. SMEs are the backbone of the economy and their success should be prioritized to ensure a well-functioning local economy.” (Creative Growth Capital)

 

Anchored by an investment from one of the largest institutional investors in Africa, Creative Growth Capital has recently made a debt investment into an artisanal ice cream company based in Cape Town.  The loan will enable the business to grow its production capacity and expand its delivery and distribution channels to a broader network of customers, both important prerequisites for scale.

Recognizing that private investment is essential for small business growth and job creation, the USAID Southern Africa Regional Economic Growth Office has supported Creative CFO with the establishment of Creative Growth Capital. USAID’s support of these vehicles through its INVEST initiative reflects a growing consensus that private investment is critical to inclusive, sustainable development. In support of the shared commitment to invest for impact, all of Creative Growth Capital’s investments will embody targeted social development objectives, including but not limited to scaling women and minority-owned- businesses, expanding local business operations and supporting job creation. Creative Growth Capital, with USAID support, will continue to fund SME growth within the region, bridging the demand gap between small and medium-sized enterprises and affordable, flexible financing.

 

“Creative Growth Capital aims to uplift entrepreneurs and support businesses that make a real contribution to society by creating jobs, up-skilling their employees, and fostering a thriving and inclusive SME ecosystem. We view investing in SMEs as being the most-impactful mechanism with which we can improve the livelihoods of others and inspire the greatest change in our country and eventually abroad.” (Creative Growth Capital)

 

About Creative CFO

Creative Growth Capital is part of  Creative CFO , an international business advisory firm that, over the past nine years, has been advancing its vision to create a world where more SMEs succeed.

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For South African business owners, the economic stability of Europe coupled with business-friendly legislation makes the continent a desirable place for expansion. While these factors are attractive, access to financing and the potential for lucrative upside when exiting a business are the real drawcards.

We recently performed a valuation exercise for a client who intends to swap shares in a successful South African application software company for those of a similar company in the Netherlands. While these companies operate in the same industry, we found the comparative valuations to be vastly different.

The 3 factors that had the greatest impact on the valuation – the ” triple edge sword” –  were the valuation multiples, the cost of debt, and the cost of equity.

Valuation Multiples

When we perform valuations, we use search parameters to screen hundreds of companies within a comparable industry and/or geographic region. Through this process, we derive a range of companies deemed comparable to our subject. Without regard to a specific industry, we found that the median EV/EBITDA multiple (i.e. the value of a company over its earnings) of selected listed companies in the Netherlands was just under 12x, whereas in South Africa, the multiple was just over 6x. Assuming that our South African and Netherlands companies achieve the same currency-adjusted EBITDA, our South African company takes a valuation hit of about 50% before we even consider the cost of capital for the business.

A report compiled by the CAIA Association echoes our findings, stating that EBITDA multiples in Europe during 2020 approached 12.6x, while in Africa, multiples were between 4x and 8x.

Cost of Debt

The CAIA Association also alludes to the second edge of the sword –the cost of debt – suggesting that higher valuations are likely a result of prolonged quantitative easing and low-interest rates in developed countries. Access to debt at low-interest rates benefits a business from a valuation perspective, as the weighted average cost of capital (“ WACC” ) used to discount the company’s cash flows is lower (lower discount = higher value). The OECD reports that SMEs in the Netherlands have access to debt at an interest rate of 3.3% per annum, whereas we know from experience that an SME in South Africa will be lucky to service debt at less than 15% per annum. In our example below, if both companies were financed entirely by debt, a South African company would achieve a valuation of about 30% lower than a Netherlands comparable.

Cost of Equity

The third edge of the sword and the second component of WACC –the cost of equity – is essentially sharpened by the stark contrasts in the economic climate between Europe and South Africa. Using the capital asset pricing model (“ CAPM ”) to derive a cost of equity, our starting point is the “risk-free rate”. As mentioned, developed countries have benefited from a period of quantitative easing which sees the yield on 10-year government bonds (a proxy for the risk-free rate) in the Netherlands at 1.4% at the time of writing, versus a yield of just over 10% in South Africa. This makes South African bonds an attractive investment but greatly elevates the cost of equity which is detrimental to a South African company’s valuation.

