Successful Business Running in Australia · 1.1 Registration of a Business If you want to plan to start business now, you need to have an Australian Business Number (ABN) to start

1st

Edition

Ben Youn

Quantum Business House

1st Edition

Successful Business Running in Australia A Comprehensive and Practical Business Guide to help increase value and sustainable growth

Successful Business Running in Australia

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Table of Contents

Part I: Setting Up a Business in Australia .......................................................................... 4

Chapter 1. A New Business Setup .................................................................................. 5

1.1 Registration of a Business ....................................................................................... 5

1.2 Business Structures ............................................................................................... 7

1.3 Licences & Permits ............................................................................................. 10

Chapter 2. Buying a Business ...................................................................................... 12

2.1 Pros & Cons ..................................................................................................... 12

2.2 Proper Procedures of a Buying a Business .................................................................. 12

2.2.1 Finding a business for sale .................................................................................. 12

2.2.2 Assessing Experience and Skills ............................................................................ 13

2.2.3 Signing a Terms Sheet ....................................................................................... 13

2.3 Due Diligence ................................................................................................... 14

2.4 Business Valuation .............................................................................................. 18

Chapter 3. Business Planning ...................................................................................... 21

3.1 Overview of the business plan ................................................................................ 21

3.2 Strategic Business Plan ......................................................................................... 22

Chapter 4. Marketing your business ............................................................................. 24

4.1 Customers ........................................................................................................ 24

4.2 Value Proposition ............................................................................................... 25

4.3. Becoming a customer-centred organisation – Seeing through your customers’ eyes .............. 26

4.4 Industry and Competitors ..................................................................................... 31

4.5 Marketing Strategy ............................................................................................. 33

Chapter 5. Raising Finance......................................................................................... 39

5.1 Equity vs. Debt .................................................................................................. 39

5.2 Short Term vs. Long Term Debt ............................................................................ 41

5.4 Loan Application ................................................................................................ 47

Part II: Managing Your Business .................................................................................. 51

Chapter 6. Understanding Tax System .......................................................................... 52

6.1 Income Tax ...................................................................................................... 52

6.2 Goods and Services Tax ....................................................................................... 58

6.3 Capital Gains Tax ............................................................................................... 61

6.4 Fringe Benefits Tax ............................................................................................. 62

6.5 Withholding Taxes ............................................................................................. 62

Chapter 7. Implementing Computer Based Accounting System ............................................ 64

7.1 Understanding Business Accounting ......................................................................... 64

7.2 Implementing Accounting Systems .......................................................................... 67

Chapter 8. Exporting & Importing ............................................................................... 76

8.1 Export ............................................................................................................ 76

8.2 Government Grant and Assistance .......................................................................... 79

8.3 Import ............................................................................................................ 80

8.4 Payment & Trading Terms .................................................................................... 82

8.5 GST Issues........................................................................................................ 84

8.6 Customs and Quarantine ...................................................................................... 85

Chapter 9. Risk Management & Financial Control ............................................................ 88

9.1. Risk Management .............................................................................................. 88

9.2 Internal Financial Control ..................................................................................... 93


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9.3 Insurance ......................................................................................................... 96

Chapter 10. Financial Management & Reporting .............................................................. 98

10.1 Profit and Expenses ........................................................................................... 98

10.2 Balance Sheet Items .......................................................................................... 105

10.3 Working Capital Management ............................................................................. 107

10.4 Cashflow Management ...................................................................................... 114

10.5 Budget & Forecast ............................................................................................ 115

Chapter 11. Managing Business in Tough Times .............................................................. 119

11.1 Financial Health Check ...................................................................................... 119

11.2 Cash Flow ..................................................................................................... 119

11.3 Profitability .................................................................................................... 119

11.4 Updating Marketing Plan based on Opportunities ..................................................... 119

11.5 Risk Management Strategy ................................................................................. 119

11.6 Exiting Your Business ....................................................................................... 120

Part III: Financial Health Check & Improving Value ......................................................... 127

Chapter 12. Business Health Check & Evaluation ............................................................ 128

12.2 Business Evaluation and Value Increase Strategy ....................................................... 129

Chapter 13. Increase ROI with Lean Six Sigma ............................................................... 136

13.1 Business Value (ROI) and Service Process Improvements ............................................ 136

BIBLIOGRAPHY ................................................................................................................... 147


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Part I: Setting Up a Business in

Australia

Starting a business is a

challenging task for new

entrepreneur, and this

requires registration of

business to the various

government bodies. It also

requires planning business

for short and long term. At

this stage, you should engage

marketing strategy to attract

enough sales to survive.

Setting up business system

and proper business process

with or without employees

also require great time and

efforts for business owners

and managers.


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Chapter 1. A New Business Setup

If you have a business concept and willing to make profit from the business, you now need to

have Australian Business Number (ABN) for your business along with other registrations depending

on the type of business structure and business itself. There are number of different options for

business structure, and you need careful consideration to select right type of business structure as

they have all different perspectives in legal and taxation consequences. Also, it is sometimes

difficult and costly to change the business structure while you are running the business.

1.1 Registration of a Business

If you want to plan to start business now, you need to have an Australian Business Number (ABN)

to start a business in Australia. The ABN is a single identifier for all business dealings with the

Australian Taxation Office (ATO) and other government agencies. When you register for ABN, it is

easy to register for Goods and Services Tax (GST) if the annual turnover is expected to over

$75,000. All not-for-profit organisations with an annual turnover of $150,000 or more must

register for GST. If your business is being run by a company, the Australian Company Number (ACN)

is required to get the ABN. Also a business is required to get a tax file number (TFN) and a business

name registered. A business name is the name under which a person or other entity trades. If your

trading name is different from your entity name (your personal name or company name), you are

required to register your business name in each state in which you are trading. The main objective

of requiring registration of a business name is to enable the public to find out who is operating the

business. However, registering a business name does not mean your business name is legally

protected. The best way to protect a trade name is to register a trademark.

However, from 28 May 2012, ASIC will be taking over the registration of business names from the

states and territories. To register a business name, you must complete an online application and

lodge it with ASIC.


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Figure 1. Summary of the new business name registration process with ASIC

If your business name is currently registered in a state or territory, it will be automatically transferred to

ASIC’s Business Names Register and you do not need to register with ASIC.

So the general process of registration of a business in Australia is,

Was your business name registered in

a state or territory before 28 May

2012?

Are you exempt from registering your

business name under one of the

exemptions in the Business Name

Registration Act?

Are you ‘carrying on a business’ under

your business name?

You must lodge an application to

register your business name with ASIC

If you wish to continue using

the business name, renew

your registration before it

expires, and pay the

registration renewal fee.

You do not have to register

your business name – your

business name will be

automatically transferred to

the Business Names

Register on 28 May 2012

If you proposed name is

‘available’, pay the

registration fee.

Ensure your details on the

Business Names Register

remain correct and up-to-

date.

You do not need to register

your business name

No

No

Yes

Yes

Yes

No

To apply, you will need to create an ASIC

Connect account and must provide

certain information, including:

The ABN of the proposed

business name holder;

Your proposed business name;

Your preferred registration

period (1 or 3 years);

The business name holder and

details;

The address of the business


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1.2 Business Structures

There are number of ways running a small business in Australia. You can setup your business with

your own name being sole trader; or, you setup a company being separate from you. Partnership

and trust structure is other options to consider. It is very important to choose the right business

structure before you commence business activities with regard to legal obligations, taxation, and

other matters such as asset protection purpose. Changing the business structure while you are

running can be costly and sometimes cause inevitable negative consequences(HumphreyNicholas,

2004).

Company

A company is a separate legal entity from its owners (shareholders). It can incur debts, sign

contracts, and can sue or be sued. A company can own its own property and must lodge its own tax

return. In a company, ownership and control are separate. The shareholders own the company but

the directors exercise most of the control over the business.

Companies are registered with the Australian Securities and Investments Commission (ASIC). Once

registered, you will have an Australian Company Number (ACN) mentioned above. You also need to

file your company every year with ASIC with costs of $216 at the time of this writing.

Under the Corporations Act, a shareholder’s liability is limited to the amount of capital they

contributed, plus any unpaid capital. Directors of a company, however, can be personally liable to

the company’s creditors if the directors knew that the company was trading while it was insolvent.

Having insurance policy over director’s liability is common to protect the directors against his or her

personal liabilities.

Private companies (Pty Ltd) are divided into two groups, ‘large proprietary companies’ and ‘smaller

proprietary companies’. If a company satisfies any of two of below categories, then the company is

a large proprietary company.

Gross operating revenue of more than $25 million

Gross assets of more than $12.5 million

Having more than 50 employees

Australian Company Number(ACN)

• Registration as a company in Australian Securities and Investments Commission (ASIC)

Australian Business Number (ABN)

• Registration of ABN, GST, Tax File Number, PAYG Withholding Tax, etc in Australian Business Register (ABR)

Business Name & Trademark

• Registration of a business name in each state government agent (e.g. The Dep. of Fair Trading in NSW until May 27, 2012)

• Registeration of trademarks in IP Australia


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A large proprietary is required to lodge an audited financial report with ASIC. Smaller companies

are not required to prepare a financial report unless 5 per cent of shareholders require it.

Private companies are only required to have one director who is resident in Australia. Directors are

bound to the various duties under Corporations Act, and breach of these duties may result in large

fines or imprisonment.

Sole Trader

A sole trader is someone who owns and runs the business by themselves. All of the property of the

business, such as leases, stock and office equipment is owned by the owner.

The results in the following legal consequences, among others:

The income of the business is the owner’s personal income;

The owner is responsible for any liability of the business and business creditors can satisfy

liabilities out of the owner’s personal assets;

When someone deals with a sole trader business, it is the owner who is legally obliged to

carry out the deal;

The owner is personally responsible for any wrong doing of the business, even if it is

committed by an employee.

There are number of advantages for being a sole trader.

As all of the rights, obligations and property of the business are in the owner’s name, there

is no need for any sort of additional legal arrangement. As a result, setting up a business as

a sole trader is simpler and easier than any other form of business;

Maintenance of a sole trader business is easier. As a sole trader, there are no

requirements for some of the administrative tasks required for other business structures,

such as annual meetings, lodgement of returns or the passing of resolutions for certain

actions;

The minimal legal disclosure regulations attached to a sole trader mean you have the

greatest privacy;

Just as the owner owns the assets of the business, so all of the profits of the business are

owned by the owner. There is no need to share profits nor is there any obligation to use the

profits for the good of the business.

There, however, are number of disadvantages to the sole trader structure, including following.

The sole trader is liable for all the obligations of the business. In the event of insolvency,

the sole trader must cover the shortfall from personal funding;

A sole trader may not offer shareholdings to other people as such the only way to raise

capital is by borrowing debt or using personal assets;

As the owner is the business, both legally and commercially, it can be difficult to sell the

business if the owner dies or simply wishes to get out;

Sole traders are taxed at individual marginal tax rate, but companies are presently taxed at

a lower rate than individuals unless the taxable income is in low level.

Partnership

Partnership is defined as ‘an association of two or more people formed for the purpose of carrying

on a business with a view to profit’. Partnership has no separate legal existence. Instead, the

partnership agreement sets up the rights and obligations of the partners.


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With a partnership, the business is made up of all of the partners acting together. Under this

arrangement, every one of the rights, obligations, assets and liabilities of the business is owned

and owed by each of the partners, both separately and as a group. As a result, each of the partners

has an interest in all of the property and the profits of the business.(HumphreyNicholas, 2004)

One should note that each partner is liable for debts incurred by the other partners regardless of

knowledge of the other partner and the liability of partners is not limited to the assets of the

business, i.e. if a debt is greater than the available funds of the business, a creditor can recover

from the personal funds of the partners. Partners will have a ‘joint and several liability’. A creditor

can recover the entire amount of any debt from any partner, even if another partner was

responsible for creating the liability. This is important fact that you should consider before

engaging partnership based business.

The basic principle of the partnership extends to control of the business as well. Each partner will

have an equal say in controlling the business, unless the partnership agreement specifies

otherwise.

As with companies and sole traders, partnerships have number of advantages and disadvantages

built into the structure. The advantages include the followings:

A partnership can split the income of the business between the partners. If the partners are

members of the same family, the income can be evenly split so as to minimise the amount

of a family’s income which is in higher tax brackets;

As the income of the business is really the income of the partners, losses of the business

can be offset against other income of the partners. If the partnership agreement allows, it

is possible to split income on a different basis to losses;

If the partners desire, it can be possible to access assets of the business easily. This must

be expressed in the partnership agreement.

Joint and several liability means that creditors will have greater security for any loans

advanced to the partnership, meaning that they will be more willing to take the risk.

However, a partnership structure restricts equity finance to what is contributed by new and

existing partners.

The disadvantages of the partnership structure can be summarised as follow:

Each partner is personally responsible for each and every debt of the partnership. As every

partner is bound by the actions of any one partner, partners can find themselves liable for

a debt that was incurred without their knowledge or consent;

As each partner has an interest in the partnership, making decisions for the business

requires considering the interests of all of the partners. This may cause management

difficulties;

A partnership is a legal relationship between a set group of partners. If any one of the

partners leaves that set group, the previous partnership no longer exists and a new

partnership must be formed.

Trusts

Under a trust structure, a trustee owns the assets on trust for the beneficiaries, which are often

family. The general rule is that a trustee may not benefit from the property of the trust. The trustee

is entitled to be reimbursed for expenses, but is not entitled to be paid fees, unless the trust deed

provides for this or all the beneficiaries agree to the payment. Trustees cannot sell the property

and keep the proceeds for their own use.


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The specific rights, restrictions and powers of the trustee, manager and beneficiary are set out in a

document called a trust deed. This sets out the objectives of the trust, and describes the

investment/business guidelines and how the income is distributed.

Types of trust

There are two basic types of trust – unit trusts and discretionary trusts. In a unit trust, the

beneficiaries hold ‘units’ in a trust, similar to how shareholders hold shares in a company. However,

the most commonly used in small business trading trusts is a discretionary trust. In a discretionary

trust, the beneficiaries are specified as a class of persons. None of those people has a claim on a

fixed proportion of the trust property, unlike a unit trust. The trustee has discretion to distribute the

income of the trust in any way among the beneficiaries. This means you can apportion income

between members of your family to minimise tax. However, under the tax law, trusts cannot be

established for the express purpose of avoiding tax.

The trust structure may also make it harder to access assets quickly. Unless the trust deed

provides otherwise, assets cannot be taken out of a trust without the consent of all the

beneficiaries. And in the case of some discretionary trusts, it may not be possible to determine who

all the beneficiaries are.

There are many advantages and disadvantages to trust structure.

A discretionary trust allows the trustee to split income between the beneficiaries, allowing a

family to put as much of a business’s income as possible into low tax brackets;

If the trustee is a company, the trust can take advantage of the corporate structure in

terms of limited liability and ease of succession.

The drawbacks of trusts include the following:

The assets of the business are tied up in a complex structure which makes it difficult to

access assets easily;

In order to trade as a trust, a trustee company may need to be set up and a trust deed

drafted. The setup costs for this can be significant;

What the trustee can do may be limited by either the trust deed or the law of

trusts(HumphreyNicholas, 2004).

1.3 Licences & Permits

The state and federal governments require certain type of businesses to obtain licences or permits

to carry out business. As a pre-condition to obtaining a licence you may need to satisfy certain

criteria, such as educational requirements, fitness, character or experience, as well as paying a fee.

The objective for this is to protect consumers from ‘shonky’ and untrained service providers.

The Business Licence Information Service (BLIS) provides a centralised information service in

relation to the various licences and permits required to operate a business. If you are planning to

run your business from home, you may also need to comply with local council

regulations(HumphreyNicholas, 2004).

Industries subject to registration

Special licences, permits, approvals and registrations are required by a variety of different

government authorities for a variety of different industries including:

Advertising agents


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Auctioneers

Builders/plumbers/electricians

Conveyancers

Dealers/advisors in securities and other financial products

Employment agencies

Importers of medical goods/devices

Real estate agents

Restaurants

Retail outlets

Security guards

Tax agents/advisers

Travel agents

Valuers

Retail outlets and factories are subject to a broad range of additional regulations including:

Health regulations

Safety regulations

Storage of chemicals

Trading hours

Waste disposal

Water/gas/electricity connections

You will also need a permit to display signs or advertising materials outside your premises.


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Chapter 2. Buying a Business

Sometimes, it is a better way to start a business by purchasing an existing

business especially when you do not have sufficient time and skill to build a business from a

scratch. In this chapter, we will discuss the pros and cons of buying a business with the required

procedures of business buying to minimise risks and how to value the business you want to buy.

2.1 Pros & Cons

The main advantages of buying an existing business are:

You will save the time and effort required to build the business and eliminate any teething

problems including purchase of equipments such as computers, desks recruitment of staff

and securing suitable premises.

It is lower risk as supplier relationships have already been established.

Existing clientele should mean that you are not exposed to a long set-up period without

incoming revenue

It will be considerably easier to obtain finance for a business with a track record than for a

start-up.

The main disadvantages of buying an existing business are:

Starting from scratch can be cheaper, as you are not paying for goodwill.

You may overvalue the business if you are too optimistic about the future earnings

potential of the business.

The previous owner may have had poor relationships with employees, customers or

strategic partners. This exiting illness could be difficult to overcome.

The seller may have misstated the value of the assets or the business’s financial

statements.

You may inherit prior mismanagement such as holdings obsolete stock or software which is

antiquated.

2.2 Proper Procedures of a Buying a Business

2.2.1 Finding a business for sale

Finding suitable businesses for sale is a challenging task and considerable amount of time and

energy need to be taken. The most main sources of leads are:

Business brokers, corporate advisory firms and merchant banks

Newspapers

Newsletters and magazines

Word of mouth

The internet


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Business brokers and Corporate Advisors

You will need to contact a range of intermediaries including business brokers to register your

interest in acquiring a business in a certain price range, industry sector and geographical area.

A business broker matches people who want to buy a business with people who are selling one.

Brokers typically deal in smaller businesses such as retail, manufacturing, hospitality and

professional practices.

Corporate advisers tend to act in larger deals (over $5 million) and generally play a more active

role in the transaction than a business broker – actively finding buyers, preparation of information

memorandums, setting the terms and pricing. One of the benefits of buying a business through

corporate advisors is that they will generally screen the businesses for sale to determine if there

are any major problems and will also help set a realistic price(HumphreyNicholas, 2004).

2.2.2 Assessing Experience and Skills

One of the first steps in buying a business is a thorough personal assessment of your risk profile,

motives and the seriousness of your search. You also need to assess realistically the size of the

financial/professional resources to which you have access. Another key assessment is to

determine how closely the business matches your personal skills and interests. The closer the

match, the better your chance of success.

The next step is to ensure that you have the necessary experience and skills to operate the

business. In addition to general business skills such as finance, marketing and operations, you will

need experience and expertise in running a business of that magnitude and in that particular

industry. You must ensure that you have the myriad of business and management skills required.

You should also join the relevant industry association and consider undertaking a short course of

study.

Some industries also require business operators to have special qualifications. For example, you

may need a suitable degree or diploma and relevant industry experience to hold the necessary

licences or permits. Please see ‘Licence and Permit’ section of this book for more information.

2.2.3 Signing a Terms Sheet

Before you spend significant time conducting due diligence, you should consider signing a terms

sheet with the seller. Do not sign a fully binding terms sheet unless it is conditional upon the

satisfactory completion of due diligence, raising of finance and execution of legal documentation.

You should also seek legal advice before signing a terms sheet.

A terms sheet summarises the intentions of the parties and describes the general terms and

conditions of the transaction. The terms sheet should deal with:

The purchase price and how it is to be calculated;

Whether the sale is by shares or assets;

The assets and liabilities to be transferred and excluded.

Terms sheets are usually non-binding. However, the ‘no-shop’ or ‘exclusivity’ clause and the

confidentiality provisions should be binding. The no-shop clause protects the buyer by stating that

the seller will not negotiate with other potential buyers for a period of time.


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Tips for drafting

Typically, the terms sheet is drafted b the buyer.