The other levers for the CAPM formula are the market risk premium and “beta”. The latter measures how a company reacts to systematic market risk and is generally lower in developed markets vs emerging markets. Put simply, this means companies in developed markets are less exposed to downturns in the market. The measure is highly dependent on industry and would not be considered a main component of the differences in valuations between European and South African companies. Market risk premiums, however, can increase the discount rate considerably. A South African equity risk premium is circa 7%, versus circa 4% in the Netherlands, based on research done by Prof. Damodaran of NYU Stern. Interestingly, the combined difference in risk-free rate and market risk premium results in a South African company achieving a valuation that is again 30% lower than the Netherlands comparable (again, assuming all else equal).

There are, of course, many other factors to consider when performing a valuation; however, based on these 3 simple metrics alone, it is clear to see why South African business owners look outside of the country to unlock greater value for their companies.

References

CAIA Association. (2021). African Private Equity Returns, Risk and Potential in a Global Context – Part I | Portfolio for the Future . [online] Available at: https://caia.org/blog/2021/11/23/african-private-equity-returns-risk-and-potential-global-context-part-i   [Accessed 19 Aug. 2022].

OECDiLibrary. (n.d.). Financing SMEs and Entrepreneurs: An OECD Scoreboard (The Netherlands) . [online] Available at: https://www.oecd-ilibrary.org/sites/d339ecf2-en/index.html?itemId=/content/component/d339ecf2-en   [Accessed 19 Aug. 2022].

Tradingeconomics.com. (2022). South Africa Government Bond 10Y . [online] Available at: https://tradingeconomics.com/south-africa/government-bond-yield [Accessed 19 Aug. 2022].

Tradingeconomics.com. (2022). Netherlands Government Bond 10Y . [online] Available at: https://tradingeconomics.com/netherlands/government-bond-yield [Accessed 19 Aug. 2022].

Damodaran, A. (2021). Country Default Spreads and Risk Premiums . [online] Nyu.edu. Available at: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html . [Accessed 19 Aug. 2022].

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When the ground starts to shake around Cape Canaveral, it is a matter of seconds before a rocket is launched and begins its journey into space. But leading up to this moment there have been months, if not years, of preparation and planning for every eventuality. Countless inputs are considered and risks mitigated by modelling various potential scenarios. Without these meticulous processes, a mission is destined for failure.

Like launching a rocket into space, a business needs a thought-out and refined plan to have any hope of lifting off. A key step in assessing the viability of a business plan is forecasting what could be achieved, taking into account as many factors as possible. Such factors include expected sales, customer types, product and service pricing, human resources, capital expenditure, and financing requirements.

How do we consider this plethora of factors effectively, you may ask? Enter the Financial Model.  A Financial Model, as the name suggests, seeks to model the potential performance of a business by combining relevant inputs and assumptions into a financial forecast. A Financial Model can be used as a budgeting tool, to stress-test different scenarios, to calculate the financial impact of a new project, to allocate corporate resources, and to determine the value of a company.

The first step in developing an effective Financial Model is to apprehend the environment in which a business operates and to identify inputs that will impact its performance. At Creative CFO, we have prepared Financial Models for companies like Wingu Academy, BancX, and Automata;  all three of which are exciting, high-growth companies, but operate in significantly different business environments.

For Wingu Academy , the inputs we considered include student enrolment numbers, subjects and classes per student, books per student, and the number of classes a teacher can manage. For BancX , we factored in banking certification costs, volumes of accounts and cards, interchange fees, interest rates, and platform fees. For Automata we needed to consider the manufacturing process for robots, including production capacity, supplier terms, shipping policies, customer warranties, and commission structures for their sales team. Because no two businesses are the same, the specific inputs to every Financial Model are unique.

Once the inputs for the Financial Model are determined, the second step is to consider how these inputs may change over time or how they may be influenced by different scenarios. Again, the way this step plays out is dependent on the specific business. For Wingu Academy , the scenarios we considered hinged on the number of enrolled students, for BancX the scenarios were driven by the number and type of customers that were onboarded, and for Automata the scenarios were driven by considering business performance for different levels of demand and stress-testing whether production could keep up with each scenario.