It is better if the first draft is prepared by the principals, rather than the lawyers.

Focus on the major points; do not go into the details.

The letter should be short – three or four pages at most.

State expressly which terms are meant to be legally binding and which are not.

Specify what conditions must be satisfied before the transaction is completed.

State expressly that the investment, sale of purchase depends upon the execution of a

definitive agreement.

2.3 Due Diligence

The legal adage of caveat emptor or ‘let the buyer aware’ applies when you purchase a business.

Before you buy the business, you must satisfy yourself as to the prospects and viability of the

business. You should undertake extensive due diligence into the business you are purchasing. You

should also seek appropriate professional advice from legal, tax and accountants.

Your investigations should focus on the following things:

What are the maintainable earnings of the business?

Is there potential to improve sales/earnings?

Is the asking price justified by the value of the assets and the past and potential profits?

Is there sufficient working capital to operate the business (i.e. will additional funding be

required)?

Will the potential profits provide you with an adequate salary plus a return on your capital?

Is the cash flow predictable?

Are the sales and revenues growing, stagnant or declining?

Have adequate financial records been kept over the life of the business?

Is there any capacity to reduce the level of overheads?

Are key personnel ‘locked in’?

Ensure you review all major contacts (customers, suppliers and personnel). You should

ensure that there are no termination provisions which are triggered by a change of control

or assignment, that proper arrangements are in place for fees payments, and there is no

excessive exposure to liability or indemnities. Note any key performance indicators (KPIs)

which must be met and assess if they are achievable (industry benchmarks)

How long has the business been on the market? Clearly, the longer it has been for sale the

more bargaining power you are likely to have.

Why are the owners selling?

Part of your due diligence enquiries should be to establish why the current owners are selling. Are

they simply getting out before the business goes into insolvency?

Most sellers will offer a range of seemingly valid reasons for disposal. An individual seller may be

sick or planning to retire. A corporate seller may explain the division is no longer part of the overall

group’s strategic focus or no longer has support from head office.

You need to find out the real reason they are selling. An analysis of external threats may highlight

the real reason. For example:

Demographics – changing demographics in the market may mean the long-term prospects

of the business are not viable.


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Regulation – the government may be planning to introduce new legislation which will

hamper the industry. The local council may be planning to rezone the area, restricting your

ability to carry on the business, or it may be planning to change regulations such as traffic

flow or parking which may also be detrimental to the business.

Competition – a new well-funded competitor may be launching. Consider the impact of the

introduction of Coles Supermarket nearby a small family owned grocery shop. Trade and

industry associations are good place to gain intelligence on new competitors.

Obsolescence – Are the products or services sold by the business about to become

obsolete through the introduction of new technology?

It is also worth checking on the seller’s intentions after the sale. Are they simply moving down the

road to a more prominent location or cheaper premises? A restraint of trade provision is important

in any business purchase.

Below is the sample check lists for due diligence process.

A. Organization and Good Standing.

The Company's documents of incorporation and all amendments thereto.

The Company's constitution, and all amendments thereto.

The Company's minute book, including all minutes and resolutions of shareholders and

directors, executive committees, and other governing groups.

The Company's organizational chart.

The Company's list of shareholders and number of shares held by each.

Copies of agreements relating to options, voting trusts, warrants, calls, subscriptions, and

convertible securities.

Annual reports for the last three years.

A list of all states or countries where the company owns or leases property, maintains

employees, or conducts business.

A list of all of the Company's registrations of business names and copies of registrations

thereof.

B. Financial Information.

Audited financial statements for three years, together with Auditor's Reports.

The most recent unaudited statements, with comparable statements to the prior year.

Auditor's letters and replies for the past five years.

The company's credit report, if available.

Any projections, capital budgets and strategic plans.

Analyst reports, if available.

A schedule of all indebtedness and contingent liabilities.

A schedule of inventory.

A schedule of accounts receivable.

A schedule of accounts payable.

A description of depreciation and amortization methods and changes in accounting

methods over the past five years.

Any analysis of fixed and variable expenses.

Any analysis of gross margins.

The company's general ledger.

A description of the company's internal control procedures.


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C. Physical Assets.

A schedule of fixed assets and the locations thereof.

All leases of equipment.

A schedule of sales and purchases of major capital equipment during last three years.

D. Real Estate.

A schedule of the company's business locations.

Copies of all real estate leases, deeds, mortgages, title policies, surveys, zoning

approvals, variances or use permits.

E. Intellectual Property.

A schedule of domestic and foreign patents and patent applications.

A schedule of trademark and trade names.

A schedule of copyrights.

A description of important technical know-how.

A description of methods used to protect trade secrets and know-how.

Any "work for hire" agreements.

A schedule and copies of all consulting agreements, agreements regarding inventions,

and licenses or assignments of intellectual property to or from the company.

Any patent clearance documents.

A schedule and summary of any claims or threatened claims by or against the company

regarding intellectual property.

F. Employees and Employee Benefits.

A list of employees including positions, current salaries, salaries and bonuses paid during

last three years, and years of service.

All employment, consulting, nondisclosure, nonsolicitation or noncompetition agreements

between the company and any of its employees.

Resumés of key employees.

The company's personnel handbook and a schedule of all employee benefits and leave

entitlements.

Copies of collective bargaining agreements, if any.

A description of all employee problems within the last three years, including alleged

wrongful termination, harassment, and discrimination.

A description of any labour disputes, requests for arbitration, or grievance procedures

currently pending or settled within the last three years.

A list and description of benefits of all employee health and welfare insurance policies or

self-funded arrangements.

A description of worker's compensation claim history.

Copies of all stock option and stock purchase plans and a schedule of grants thereunder.

G. Licenses and Permits.

Copies of any governmental licenses, permits or consents.

Any correspondence or documents relating to any proceedings of any regulatory agency.

H. Environmental Issues.


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Environmental audits, if any, for each property leased by the company.

A listing of hazardous substances used in the company's operations.

A description of the company's disposal methods.

A list of environmental permits and licenses.

Copies of all correspondence, notices and files related to Federal, State, or local

regulatory agencies.

A list identifying and describing any environmental litigation or investigations.

A list identifying and describing any contingent environmental liabilities or continuing

indemnification obligations.

I. Taxes.

Company income tax returns for the last three years.

GST & FBT returns for the last three years.

Any audit and revenue agency reports.

Any tax settlement documents for the last three years.

Employment tax filings for three years.

Any tax liens.

J. Material Contracts.

A schedule of all subsidiary, partnership, or joint venture relationships and obligations,

with copies of all related agreements.

Copies of all contracts between the company and any officers, directors, shareholders or

affiliates.

All loan agreements, bank financing arrangements, line of credit, or promissory notes to

which the company is a party.

All security agreements, mortgages, indentures, collateral pledges, and similar

agreements.

All guaranties to which the company is a party.

Any instalment sale agreements.

Any distribution agreements, sales representative agreements, marketing agreements,

and supply agreements.

Any letters of intent, contracts, and closing transcripts from any mergers, acquisitions, or

divestitures within last five years.

Any options and stock purchase agreements involving interests in other companies.

The company's standard quote, purchase order, invoice and warranty forms.

All nondisclosure or noncompetition agreements to which the company is a party.

All other material contracts.

K. Product or Service Lines.

A list of all existing products or services and products or services under development.

Copies of all correspondence and reports related to any regulatory approvals or

disapprovals of any company's products or services.

A summary of all complaints or warranty claims.

A summary of results of all tests, evaluations, studies, surveys, and other data regarding

existing products or services and products or services under development.

L. Customer Information.

A schedule of the company's twelve largest customers in terms of sales thereto and a

description of sales thereto over a period of two years.

Any supply or service agreements.


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A description or copy of the company's purchasing policies.

A description or copy of the company's credit policy.

A list and explanation for any major customers lost over the last two years.

All surveys and market research reports relevant to the company or its products or

services.

The company's current advertising programs, marketing plans and budgets, and printed

marketing materials.

A description of the company's major competitors.

M. Litigation.

A schedule of all pending litigation.

A description of any threatened litigation.

Copies of insurance policies possibly providing coverage as to pending or threatened

litigation.

Documents relating to any injunctions, consent decrees, or settlements to which the

company is a party.

N. Insurance Coverage.

A schedule and copies of the company's public liability, personal and real property,

product liability, errors and omissions, key-man, directors and officers, worker's

compensation, and other insurance.

A schedule of the company's insurance claims history for past three years.

O. Professionals.

A schedule of all law firms, accounting firms, consulting firms, and similar professionals

engaged by the company during past five years.

P. Articles and Publicity.

Copies of all articles and press releases relating to the company within the past three

years.

2.4 Business Valuation

The principles of valuing a business and components of a business are well established. The seller

wants to get as much as possible, the buyer wants to pay as little as possible, and the value lies

somewhere in between. Business valuation methods are different in today’s market place

depending upon size, profitability and nature of the business. However there are five generally

accepted methods for business valuation. Ultimately, the ultimate goal for business valuation is

value the future maintainable profits of a business.

Price / Earnings method

The capitalisation of future maintainable profits method is the most common way of valuing an

existing business in good order, as it usually aligns reasonably well with the expectations of

potential purchasers. This involves multiplying an estimate of future maintainable earnings by the

capitalisation rate. The capitalisation rate differs between industries and businesses and is usually

expressed as a multiple of price / earnings ratio (PE).


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EBIT method

This is the most common method of valuing private businesses worth around $2 million and above.

Relatively few add-backs are made to the book profit when valuing a large business. Interest is

added back and depreciation in some cases. Owner’s wages not added back (but may be adjusted

to bring them in line with commercial rates) as these businesses are valued as running under

management.

EBIT – earnings before interest and tax

EBITDA – earnings before interest, tax, depreciation and amortisation.

The EBIT figure is used in valuation calculations, although the EBITDA can be used.

The EBIT method is simply calculated by the following formula:

Value of business = EBIT × EBIT multiple

For example, if the EBIT is $2.5 million and the multiple is four, the value is $10 million. This is the

value of the business assets comprising stock, plant & equipments and goodwill. Debtors and

creditors are not usually included.