We develop a “low road”, or worst-case, scenario based on the premise that things don’t quite go according to plan (e.g. low student intake, low volume of accounts, or inefficient manufacturing processes). This gives the business owner an indication of the risk involved in embarking on the business journey. On the other end of the scale, we build out a “high road” scenario that portrays to business owners and investors the results that the company has the potential to achieve. Somewhere between these two extremes is the “middle road” scenario where we use more conservative estimates and assumptions for each of the required inputs. An effective Financial Model allows the user to toggle between every scenario with the click of a button.

Finally, we need to arrange the inputs into a format that allows business owners and investors to easily observe and evaluate the financial performance of a company over time. The format is known as the 3-Statement Model. It is a combination of an Income Statement, Balance Sheet, and Statement of Cash Flows. These three statements are presented on one page, allowing the user of the model to observe how income and expenses generate assets and liabilities and translate into cash for the business. The final line of the 3-Statement Model is typically Free Cash Flow to Equity (“FCFE”) – this figure is the cash that can be distributed to the shareholders of the company as dividends after all expenses, reinvestments, and debt repayments are taken care of. FCFE can also be altered into Free Cash Flow to the Firm (“FCFF”) by adjusting for debt. FCFF represents the cash flows available to both shareholders and lenders. Both of these figures are vital metrics that investors use to arrive at a Business Valuation.

A Financial Model is an essential step in making sure your business doesn’t get stuck on the launch pad. Get in touch with our investment team to ensure your business is ready for lift-off.

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In the world today, a cautious sense of relief is beginning to take hold as vaccines are increasingly being rolled out and the scourge of Covid-19 starts to take a back seat in the international news media. The world we are starting to imagine for the future can justifiably be dubbed, ‘post-Covid’.

As anyone in the professional world will be able to attest, the pandemic has fundamentally changed the environment in which we do business. This, in turn, has altered our investment decisions and the necessary checks and audits that need to be performed.

What is Financial Due Diligence

Due diligence is something that companies normally perform in order to avoid committing an offense and to ensure that they are operating within the boundaries of the law.

Similarly, financial due diligence (FDD) is the term used to describe an inquiry or investigation into a potential investment to confirm the facts that could significantly influence investment decision-making. The purpose of this could be for a merger or acquisition, issuing new shares, or any other transaction where risk is relevant and necessary to make a decision using reasonable care.

An FDD is commonly misunderstood as an audit. The key difference between them is that an audit looks back, while an FDD looks both backwards and forwards, to uncover vulnerabilities and opportunities, and to reveal a realistic future for the company.

The primary purpose of an FDD is an assessment of the financial health of a business.

What do we mean by “Financial Health”?

Financial health can be summarised in four main internal areas of a business:

  • Liquidity is the cash on hand that can be used by the business today.
  • Solvency compares the assets of a business to its liabilities to measure whether a company can meet its long-term financial obligations.
  • Profitability measures profit against revenue and costs, to give a broad overview of a business’s current financial position and viability. The gross profit, net profit and EBITDA margins are good indicators for understanding and strengthening profitability.
  • Operating efficiency measures operating costs against sales to show how profitably a business is serving its customers.

These four aspects taken together make up the overall health of the business, and they can be used as a measure of present performance and future success.

Why perform an FDD?

FDD’s are very useful, especially where investment transactions are concerned. For starters, investment transactions that undergo a due diligence process offer higher chances of success.

Due diligence contributes to making informed decisions by enhancing the quality of information available and identifying all material risks. Such risks will need to be managed should the acquirer proceed with the transaction.

The risks may also be used as negotiating power for the acquirer in determining the value at which the transaction takes place. Alternatively, if the risk is outside of the acquirer’s appetite, the process might result in an unsuccessful transaction.

A systematic process helps to ensure that buyers and sellers are on the same page. This helps to prevent any entity from unnecessary harm to either party throughout a transaction.

FDD’s Post-Covid shift

With market stability returning in what we are tentatively calling the ‘post-Covid era’, FDD’s focus has changed and there are new factors to consider in a business environment that is fundamentally different.

An FDD looks both backwards and forwards, and it is therefore useful for envisioning a realistic future for a particular company. FDDs will now need to assess how businesses responded to the pandemic and how they may have carried on differently. Investors may specifically consider new post-pandemic liabilities. Identifying a company’s ‘new normal’ – in other words, the way that it does business now and in the future – may be necessary.

Furthermore, we expect there to be a focus on areas such as supply chain risk, health and safety, financing arrangements and cybersecurity, given the accelerated digitisation in many sectors of the economy. A business’s digital capabilities will be of utmost importance.

Also, going forward, force majeure clauses in fundamental legal agreements will be relevant especially with the possibility of future waves of the pandemic.

In the current environment, we are seeing an increase in ‘quasi-distressed’ deals coming to the market which is where companies are needing to dispose of assets to support their core business post-pandemic.

While Covid-19 hasn’t changed the overall purpose of an FDD, it is important to assess the impact that the virus has had on the FDD process. It would be difficult to find even one company that has not been affected by the pandemic in some way, so it is only natural that financial and professional advice is needed now, more than ever.

If you think you might need professional assistance in assessing the risks of a potential investment transaction, contact Creative CFO for FDD support.

References

Arnoldi, M. (n.d.).   Pandemic has influenced due diligence priorities for M&A activity, says law firm. [online] www.engineeringnews.co.za. Available at: https://www.engineeringnews.co.za/article/pandemic-has-influenced-due-diligence-priorities-for-ma-activity-says-law-firm-2020-09-14/rep_id:4136

International, B. (n.d.).   Post-COVID Due Diligence. [online] blog.benchmarkcorporate.com. Available at: https://blog.benchmarkcorporate.com/post-covid-due-diligence

https://www.nortonrosefulbright.com/en-za/knowledge/publications/2021/q1. (n.d.).   Due diligence in the time of COVID. [online] Available at: https://www.nortonrosefulbright.com/en za/knowledge/publications/ce966575/due-diligence-in-the-time-of-covid

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In an office-based work environment, smart shoes are essential. However, as the recent pandemic has shifted meetings from board rooms to video calls the need for formal attire has become limited to clothing seen from the waist up. This, in turn, has caused the demand for comfortable shoes to climb through the roof, while the need for formal footwear, like stiletto heels, has dropped sharply – pun intended.

The German footwear brand, Birkenstock, was ready for this transition with their famously comfortable sandal. Birkenstocks are adored for their arch support and hipster appeal – hardly the purview of high-finance – but at least two private equity firms expressed an interest in buying the sandal manufacturer, which was valued at between € 4–4.5 billion*. L Catterton, the company behind fashion giant Louis Vuitton, finally won the bid, purchasing Birkenstock in February 2021**.

The purpose of a Business Valuation

While most can only dream of selling their business for that amount of money, it is important to know how one goes about valuing a business, no matter what the size. A valuation may be required for periodic reporting (i.e. feedback to investors), investment analysis, capital budgeting, raising capital, selling shares in the company, or selling the entire business, as is the case with Birkenstock.

Birkenstock is a well-established company (over 200 years old) and the valuation techniques used for this golden oldie are very different from what would have been used if the company was still in its infancy. Aligned with our vision at Creative CFO to create a world where more SMEs succeed, we will focus on explaining the valuation techniques that would be helpful for the “next Birkenstock”.

How do we value a business?

There are various methods of valuation that are acceptable in terms of the International Private Equity and Venture Capital Valuation (IPEV), and using two or more is considered best practice for valuing a company. This allows for the business to be seen from different perspectives, resulting in a more comprehensive and reliable view.

The methods we often use to value companies in the start-up and growth phase include two Discounted Cash Flow (DCF) methods, the Venture Capital (VC) method, and two qualitative methods:  the Scorecard Method and the Checklist Method. The DCF methods, which we will be describing in this article, represent the most well-known approach to company valuation. These methods are recommended by academics and are also used as a daily tool for investment analysts.

The DCF methods: The go-to guys

The two DCF methods are “DCF with LTG” (Long Term Growth) and “DCF with multiple”. Using these methods we attempt to derive the value of the company today based on projections of how much cash a business will generate in the future. From a technical perspective, we derive the present value of the projected cash flows that the company is forecasted to generate each year in the future by discounting these cash flows by a market risk rate. In essence, this takes into account the time value of money and reduces the cash flow each year – acknowledging that R100 in a few years’ time isn’t worth as much as R100 today.

In South Africa more than 70% of SMEs fail within their first 5 years. This means that it is extremely important to weight projected cash flows by the probability of an SME’s survival. In determining an appropriate risk rate, we consider risks related to the specific industry that the company operates in, the company’s size, stage of development, and the company’s perceived profitability.