It is becoming increasingly common for the purchaser to buy the entire company by way of

purchase of the shares in the company. In this case, the final price is adjusted to reflect the other

items on the balance sheet, including debtors, creditors, accruals for staff entitlements and

perhaps company debt.

The EBIT multiple to be applied to value a business can vary from around two up to around six, and

sometimes higher, depending upon a number of factors, including:

The total EBIT figure (the higher the EBIT figure, the higher the multiple)

The quality of the management team

Stability of sales and profits

The type of industry

Barriers to entry

The ability of the business to generate profits without the owner’s involvement

Growth potential

Market dominance.

Discounted cash flow method

This method is based on the concept that the value of a business depends on the future net cash

flow of the business discounted back to present value at an appropriate discount rate.

The discounted cash flow method is usually used to value new or immature businesses or a

business in which there is considerable variation in income or expenditure expectations. This

discount rate increases with the level of risk and the estimated time taken for the business to

reach maintainable earnings. It could also be used where small or medium company has long term

contracts for the supply of goods and services or where the company has a history of regular cash

flows.

Asset valuation method

Under-performing businesses are valued according to the asset valuation method. There is no

goodwill component and the value of the business is derived solely from the value of the plant and

equipment (usually at current market price) and inventory.


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This method is used when other valuation methods give a value that is less than the net tangible

assets of a business. This is based on the concept that a business owner is highly unlikely to sell

his business less than he can receive by way of an ordinary disposal of the business assets.

Inventory is valued at invoice cost, but may be discounted depending upon the amount of slow-

moving or obsolete stocks.

Return on Investment (ROI) method

This is the most common method applicable to value businesses worth up to about $2 million. It

reflects the percentage returns to an owner on his capital investment in the business. The net

profit used in the calculation is not the same as shown on the Profit & Loss Statement. A number

of adjustments and “add-back” are made to the P & L statement to reflect the return to an owner

and to add back non-business expenses and one-off expenses.


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Chapter 3. Business Planning

A business plan is a written document which identifies your objectives and outlines your strategy

for achieving those objectives. It should set out all the key facts about your business – the

activities of your business, your financial plan, the industry in general, your competition, your

customers, and how you will use your resources to achieve your objectives. The business plan will

help you to assess whether the business is viable and will allow you to anticipate and plan for

potential weaknesses within it.

A business plan can also be used to help raise finance from lenders or other investors. A well-

presented and organised business plan will make a lasting first impression on the lender or

investor and demonstrates your standards and business skills. Most lenders, investors or venture

capitalists will simply not advance funds unless you have a comprehensive plan that shows how

you will be able to provide them with a reasonable return on their investment.

The frequency of planning depends on the nature of your external environment and the maturity of

your company. Comprehensive and detailed business planning must be conducted when starting a

new business. If you are in a dynamic and rapidly changing industry then you will need to

undertake a comprehensive review of your plan as frequently as every six or twelve months. You

should also undertake detailed strategic planning when you are considering the launch of a new

product or entry into a major alliance. Implementation reviews of your strategic plan are generally

undertaken on a quarterly basis(HumphreyNicholas, 2004).

3.1 Overview of the business plan

Before drafting your plan, gather as much information as possible about the industry, your markets,

and your potential products and services. There are number of elements that make up the

contents of a business plan listed below:

Cover page – company details should be clearly printed on the cover page

Table of contents – this makes it easy for readers to navigate through your plan

Executive summary – provide a brief summary that captures the essence of the business

plan

Mission/vision – the mission statement captures the purpose, activities and values of your

business

Description of industry – describe the industry you are operating in including the size and

latest trends

Description of business – provide a brief description of the proposed or current activities of

the business

Products or services – describe what products and services your business supplies

Identification of market – discuss and analysis the size and nature of the market

Competitors – provide an analysis of all your competitors and how you will capture a share

of their market

Marketing plan – describe the strategy you will use to ensure customers know about your

business and its products or services

Business goals – summarise the primary objectives of the business.

Management team – provide a brief background of the experience and qualifications of

your staff, one of the key assets of your business

Corporate structure – provide details of the business structure in place, including shares

and options on issue.

Risk management – list the main risks associated with the business

Implementation plan – describe the key milestones for the development of your business

and when they should be reached.


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Financial forecast – provide historical financial statements and a projected profit and loss

statement

Terms of investment – describe how much you are seeking to raise and the terms attached

to the finance

Appendix – include other documents that support claims made in the business plan.

3.2 Strategic Business Plan

Strategic planning provides direction for the future of the business by establishing priorities and

allocating resources to achieve the objectives outlined in the plan. When a business implements a

formal process of strategic planning on a regular basis, business performance is measured and

assessed. The process allows for business owners and managers to allocate resources and

implement changed business practices for improved business performance. Having a strategy in

place that focuses on continual improvement will ensure that the business strives, but it also

means that many crisis situations that can be the undoing of a business may be identified and

addressed before they have a negative effect on the business.

Good practice in strategic planning should incorporate a regular formal review that:

Addresses critical performance issues by assessing actual performance against objectives

and criteria established during the business evaluation.

Identifies long-term objectives.

Recognises capabilities and resources needed to achieve these objectives (or identifies

gaps).

Documents activities required to achieve the objectives within a specific time frame.

The objectives need to be clear, concise and achievable. It is also focusing on the key drivers in

business and be monitored and measured. Effective strategic planning will determine what

business success looks like and what needs to be done to achieve it.

Financial Planning

Financial planning is a continuous process of directing and allocating financial resources of the

business to meet strategic goals and objectives. Undertaking a regular review of the potential

future financial position of the business will provide clarity on the ability of the business to meet its

strategic direction. Budgets and forecasts are critical tools that can be used to predict the future

financial position of any business.

The difference between a budget and a forecast is that the budget sets out the financial goals of

the business in line with the strategic plan and a forecast tracks the financial outcomes in line with

budget predictions, providing a valuable tool to assess the likelihood of the achievement of the

budget.

Tips to improve financial planning

Development of realistic targets that align with both the strategic plan and historical

trading activities

A review of industry trends and other information available that will assist in preparing

credible assumptions and targets

Documented assumptions, including source of information

Budgeted timelines that align to both the strategic plans and the preparation of financial

statements

Regular comparison of budgets against actual financial results


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The scope to amend activities and targets where actual results indicate that budgeted

outcomes will not be met


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Chapter 4. Marketing your business

The market is the thing to have a product or service to sell. It is also the place who to sell it to.

You need to target or define your prospective customers so that you will know who to target with

your marketing. You must know your market – who they are, where they are and why they will buy

your product/service.

In simple terms, a market is the potential that exists for the exchange between the producers of

goods/services and the buyers or customers of goods/services. It is important to remember that

new markets are constantly being emerged with technological developments and changing

customer needs and tastes.

4.1 Customers

Make sure you identify the current and potential value of your customers and have an

understanding of what they are worth. Such considerations must be made to determine if the

market is large enough to justify the investment in pursuing it.

High

Po

ten

tial V

alu

e

Grow Promote

Manage Retain

Low

Low

High

Current Value

Figure 2. Customer Value Matrix

Current value is the customer’s value to your business today. Their value is somewhere between

low and high, based on their profitability. Some customers are extremely low value because, for

instance, they transact with you in a costly way.

Manage

If a customer’s current and potential value are both low, then you should aim to ‘manage’ them

hard, driving greater efficiencies and seeking to reduce the cost of serving them. You may even

decide to put in place strategies to get rid of these customers, as some may be detracting value

from your business. You certainly don’t want to acquire more customers like these.

Retain


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If a customer’s current value is high and their potential value is low, then you are extracting the

most value possible out of these customers and there is no more potential value to extract. You

should aim to ‘retain’ these customers, as they are profitable today. However, in trying to increase

their value, beware of over-investing; there is not much more to gain from them.

Grow

If a customer’s current value is low and their potential value is high, then they represent a fantastic

growth opportunity. This is where you should prioritise and direct your investments. Change the way

you serve them in order to create a more profitable relationship, because there is much to gain.

Put in place loyalty strategies to ensure you don’t lose these customers, and be aware that your

competition will try to steal them from you.

Promote

Finally, if a customer’s current and potential value are both high, they represent a goldmine

customer. These are the ones to ‘promote’ in your business. The way you are serving them is

obviously working; seek to improve your service as much as possible here because they offer a

substantial opportunity to grow profits if you can serve them better. Needless to say, you also want

to ensure that you are proactively retaining these customers because these are the ones that your

competitors have their eyes on.

Enhancing Value

You can influence the potential value of a customer over time to make them more profitable to

your business. The marketing, sales, service and loyalty strategies you apply to your customers

over the life of the relationship you have with them will impact their behaviours – how they deal

with you, talk about you, feel about you and ultimately how they interact with you. If you possibly

impact their behaviours, then you can increase the potential future value of the customer. Further,

good customer experiences and service will provide incentives for them to refer you to their family

and friends.

4.2 Value Proposition

You need to define your value proposition. Without a positive value proposition to all stakeholders

in your business, you will find that your entire business is operating inefficiently – you will either

need to vastly over spend on marketing to meet your uptake targets, or you will never reach your

targets. Defining your value proposition is a simple two-step process: identify where you create

value and allocate that value to each stakeholder.

Step 1: Identify where you create value

The first step in defining your value proposition is to understand where your business will create

value. The best way to identify where your business creates value is to analyse the value chain

relevant to your industry. The easiest way to define the value created by your business is to

understand either the inefficiencies you are addressing or the new sources of value you are

creating.

The value created by your business needs to meet the following criteria:

1. Measurable: one potential value created could be increased quality of service. That

statement alone, however, does not properly describe the value created. The increased

quality of service comes from a reduction in the time to serve. Both of these value

statements can be measured.


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2. Relevant: too often, business plans will list up to ten value statements with no indications

of where the real value created lies. More than half of these statements are irrelevant.

Focus on the key value drivers.

3. Linked to a stakeholder: sometimes, value to the business is confused with value to the

stakeholders. Unless your stakeholders are also shareholders of your business, you cannot

state that your image and brand in the market are benefits to your customers.

Step 2: Allocate value to each stakeholder

The second step in defining your value proposition is to allocate the value created to each

stakeholder. This step is self-evident, but the following simple rules will help you understand the

value as perceived by your stakeholders.