Long Term Growth or a Multiple?

Once we have modelled the cash flow over a specific period by constructing a financial forecast , we need to assign a Terminal Value (TV) to the business. The TV represents potential future cash flow, beyond the projections we determined through the financial forecast.

To calculate the TV we use one of two DCF methods: DCF with LTG or DCF with multiple. DCF with LTG assumes cash flows will grow at a constant rate beyond our forecast, while DCF with multiple assumes the TV is the exit value (the price the investor receives upon sale) of the company which is computed by incorporating an industry-based multiple of EBITDA. The multiple is derived by taking into account the EBITDA average of recently acquired companies compared to their value (e.g. if Company X was sold for R10 million but has a TV of R800,000, the applied multiple would be 12.5).

Once we have calculated the projected cash flows and the TV of a specific business we apply an illiquidity discount to complete the valuation. Illiquidity (the opposite of liquidity) refers to how difficult it is to convert an asset into cash. The illiquidity discount is therefore built in to acknowledge that selling an SME (liquidating) is not as easy as selling a large, well-established company like Birkenstock.

The illiquidity discount essentially means that a big, Birkenstock-type company will be more expensive than a small anonymous one. Therefore there will be a more substantial discount for the buyer of the small company because it would be harder to exit (sell).

Using more than one method

Aligned with best practice, we use the other three methods mentioned above to derive a weighted average of the valuations. This leads us to our final valuation – how much we think the company is worth. The weights of each method are applied according to the stage of the business (i.e. idea stage, development stage, start-up stage, and growth stage). The DCF methods make up the majority of the weight once the company is in the start-up stage and beyond.

A Business Valuation requires consideration of a plethora of different factors and can be tricky to get right, especially for a company in the early stages of operations. Knowing the value of a concept or a business model is vital to upscaling into a world-class company.

At Creative CFO we love to see the SMEs of this world become the Birkenstocks. Get in touch and let us help you out with the first step.

References

*Birkenstock sold to LVMH-backed group in €4bn deal. The Financial Times. 26 Feb 2021. https://www.ft.com/content/5d511022-46db-403e-9784-eb3807f918f9

**Bain, Marc. The company behind Louis Vuitton is now backing Birkenstock. Quartz. 26 Feb 2021. https://qz.com/1977953/birkenstock-has-been-bought-by-a-lvmh-backed-private-equity-fund/

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Key Performance Indicators do just what they say on the box; they indicate how well your business is performing in key areas. If we liken a business to a vehicle, KPIs are the dashboard. They can answer questions such as: How fast are we going? How much fuel is in the tank? Should we change gears?

Just as you would check your car’s dashboard while you drive, so you should also keep an eye on your KPIs as a business.

“Key Performance Indicators indicate how well your business is performing in key areas.” 

Although KPIs are not compulsory, they should be included in a management report pack where they can be regularly viewed and, where necessary, investigated.

Designing your KPIs

When designing a set of KPIs for your business, you should ask the question: “What information do we need to make decisions based on the core operations of the business?”

This enquiry should be your point of departure and the KPIs will naturally emerge from the answers to this question. Answering this question will also help you to crystallise a deep yet simple understanding of the nature of the business.

Less is more

There is always the temptation to overcomplicate the KPI creation process. This often leads to a myriad of vague KPIs across the board, most of which will be of little use in making mission-critical decisions. Moreover, a weak set of KPIs will inevitably dilute crucial insights. We should guard against this over-the-top approach. KPIs are, after all,  key  performance indicators.

To return to the vehicle analogy, the dashboard shows you only the most important readings for your car. A cluttered dashboard is distracting and essentially useless because the crucial indicator should be evident at a glance. The same applies to KPIs for your business.

In order to whittle down the various indicators, we need to align our priorities and focus on the few measures that are truly indicative of the performance of the business. The idea is to be able to answer this question at all times: “Are we winning or are we losing?”.

“We need to align our priorities and focus on the few measures that are truly indicative of the performance of the business.”

Keeping score

Behavioural psychologists have proven that people play a game very differently when scores are being kept. In this sense, KPIs can be used as the scoreboard within an organisations’ incentive structure to motivate the team to play harder and assume more ownership of their deliverables and responsibilities. Everybody wins, and when they know they are winning, that is good for the whole business.

“KPIs can be used as the scoreboard within an organisations’ incentive structure to motivate the team.”

When designed correctly, these incentive structures can lead to positive feedback loops within the organisation. This has the potential to unleash greater human ingenuity, which is arguably one of the most valuable commodities in any organisation.

Lead, don’t lag

In their book   The Four Disciplines of Execution  Sean Covey and his team make a distinction of particular relevance to KPIs: the idea of lead and lag measures.

Lag measures  are reported after the fact. They typically shed light on what has already happened. Little attention is paid to the causal factors of this historical data. By contrast,  lead measures  are predictive and future-orientated. So while lag indicators look backwards, through the rear-view mirror, lead indicators look forward to the road ahead. In essence, lead measures are proactive, taking initiative for the future journey.

“Lag measures are reported after the fact; lead measures are predictive and future-orientated.”

Let’s use the vehicle analogy as an example. Our lag measure is revealed when we do a roadworthy test. Let’s say the car failed the roadworthy because the tyres are slick and one brake light is broken. The lead measures in this example are regular service check-ups on the car, to ensure that broken lights get fixed and tyres are in good order. When we concentrate on lead measures (regular car services), we can be more confident about the lag measure of “roadworthiness”, and that our vehicle will pass the test.

To put it simply, attaining lead measure targets invariably leads to the attainment of lag measures. This is far better than looking at a lag measure of, for example, revenue growth at the end of each month, and hoping that it will look better next month. Instead, we should be focused on lead measures, for example, reducing machine downtime through routine preventative maintenance. We predominantly want to make use of lead measures because this puts us in control.

Qualitative and quantitative indicators

Not all KPIs need to be finance-orientated. In fact, it’s a good idea to have a blend of both quantitative (hard numbers) and qualitative (softer and more subjective, but still measurable) indicators.

Quantitative indicators  will zoom in on things like revenue growth, machine downtime and physical output.  Qualitative indicators  bring awareness to the more subjective and ethereal dimensions of the business. This includes customer and employee satisfaction and motivation levels, the success of training programs and awareness campaigns, as well as other elements which are harder to quantify in absolute terms. Although they are slightly more difficult to measure, however, we should not neglect them.

“Quantitative indicators focus on things like revenue growth and physical output, while qualitative indicators bring awareness to things like customer and employee satisfaction and motivation levels.”

There are significant lead measures to be uncovered on the qualitative side of the KPI dashboard. Take the time to figure out how best to collect the data to gain these insights. As an example, Creative CFO used OfficeVibe, and now Lattice, to gauge the morale of its team anonymously. It is a great way to keep tabs on the more subjective side of running a business, which can be just as illuminating as the hard data.

Final thoughts

When identifying a business’ KPIs, what are the key takeaways?

  1. Keep it simple. When designing your KPIs, distil them down as much as possible to gain only the most essential and illuminating insights.
  2. Are we winning or losing? Ask this question of every KPI.
  3. Lead, don’t lag. Concentrate on being proactive and focus on lead measures that will invariably help you achieve your lag measure targets.
  4. Blend qualitative and quantitative indicators. Don’t focus exclusively on hard statistics, but look at the affective aspects of your business performance too.

Ultimately, every set of KPIs will be as unique as the business that designs them. They should be tailored to reflect the key drivers of value, as well as the best way to interpret these. The process of building out a business’ KPI dashboard should take time and careful reflection, which can be seen as an exercise in setting priorities.

Business owners have often been impressed by the clarity and decision-making capabilities that emerge from this exercise. Moreover, the exercise empowers business owners to initiate effective action to take their organisation from strength to strength.

No matter the size of your organisation, there will be those few key indicators of unparalleled importance. Identify them, track them, refine them, and let them lead your decisions.

If you require some assistance in this process, please reach out to us. We would be happy to cast a KP-eye over things.

Happy reflecting!

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The cash flow statement is the final piece of the puzzle when it comes to the monthly management reports that we prepare here at Creative CFO. This is without a doubt one of the most important and often overlooked financial reports within the monthly report pack.

The cash flow statement in context

The profit and loss statement, discussed in an earlier blog, provides information on the revenue and expenses over a certain period of time. This is used alongside the balance sheet, which gives a snapshot of the financial health of a business. Out of the information from both of these reports, the cash flow statement is born.