1. Identify all stakeholders. Your customers are often not the only stakeholders in your

business. It is essential that you create a positive value proposition for your customers,

your suppliers and your value-added service providers.

2. Ensure you account for the negative value proposition.

Case Study – Value Proposition

Zorch

Supply chain management is at the core of rapid-growth companies like Zorch, ranked one of the

fastest-growing private companies in US. Zorch provides strategic brand management and

promotional brand management for major international companies in the US$20 billion

promotional products industry. The business model relies upon security and quality of supply.

Zorch operates an online portal where corporations can buy merchandise branded with their

names and logos from manufacturers vetted by Zorch. Their value proposition is to simplify

procurement while ensuring quality, customer service and assured delivery.

“Managing supply chain risk is therefore critical to the success of our business,” says Jackie Barry,

CFO and COO at Zorch. “Consumer safety is a core element of our growth strategy,” Barry says. “A

lot of it focuses on China when it comes to supply chain risk for us, as that’s where most

companies are sourcing their blank products for this market today. We are very tightly integrated

with our core domestic suppliers, who are big players in Asia. Zorch, and our domestic suppliers,

have a very tight set of quality controls, audit and certification processes that we’re continually

revamping, improving and tightening.”

Zorch expects rapid growth to continue at an increasing rate and will focus on building

infrastructure, continuous recruiting and expanding its client base from the Fortune 500

companies to mid-market and smaller US-based clients.

In addition, Barry says: “We will extend our product offerings both domestically and internationally

to include basically anything that someone might be inclined to put their corporate mark on.”

(Dzinkowski, 2011)

4.3. Becoming a customer-centred organisation – Seeing through your customers’ eyes

Voice of Customer (VOC)

VOC Use #1: Strategic Business Decisions


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An understanding of your customers (and the market they create) should be integral part of

decisions about your organisation’s market positioning and strategic goals. Five types of customer-

related information are useful for this purpose:

• How well your current services/products meet (or don’t meet) customers’ needs

• What customer needs exist that you are not currently meeting market opportunities

• What offerings that customers feel are unnecessary (product/service line analysis)

• How your offerings compare to the competition

• What world-class levels of performance are (benchmarking)

Review of VOC Collection

Reactive methods mean that information comes to you through a customer’s initiative. It

encompasses customer calls (complaints, compliments, queries, technical support, sales), web

page hits, emails or cards that customers send to you, point of sale survey cards they fill out,

contract negotiations, referrals, and so on. Having well-developed methods for gathering, tracking,

and using this information is absolutely vital in retaining current customers because it tells what

they think about your current offerings. Because customers are more likely to contact you when

they have problems or questions, reactive methods are better at detecting product/service

weaknesses than strengths. They may also be biased in terms of representing some customer

segments more than others.

Proactive methods mean that you take the initiative to contact customers. They include

surveys/questionnaires, focus groups, interviews, site visits or tours, point-of-sale contact, and so

on. Because you control the timing and content of the contract, proactive methods can be used for

a wider range of purposes than reactive methods, including product/service design, process

improvement, performance monitoring, market analysis, and so on. In recent years, it has also

become increasingly popular to include representatives from one or two customers on problem-

solving/process improvement teams.

Remember that data “costs”. So if you’re going to be investing time and dollars in gathering VOC

data, make sure you use that investment wisely by getting timely, accurate, reliable customer

information that is easy for employees to use and easy for them to access(GeorgeMichael, 2003).

VOC Use #2: Product/service evaluation and design

The strategic use of VOC information relies on broad market-level pattern; here, the focus is much

narrower, on customers’ reactions to specific product or service designs, features, functionalities,

etc. The two situations where you typically need this information are:

Evaluating how well current services/products match Critical-to-Quality (CTQ) needs;

Gathering VOC data to generate design requirements for new or redesigned

services/products

Both of these uses revolve around understanding what is important to your customer and what

isn’t.

A. Do your priorities match your customers’?

Customers don’t purchase a service or product based on overall market trends. They react to

individual features or functions. That’s why you should always check whether the

features/functions of your service or product match what your customers need. Many businesses


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overlook the importance of this, and do poorly on the customer’s top attributes but do put efforts

which are not that important to the customer. In short, theses businesses mistakenly focus on

attributes that are lower in importance to the customer and this of cause lead poor financial

performance.

B. Using VOC in design decisions

The standard Six Sigma methodology used for service/product design purposes that aim to meet

VOC, and it is called Quality Function Deployment (QFD), a technique for converting customers’

needs into specific product/service design features. The involving steps for this are:

Determine VOC (understand what is critical to customers)

Use QFD to transform customer needs into functional requirements then into design

requirements.

Step 1: Determine the Voice of the Customer

The objectives here are to understand what your customers want and need from your

service/product (their Critical-to-Quality requirements), organise that information, analyse the

patterns it contains, then develop priorities and strategies. The output is a complete and organised

list of customer requirements; the highest priority requirements are the input for design. The

process is:

a. Identify the customers (external, regulatory, internal) of the given product/service: whose

needs must it meet. If required, you will need to segment for different voices and look for

differences between segments. Typical segmentation factors include economic information

(frequency of purchase, revenues generated etc.), descriptive factors (geographic, demographic,

product/service features, industry), and product/service preferences (price, value, features). What

you want to do is focus on segments that align with your company’s business strategy.

b. Perform the customer research. Use market research, focus groups, interviews, surveys,

etc., as appropriate. Besides proactive customer information, look into market research reports,

completed evaluation, industry reports, competitor assessments, webpage hits. Capture your

decisions in a Customer Research Plan.

c. Analyse the information. The goal is to translate VOC input into customer requirements. The

tools used most often here are affinity diagram to identify themes and tree diagrams (to organise

the themes in increasing levels of detail).

Step 2: Use QFD to translate the VOC into design/performance requirements

Quality Function Deployment (QFD) is a very customer-focused method for product and service

design. It emphasises “outside in” quality i.e. brining the VOC into your company, rather than

relying on internal experts to take their best guesses. QFD is a more efficient, effective planning

method, reducing the cost and time of development.


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Figure 3. A Quality Function Deployment Map. Source: Lean Six Sigma for Services

QFD encompasses a series of analyses linked to the construction of a “House of Quality” that

succinctly captures an enormous amount of information: what customers said they wanted, what

importance was attached to those needs, how the needs translated into functional requirements,

and how the proposed product/service compares to the competition.

VOC Use #3: Process improvement and problem solving

The DMAIC (Define – Measure – Analyse – Improve - Control) methodology associated with Six

Sigma is very good at reinforcing VOC awareness. In the Define stage, for example, instructions for

creating a team charter include capturing any available VOC information relevant to the project and

defining targets based on customer needs.

In addition, it is increasingly popular for teams to include customer representatives on their teams.

VOC Use #4: Shaping job descriptions & skill sets around customer needs

Organisations that are truly learning to see through their customer’s eyes usually take steps to

build customer awareness (internal or external, as appropriate) among all employees, not just

managers making strategic decisions.

Value Stream Map with highest potential for increasing shareholder value

Value streams are usually defined within a business unit by product or service type, and include

supplier’s processes and internal processes, and extend to customers and often their processes.

The metric to look at first is Economic Profit segmented out by value stream. When you arrange the

results in descending order of value creation vs. value destruction, you end up with a waterfall

diagrams like those shown in below:


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Figure 4. “Waterfall” of Value Stream Assessment

Figure 5. Strategic Position “Bubble” Diagram

Analysis

Sell (or shut down) value stream E: this loses out on both side of the analysis. The value

stream E generates the largest negative Economic Profit (EP); it also at a significant


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competitive disadvantage and has relatively small revenue in an industry that has

aggregate negative EP. Companies have to consider whether effort applied to a Value

Stream like E would be better applied to a different set of customers, products, or

geographies. If that is the case, then they should make a graceful exit from that business

and focus improvement efforts on businesses that can earn a positive economic profit.

Undertake a major initiative to improve the position of value stream D: though it showed

negative EP, it positioned at an advantaged area. Though value stream D was competing in

an unprofitable industry overall, customers preferred D to the market competition. This

means that D was a value stream well worth studying to determine if non-value-add costs

comprised a significant portion of total costs. If yes, an investment in cutting waste and

costs could move them into strong Economic Profit position and capitalise on their already

strong competitive position.

Invest in making value stream C more competitive: C was in the opposite position to D,

neither creating nor destroying value, but lagging in a market sector that was profitable.

The company didn’t need to worry as much about removing wastes and costs as in making

sure that brand line C was more responsive to the Voice of the Customer (VOC). Such VOC

input could help them determine whether enhancements to current offerings or additional

new offerings would give them competitive advantage.

Monitor Value Stream A and B for any weakening of their competitive position or market

sector. The VOC and competitive analysis demonstrated to the company just how important

these brand likes were to their financial and market strength. Another way to look at it is

that any current improvement opportunities in value streams A and B are not as critical to

the company overall as those represented by the other brand lines. However, market

conditions can change rapidly, so the company must maintain its vigilance to protect these

valuable business lines.

Applying Lean Six Sigma to value streams D and C would likely have the best chance of generating

significant improvement in ROI and value(GeorgeMichael, 2003).

4.4 Industry and Competitors

Every business has direct or indirect competitors. Competitive analysis is a critical, although often

ignored, element of business plan formulation. It should include identifying the elements of your

business model that translate into competitive advantage. In order to analyse your competitors,

you need to know who they are, understand them, and define your competitive position against

them.


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Market Share GE Healthcare

Australia Pty

Limited

5.0%

ABB Australia Pty

Limited

4.5%

Siemens Ltd

3.0%

Key External

Drivers Total health

expenditure

Demand from

mining

Demand from

manufacturing

Trade-weighted

index

Demand from

scientific

research

Industry Structure Life Cycle Stage Mature

Regulation Level Heavy

Revenue Volatility Medium

Technology Change Medium

Capital Intensity Low

Barriers to Entry Medium

Industry Assistance Low

Industry Globalization High

Concentration Level Low

Competition Level Medium

Figure 6. Industry Information for Medical & Scientific Equipments Wholesaling; Source: IBIS World Australia

http://clients.ibisworld.com.au/car/default.aspx?entid=6411






http://clients.ibisworld.com.au/bed/default.aspx?bedid=2338





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The Porter Forces Model provides a framework in which you can analyse your competitors. From it,

you should be able to define three sets of competitors.

Current competitors: A good source of detailed information about current competitors is their

financial statements and reports. Where current competitors are publicly traded, your are likely to

find good information in stock brokers’ analysis of the market, in research firm reports, in

magazine articles (such as BRW Top 1000 enterprises), in competitors’ advertising, at trade fairs

and by doing primary research by talking to a representative of the company.

Substitute: provide products and services for the same underlying need. These are harder to

identify, but if their value proposition is more attractive, you are likely to lose a substantial share of

your market to these competitors. Traditional personal computer has been significantly lost its

market share as tablet PCs and Smart Phones are getting popular.

New Entrants: likely to come rapidly into your market. For example, if an entrepreneur uses a single

manufacturer and builds a business retailing a popular product, such as a game console, the

manufacturer may develop its own direct channel for getting that product out into the market. As

soon as the manufacturer builds its own direct channel it is likely to stop servicing the

entrepreneur and to market its own channel rather than the entrepreneur’s thereby killing the

entrepreneur’s retailing business.

Understand your competitors

It is not enough to identify your competitors, you must also understand the threat they pose to your

business. To be most effective, you need to compare your competitors with your business. To do

this, you need to look at the following:

Strategic intent: usually encompasses strategic partnership, explicit and implied strategies,

and value propositions. Competitors with an established brand and physical presence may

suddenly become formidable competitors or, based on their strategic intent, could also be

potential partners.

Competitive strengths and weaknesses: what are your competitors’ core competencies,

weaknesses and sustainable competitive advantages?

Performance and capabilities: your competitors’ sales, profits, return on equity/assets,

market share, operational efficiencies and financial capacities.

What they offer: must cover markets served, product mix, geographic or channel and the

R&D/new product pipeline. For example, an online travel retailer not only competes with

Yahoo on the internet, but also with Yahoo’s wireless plays, and offline partnerships.

Business systems: your competitors’ internal mechanisms. These include their

organisational structure, their major processes, their high level cost structures, and their

marketing and distribution systems. Often this analysis will allow you to identify short-term

opportunities.

4.5 Marketing Strategy

As you already know, there are four basic elements known as four Ps in marketing strategy setting.

These four components are often referred to as the ‘marketing mix’.

Product and Service


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Make sure your product is up to scratch before you launch your campaign. There is no point

embarking on an expensive and well-targeted campaign only for people to be disappointed that

your product or serve doesn’t match the quality or features you promised.

There are three key product issues:

Features – benefit analysis

Type and level of customer service

Product strategy

Features – benefit analysis

The first step in preparing your marketing plan is to analyse what benefits your services or product

offer and what needs of your customers they fulfil. If you are not absolutely certain of what

benefits you provide or their importance to customers, your marketing plan will lack focus.

You will need to prepare a detailed list of the various features of your products and services. For

each feature you will then need to identify the various benefits that it will produce for the customer.

The next step is to assess which needs of the market segments or whether you manufacture one

product for all market segments or whether you adjust the product to meet the needs of individual

segments.

A ‘features – benefits’ analysis is important because:

The more benefits a product provides to a customer the greater their perception of ‘value

for money’.

For your advertisements to be successful you must isolate the features that will encourage

your customer to buy your products.

Type and level of customer service

A customer’s decision to buy will often depend on the level of customer service offered. In order to

decide what are the most appropriate type and level of service, you need to consider the cost of

providing the service, what your competitors offer, and what the customer expect.

There is a large range of customer service and after-sales care that can be offered, including:

Free samples

Credit sales

Demonstrations

Information brochures

Free quotes/estimates

Trade-in options

Return of goods

Discounts for early payment

Product warranties

After-sales services

Call centre service

A good customer service strategy will have numerous benefits, including increased customer

retention and reduced marketing costs. Some keys to customer service are:

First impressions always count, so ensure staff members are always courteous and helpful.

Listen to what your customers want


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Avoid jargon by always explaining your product/service in simple plain language, to

minimise the risk of confusion.

Offer a wide range of payment options, such as credit cards and EFTPOS

Ensure complaints are handled quickly and politely by always listening carefully to the

complaint and not becoming defensive

Build loyalty by rewarding repeat customers with discount programs

Product Strategy

The following are the basic components which inter-relate to create product strategy. The needs of

your target market should be your key determinant.

Product line: a group of products that have a similar use or features.

Product breadth: the number of product lines offered. The more lines offered, the wider the

product breadth.

Product depth: the range of products within a product line. The greater the range of models,

colours and brands offered the greater the depth.

Product mix: the product lines you offer

Promotion and Advertising Plan

When planning your promotion strategy, you need to consider marketing objectives, image,

business and product name, competitive advantage, buying motives and where to promote.

Marketing objectives

Marketing objective should not focus solely on sales revenue, but also on changing behaviour and

perceptions. It will also change over time as the market, competition and the product all change.

The main objective of your promotion and advertising plan is to convert prospects in your target

market into loyal customers. It can also include:

Encouraging existing customers to buy more

Encouraging new customers to try your product or service

Raising awareness of the product and its name

Persuading people of the need for your product

Encouraging existing customers to try other products in the range

Competitive advantage

It is important that your marketing campaign focuses on the features that differentiate you from

your competition. What is the unique feature of your business that will make people buy from you

rather than the competition? Your competitive advantage could be:

Free installation and training

Extended warranty period

Cheapest prices

A unique product not offered by others

Make sure your product or service actually has the features promised ad that you have the

promised edge over your competitors. Also ensure it is sustainable over time.

Buying motives


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It is important to consider your customers’ basic buying motives and focus your promotion around

them.

Where to promote

Deciding where to promote depends on many factors, such as the nature of the product, the

quantity available and how much money is set aside for the promotion campaign.

If you only have a smaller amount of the product for sale, then mass media, such as television or a

national newspaper, may be inappropriate.

Place and Distribution Strategy

This component of the marketing mix deals with how your products and services will be offered for

sale. There are a large number of different sales or distribution channels, such as retail/wholesale,

direct selling and the Internet.

The basic issue is whether your company will conduct distribution itself, or whether you will

outsource to a third party such as a distributor. This decision to ‘make or buy’ will have a

considerable impact on your organisational structure and business systems. In turn, the choice of

distribution channel will also drive a number of your other marketing decisions.

The distribution method you choose is also an important driver of your product – how it will be

packaged and priced, your support strategy and advertising strategy.

You should decide who will sell your product before you make it or market it. Don’t be afraid to ask

potential dealers or distributors whether they would stock your product and how many they think

they could sell, to help you decide your best avenues.

Price Strategy

The price at which products and services sell is an important financial consideration. If you set too

low a price, you may fail to make an acceptable profit regardless of how many sales you achieve.

Too high a price means you may fail to generate a viable level of sales.

You must consider the interrelation of a number of factors in order to decide what price to charge.

The overall objective should be to maximise profits by implementing pricing policies that will result

in the best combination of sales volume, price and costs, while being consistent with your overall

image.

The basis for setting price is the willingness of a customer to pay the price asked, which depends

entirely on how they value your product. A common misunderstanding is that price is derived from

costs. While costs are important, the cost-price ratio is secondary to the customer value of your

product or service.

A common mistake is to underprice your product or service. Price is only one factor that affects a

customer’s decision to buy – there are numerous other factors that influence the decision, such as

quality, convenience and speedy service.

There is potential for implementing different pricing structures where target markets are

sufficiently dissimilar and either sympathetic to such as policy, as in the case of discounting for

senior citizens, or unaware of the policy, where target markets are geographically dispersed.


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Many new businesses take the prices set by their competitors. The golden rule, however, is not to

set your prices too low. You can always reduce prices, but to raise them can be more difficult.

Short-term goals

Price can be used to achieve a number of short-term goals:

Maximising unit profit – this is where target markets are selected mainly on the basis of

their willingness to pay high prices. The level of sales is sacrificed to obtain a high unit

profit on each sale.

Creating a penetration price – here, a low price builds up sales volume rapidly. The lower

price encourages the customers to try it, and hopefully if the product is good enough, a

large percentage of the initial purchasers become repeat customers.

Protecting against new competitors – the business may adopt a short-term pricing policy

which makes it difficult for a new company to gain a foothold.

Price elasticity

The relationship between price and sales volume is known as price elasticity. It describes the

impact a change in price has on the level of sales. A low price elasticity means changes in price

have little effect on sales volume. This is usually the case for specialised businesses with highly

differentiated products or well-established top-end brands. A high price elasticity means a small

change in the price will have a strong impact on the amount purchased. A price increase/decrease

will cause sales to drop/rise significantly. This is usually the case for highly competitive businesses

with little product differentiation.

Pricing by competitors

For your main products or services, you need to consider what prices are currently being charged

by your leading competitors. The price difference between competitors may vary from one product

to another. Is there a market price that the majority of the competition adopts? Also consider what

your competitors have done previously when a new business entered the market.

Pricing Policy

The pricing policy you adopt may have long-term ramifications for the success of your business.

Below are a number of policies and when they are best used to help you make your

decisions(HumphreyNicholas, 2004).

Policy Price When used

Normal pricing Charge the market price

You do not wish to risk

a price war

Your cost structure will

not allow you to charge

a lower price.

If you are planning to

charge market prices,

consider how much

they will fall over the

next year or two in the

normal course of

trade.


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Premium pricing

Charge a higher price than the

competition to generate a

higher gross profit on each

sale while accepting a lower

sales volume.

Demand for the

product outstrips

supply.

Price is not significant

factor affecting your

customers’ decision to

buy.

Other factors, such as

durability,

personalised service

and quality drive your

customers’ decision to

buy.

A premium price that

is the same as the

current market price,

but your entry into the

market may drive

prices below their

current levels.

You have limited

production capacity,

selling capacity or

storage space

available.

Breakthrough pricing

Charge a lower price than the

competition, hoping that

increased sales will outweigh

a lower gross profit on each

sale.

You are willing to risk a

‘price war’.