Cash is the heartbeat of a business. A business requires cash to be able to pay its suppliers, vendors and employees, but it also needs cash to be able to invest back into itself in order to grow. The cash flow statement can show how effectively a business is managing its cash inflows and outflows over a specified period of time. This is particularly important to investors seeking to determine the short-term viability of your company, particularly its ability to generate cash and pay bills.

In accounting terminology we often refer to “accrual versus cash accounting”, and this really sums up the importance of understanding the cash flow statement and how it can be utilized to grow your business. “Accrual versus cash” refers to the method in which a report is drawn up. Accrual accounting reports on revenue when it is earned and expenses when they are incurred. Generally, your profit and loss statement is drawn up on the accrual basis. This means that you could earn revenue by invoicing your customers and this will reflect on your profit and loss statement, but until cash changes hands and you receive the money in your bank account, it will not increase your cash immediately. In essence, profits do not always equal cash.

When we look at our monthly reports, it is common to go straight to the balance sheet to see what the bank balance was at month end. However, it does not necessarily tell you how it came in or went out during the month.

Breakdown of the cash flow statement

Let’s take a closer look at the components that make up a typical cash flow statement by using the example below.

Based on the indirect cash flow method, we will start with the operating profit/loss which is pulled directly from the profit and loss statement. This is then adjusted to take into consideration non-cash movements, as well as cash movements, to reconcile at the end of the report with the actual cash balance that you have in the bank at a specific month end.

Depreciation and amortisation are always adjusted for, i.e. added back, as no physical cash leaves the business for these transactions. The only time that cash is affected is when we actually buy the asset. Depreciation and amortisation simply show how the expense is allocated over its useful life.

We can then split the rest of the report into three main sections:

1. Cash generated from operations

This is such an important section of the cash flow report as it showcases how the core of your business is generating and utilizing cash. If we take a look at the movements that are represented in the above image, we can establish how these movements affect the amount of money we have in the bank.

For example, if we take a look at the (increase)/decrease in trade debtors – this would be your customers whom you have invoiced, and if this figure increases then we adjust the net income by deducting the increase, and if it decreases, we adjust with a positive figure.

At the end of the cash flow from operations, you ideally want to see a positive number here, otherwise the company is not raising its cash from its core business activities which could raise a couple of red flags. One of the most common causes of this could be that your cash is tied up – you are perhaps giving your customers long payment terms or your receivables are very overdue – which means you have to continue paying your expenses and suppliers before you have actually received the cash from your customers.

2. Net cash from investment activities

This is cash spent or received from investments, which is outside the core of the business. If you perhaps purchase a new asset or purchase shares in another company this will be reflected here.

3. Net cash from financing activities

This represents the raising, borrowing or repaying of loans and issuing of new shares or dividends paid, to name a few. If you receive a loan from the bank, the cash comes in, so this will be represented as a positive amount on the cash flow statement. This is then easily identifiable to the person reading the report that money has come in. When the company repays the principal portion of its loans, this will be presented as a negative amount, which means that cash was used which reduces the bank balance.

Managing cash flow is vital for business success, it really can be summarized as doing anything and everything possible to ensure money is coming into the business as quickly as possible and exiting as slowly as possible. In order to summarise the cash flow statement visually we use the waterfall representation as part of the monthly management reports, an example of which is below.

Tips for getting the most out of your cash flow statement

To end off, we will leave you with a few of our top tips to keep in mind for when you are next reviewing your cash flow statement and forecasting for the upcoming months:

  • Profit does not equal cash, so don’t count income until it’s in the bank.
  • Plan for the unexpected. Before you purchase that awesome new coffee machine, make sure you have cash in the bank to cover at least two months’ operating expenses.
  • Be prepared for growth. When a business grows, it more often than not comes with additional costs which can include marketing, buying additional inventory or on-boarding additional resources.
  • Line up your invoicing and collections. Too many small businesses land up with customers with long outstanding debts. Make sure to stay on top of your debtors or implement a debit order system from the start.
  • Always have an up-to-date cash flow forecast. It is vital to know what your cash commitments are for the upcoming year.

The cash flow statement is one of the most integral components of the monthly management report pack that Creative CFO provides. Now that you know what it means to have an up-to-date cash flow statement, get in touch with us to discuss your business’s financial reporting needs.

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