Unit gross margin is

high

You have lower

overheads and the

competition does not.

It is the only way you

can penetrate the

market.

The customers’

decision to purchase is

driven by price.

You have sufficient

capital resources to

overcome the possible

cash problems.


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Chapter 5. Raising Finance

5.1 Equity vs. Debt

All businesses need finance to start up operations and in order to grow. Finance can be

provided either equity or debt or both of them. Debt is provided by external sources such as bank

and equity is funded by owners and investors. Internally generated equity is the original funding

provided by the owner (shareholder for a company), and this includes profits on the sales of assets

owned by the business or profits generated by through business trading in subsequent years

(retained earnings).

Comparing debt finance and equity investment

The majority of small businesses look to raise debt finance or obtain funding support from a family

member in order to establish themselves. This is due to the difficulties of getting investors for start

up businesses. Debt finance also enables the owner to maintain control over their business rather

than having to give up some part of ownership to an investor. The following table indicates the

major difference between the equity and debt finance.

Equity Debt

Examples:

Issued capital (Company)

Trust fund (trust)

Partnership Capital (Partnership)

Owner’s capital (Sole Trader)

Retained Earnings

Reserves – Capital, profit / share

premium / revaluation

Examples:

Bank overdraft

Mortgage loan

Fully drawn advance

Commercial bills

Trade creditors / account payable

Provisions for taxation, employee

entitlements

Shareholder / beneficiary loans

Securities

Equity investors do not require any

security against funds invested.

The equity investor is providing risk

capital based on the potential to

achieve future profits and increased

business value.

Equity investors rank behind all other

unsecured creditors when the business

winds up. For this reason, they seek a

high return on funds invested (ROI).

Debt financiers generally require some

form of security against the financing.

In the event that repayment conditions

are not met, the financier can then call

up the loan then realise the security.

The level of finance available is

generally restricted by the level and

quality of security available. Examples

of common security requires includes:

First or further mortgages over property

(business or personal)

Fixed charge / debenture (business

assets)

Specific assets

Level of Risk

The equity investor bears the risk of the

success of the business and its ability

to achieve the required level of growth.

They also bear the risk of finding a

The debt financier takes the risk that

the business may be:

Unable to generate sufficient cashflow

to service the debt

Unable to repay the principal at the end


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willing buyer in order to exit the

investment.

The risk to the business is reduced with

equity funding, as it does not impose

any significant cashflow requirements

on the business.

The ultimate risk for the investor is that

they could lose their capital if the

company did not survive. Therefore,

their risk is both capital and return on

investment risk.

of the loan period.

The debt financier will generally require

a sufficient level of security to cover the

principal. However, the costs and

timing of enforcing this security poses

an additional risk.

Types of Return

An equity investor receives a return on

funds invested in two ways:

Profits generated from the business

(dividends)

Increased value of business

It can be seen by the above that the

focus for the equity investor is on long

term growth of the business. As a

result, equity funds do not generally

place cash flow pressure on the

business.

A debt financier achieves a return on

their invested funds through the

payment of interest.

Interest terms can vary significantly

based on the terms and conditions of

the finance. In order to compare the

various debt products, you should be

aware of:

The basis of calculation of the interest

Exposure to interest rate change

The timing of interest payments

Fees and charges

Debt finance often requires

repayments of interest and principal

together, thus it could greatly impact on

business cashflow and business

growth.

Repayment of Debt funds / Invested capital

The equity investor has acquired an interest in

the business. Investor can get return of the

fund by selling his or her interest in the

business. The return of the initial funds

invested will depend on the change in value of

the business and the ability to find a willing

buyer or an appropriate exiting strategy.

The debt finance agreement provides

for the terms of repayment of the funds

borrowed.

The fund borrowed will be repaid either

in instalments over the loan period or

at the end of the period.

The business will need to generate

sufficient funds from profits to meet

these commitments.

The debt financier does not share in

the risk of the business or in the

benefit of growth through increase

business value.


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Financial Structure Impact

A significant reliance on debt funding provides a higher gearing structure for a business. A higher

gearing reflects a higher risk as the business has bigger commitments to external parties than

equity providers. The use of external debt can also result in reduced profits through interest

expenditure, although debt can be more tax effective as interest payments are tax deductible for

income tax purpose.

On the other hand, the injection of additional equity capital can provide a more balanced debt-to-

equity ratio, a common measure of risk. This means the owners of business may create additional

room for debt finance as the financial structure of the business is much stronger. Also, equity

capital injection should allow the business to generate increased profits as it could save interest

expenses if otherwise raised debt capital.

With the wide range of debt products available it is not easy to compare debt versus equity for your

specific circumstances. It is important, however, you fully understand the difference between the

debt and equity and to consider the implications for you in your business. Ask yourself what would

happen under both options if something goes wrong with your expected outcome.

Deciding between debt and equity

You should carefully consider which option is more suitable for your business under the

circumstances you face. In uncertain economic circumstances, you may wish to reduce the

financial risk of taking on significant debt funding and be prepared to share in the ownership of

your business to spread your personal risk.

You may also consider a combination of debt and equity funding to meet the business

requirements. An investor may be prepared to provide both equity and debt finance. This is often

suitable where the value of the business is not sufficient to support the level of funding required,

based on the percentage of investment that you are prepared to offer.

Considerations in selecting equity investment as your finance option may include:

The ability to recognise an external investor’s interests in operating the business (voting

right in company)

Your attitude to losing a 100% of control position and loss of power to make all decisions

without consulting other owners

Identification of skills that would be advantageous to the growth of the business

The need to reduce the risk associated with the gearing level of the business through lower

interest and principal repayment commitments

Long term plans for succession and the impact on family tradition

Willingness to identify an appropriate exit strategy and its impact on you

Is your business attractive to investors?

Generally, a business would aim to maximise the use of debt finance to fund its operations – as

long as the business can service the level of debt and it has sufficient security to support the

funding. The business owner would retain the benefits of ownership in respect of growth and

profitability of their business.

5.2 Short Term vs. Long Term Debt

In selecting the right debt product for your business you need to understand the nature of

alternative debt products in the market and identify the features of each product to make an

informed decision. You also need to match the right product/features with your individual


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circumstances and requirements including tax implications. When you match the product and its

features, you need to consider:

What the funds are going to be required for and how long do you require the funds for?

Are they for short-term funding of working capital or long-term funding?

How much capital do you need?

What level of security can you offer? How will the financier view the value of the security?

How will the financier assess ‘risk’ for your business?

Short term funding

Debt product Description Repayment / Interest Fees

Overdraft

A facility that allows the

customer to operate a bank

account with a pre-agreed limit

which can be drawn down.

Overdraft accounts will usually

only be provided to a business

that has been successfully

trading for a few years. This

facility suits to finance day-to-

day cashflow requirements of

a business.

Overdraft facilities do

not have a specific

maturity date. The

product is ‘at call’ or on

demand, which means

that the bank has the

right to cancel the

facility at any time.

Interest is usually paid

on a monthly basis.

The rate of interest is

determined in

accordance with a risk

margin that the bank

will determine. The

customer will only pay

interest on the amount

of the facility drawn

down.

Generally include:

Application fee –

one off fee to

initiate the facility.

Line or facility fee –

generally charged

on the available

limit in arrears and

is payable monthly

or quarterly.

Account keeping

fees – charged

monthly for

operating the

account.

Line of credit A line of credit or equity loan

can provide access to funds by

allowing the borrower to draw

on an account balance up to

an approved limit. As long as

the balance does not exceed

the approved limit, funds can

be drawn at any time. This is

usually used to access funds

for working capital

requirements.

Repayments are

usually required to at

least cover the interest

and fees on the loan.

Interest is usually paid

on a monthly basis. As

this type of loan is

usually secured against

property, interest rates

tend to be lower than

overdrafts.

Generally include:

Application fee:

One-off fee to

initiate the facility

Line or facility fee:

generally charged

on the available

limit in arrears and

is payable monthly

or quarterly.

Account keeping

fee: charged

monthly for

operating the

account.

Credit Card Credit cards are usually offered

on either ‘interest free days’ or

no ‘interest free days’. They

are generally easier to obtain

Credit cards usually

have an expiry date,

which indicates that,

unless the facility is

Annual account

fees

Fees to use

rewards programs


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due to the high fee structure

and interest rates charged.

The ‘Interest free’ cards

generally carry higher interest

rate unless you repay full

within the interest free period.

renewed, all

outstanding amounts

will be due by this date.

Interest is generally

charged either from the

date of purchase of

items or from the date

your monthly

statement is issued.

For cash advances,

interest is usually

charged from the date

of the withdrawal.

Fees for late

payments

Payment dishonour

fees

Fees exceeding

your credit limit

Cashflow

lending

This product is generally used

for funding working capital.

This is useful for small

businesses that generate solid

cashflow, but do not own

significant fixed assets to

provide security. The loan is

secured by working capital

assets of the business such as

stocks and debtors.

This loan is similar to

that of an overdraft

facility in that it is

approved for a specific

term, with a regular

review requirement.

Interest is charged

monthly on the daily

balance outstanding.

Establishment fee:

upfront fee to

establish the line of

credit

Service/administra

tion fee: fixed or

variable monthly or

quarterly in arrears

Debtor Finance This product can provide core

working capital finance, as well

as meeting short term

cashflow needs.

This loan is also known as

factoring or working capital

finance.

The funding is secured by the

value of the amount owed by

the business’s customers

(debtors). The finance is

generally available up to 70 –

90 per cent of the book value

of debtors.

When the debtor is invoiced

the financier will pay the

agreed per cent of the invoice.

When the debtor pays the

balance of the invoice, the

remaining percentage

received.

The benefit to the business is

that they do not have to wait

until the customer pays to fund

other costs such as purchasing

additional stocks. Effectively

this shortens the working

The debtor ledger value

provides an upper limit

of funds available.

Interest is payable

monthly on the funds

drawn down, or

alternatively, the

financing company will

take a percentage of

the amount collected

from the customers of

the business.

Establishment fee:

upfront fee to

establish facility

Line fee: based on

a percentage of the

maximum facility

payable monthly

Administration /

service fee: fixed or

variable fee

charged monthly or


and based on the

balance/facility

limit.


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capital cycle for a business.

Debt finance does not always

have to be disclosed to

customers, as you still handle

all debt collection and

interaction with the customer.

However, if the outstanding

invoice is not paid up to certain

days (generally 90 days), the

funding is cancelled and the

business is required to repay

the already funded amount.

Long term debts

Debt product Description Repayment / Interest Fees

Full drawn

advance

This is for permanent or longer

term funding requirements for

property, plant and equipment

or the purchase of a business.

This finance requires principal

and interest repayments over

the term of the loan. The term

of the loan is generally

between three to ten years.

This is fixed term loan

and reduced by

monthly repayments

which include both

principal and interest

components.

The interest rate can

be either fixed, variable

or a combination of

both. There may be

penalty for early

repayment if the rate is

fixed.

Application fee:

one-off fee to

initiate the loan

Monthly account

fee: fixed amount

per month

Mortgage

equity loan

A long-term loan where

residential property is used as

the primary source of security

and the funds used in the

business. In general, lenders

will lend up to 80 per cent of

the value of the secured

residential property.

The term of the loan is

fixed, and repayments

will involve both

principal and interest.

Interest can be based

on fixed or variable

rates or a combination.

May include:

Establishment fee:

one-off fee to

establish the loan

Administration

service fee: either

fixed or variable

based on the

balance/facility

limit charged on

monthly or


Document fees:

fees to cover

mortgage

registration,

property valuation,

legal fees and

stamp duty

Interest only

loan

This facility is generally used

for medium term funding

requirements and often

suitable for cashflow needs of

The loans are generally

for a period of 1 to 3

years maturity terms.

The loan may be rolled

Establishment fee:

one-off upfront fee

to establish the

loan


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a start up business.

This loan involves the lending

of a fixed amount for a specific

period, where only interest

payments are required to be

met during the term of the

loan. The principal is due to

maturity of the loan.

over into a principal

and interest type

product at the end of

the term.

Interest is generally

paid on a monthly

basis on the full

amount of the loan.

Administration/

service fee:

charged monthly or


and is either fixed

or variable and

based on the

balance/facility

limit

Chattel

Mortgage

Chattel mortgages are used for

financing assets such as motor

vehicle or plant and equipment

of a business. This is a loan

agreement in which you borrow

funds to purchase equipments,

and the borrower provides

security for the loan by way of

a mortgage over the

equipment financed. Under

this finance, the

equipment/asset will be

owned by the borrower and

they would expect to be able to

claim the full amount of the

GST as a capital acquisition on

purchase of the capital item.

This finance is

generally over a three

to five years of period.

The repayments are

usually on a monthly

basis and include

components of interest

and principal over the

term. At the end of the

period, there is usually

a capital residual to be

paid.

Chattel mortgages

usually require

stamp duty on the

finance

arrangement.

Lease and Hire

Purchase

Leases and hire purchase

finance are generally used to

purchase a specific asset.

The financier uses the funded

asset as the main source of

security.

Leases differ from loans in that

the leased item is still owned

by the financier.

Finance lease: at the end of

the lease period, the business

has the opportunity to

purchase the asset from the

financier as its residual value.

Operating lease: the ownership

of the asset remains to the

financier at the end of lease.

Hire purchase finance is

similar to a finance lease

except that ownership passes

to the hirer at the outset of the

transaction.

Leases and hire

purchase finance are

generally for a period

of three to five years.

The payments are

usually monthly basis

and include interest

and principal over the

term of the product.

At the end of the

finance lease and hire

purchase contract,

there is usually a

capital residual to be

paid (so called balloon

purchase). GST is

charged on repayment

or hire purchases and

leases.

Leases and hire

purchase contracts

require stamp duty

on the

arrangement.

There can be a

documentation fee

for preparation of

leasing / hire

purchase

arrangements.


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Each of the above products

also has different tax and GST

implications.

It is important to ensure that the type of financing undertaken matches the purpose for seeking

finance. It is suggested that the terms of the loan matches with the length of the life of the asset

you are funding(HumphreyNicholas, 2004).

It can often be difficult for small business owners to evaluate debt product options. Financiers can

have different names for similar products, structure of the terms and fees.

Refinancing your debt

Business owners are encouraged to review their existing debt finance arrangements on a regular

basis. This ensures that the finance facility and structure fits the current needs of the business. If

you found that there is a strong need to restructure the current financing, you should carefully

consider refinancing the existing loans.

Refinancing may involve changing lending institutions while retaining the same debt products,

funding the business from different debt product and combining debt into a single facility or

product. This is also for increasing or decreasing the total amount of the borrowing, changing the

repayment amount or timing, and increasing or decreasing the security offered to the lender.

Refinancing involves undertaking a new debt facility where the new debt funds are used to pay off

your old debt facilities. If the refinancing involves an increase in debt then additional funds would

be available to draw on. The main reasons for refinancing are:

Gaining a better interest rate from a different lender or from a different mix of debt

products

Changing interest structure (from variable to fixed or vise versa)

Gaining more flexible features in a facility to meet your business needs

Increasing your overall borrowing with a new debt facility

Changing the financial cashflow commitment required to fund debt

Consolidating debts to minimise and simplify the repayments

Releasing security over personal assets/specific assets as the business reaches a level of

independent security to offer

It is important to review of your circumstances prior to undertaking any commitments for

refinancing as there are number of hidden pitfalls which may impact on the commercial costs.

There are common dangers existing in refinancing.

Underestimating the cost of paying out your existing debt facility: your existing facility may

have an ‘early repayment penalty clause’ which could outweigh any future interest savings.

Underestimating the ingoing costs of the new finance facility: changing to a new lender will

require additional costs such as application, documentation, valuation, mortgage fees,

stamp duty on a new mortgage and settlement fees.

Change in valuation of your security: Before you commit to a new lender or products, you

need to ensure that you have a firm letter of offer in place and NOT one that is ‘subject to’

satisfactory valuation or a third party validation (such as a mortgage insurer). It is important

that you do not find yourself having ‘burnt’ existing lending relationships prior to ensuring

that the new relationship is in place.


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Benefits of refinancing

New perspective based on your current position and not the past: you may find that a ‘fresh start’

with a new financier may not carry any of the long term pre-conceptions which your previous

banker may be influenced by. These may have included a poor trading period earlier years or a

particular experience they have had with another customer in your industry which has influenced

their lending decision-making against your interests.

1. Access to increase in debt finance: refinancing may also result in increasing the finance

available for business growth. You should ensure that, in taking on additional debt, you can

still service the higher debt commitment and that the investment of the new capital

available is targeted at achieving a higher return for the business.

2. Consolidation of debt funding/cash flow savings: there is often an opportunity to combine a

number of debt finance arrangements into a single product to simplify repayments and to

potentially reduce your monthly cashflow repayment commitment.

3. Restructuring security offering: Refinancing may also provide the opportunity for a change

in the security being offered to the new financier. You may find that over the time the value

of security offered to the existing financier has increased at a far greater rate than the level

of borrowing. When you negotiate your refinancing, review what is a reasonable offer of

security assets.

Refinancing a strong healthy business may also find the opportunity to replace the existing

personal property as a security to business assets to cover borrowing.

5.4 Loan Application

The successful loan application comes not only from the presentation of information but also in the

provision of all of the required information. By providing the relevant information in your application,

the financier will have something tangible to review and pass onto the credit manager and other

key decision makers. In most cases, the loan officer (or business banking manager) processes the

application and makes recommendations to the credit manager and/or loan committee.

Information for the application

Typically, banks look for three different categories for business loan applications. These are

personal, historical and forecasts.

Personal

Although financiers are lending to the business, they would make sure that the funds lent will be

repaid. One of the most important indicators for them will be your own personal spending habits

showing how you manage your own finances. This is particularly important when you apply a loan

for business start up, where a history of the business has not yet been established.

Therefore, maintaining a good credit rating is important along with repayment of credit cards and

personal loans. Remember, most financiers undertake your personal credit check before they lend

funds to your business.

The usual personal information the financier will be looking for can include (but not limited) the

following:


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Personal assets: include purchase price and date, independent valuation if available,

ownership documents.

Tax returns: you may be required to supply supporting documentation to the tax schedules

such as proof of investment income

Personal bank details: include all statements issued from the bank or other financial

institution

Credit history

Historical

Where the business has been in operation, the financier will request the financial information of

the business for review. Where available, they will ask you at least three years’ business records to

give an indication of the business operations. Ideally the financial information (balance sheet,

profit and loss statement and cashflow statement) will be prepared and reviewed by an accountant.

In addition to the financial statements, the financier will most likely also want to check the

historical operating data of the business. This will provide an overview of how the business is

managed and can provide insight into the ‘character’ of the business owner(s). Such information

will include (but not limited to):

BAS statements for the last four returns

Debtors and creditors lists

Bank statements for the past three years

Any loan agreements

Forecasts

A financier will pay particular attention to the forecasts. Thus, it is important for you how to prepare

your business forecasts in line with the financier’s expectations. By preparing both a cashflow

forecast and profit and loss forecast, you will have sufficient information to prepare a balance

sheet forecast.

Cashflow Forecast

It will provide the necessary detail to your financier on the cash available to pay back the loan.

Therefore, this is the most important part of information to the financier. For how to prepare

cashflow forecast, please refer chapter 10.5.

Profit and loss forecast

This indicates whether the business is profitable for the specified period. This will show whether

the anticipated future events for your business will not generate enough profit, then eventually you

will run out of cash and your business venture will have failed. Along with your cashflow forecast,

you need to ensure that you keep consistency.

Balance sheet forecast

A balance sheet forecast will indicate how the future plans will impact the financial health of the

business. The balance sheet forecast will be a result of the preparation of the cashflow forecast

and profit and loss forecast. Be careful that the financier will look at the consistency here as well.


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The funding application

The last step in preparing information for your financier is to provide all the relevant information on

the loan required. You will have identified the amount of loan when preparing your cashflow

forecasts and now you need to provide a detailed description of the loan required. If not provided

by your financier, you will need to prepare your own loan application form with information below:

1. The purpose of the loan

A detailed description of why the loan is required should be included in the application. Most

financiers will not be willing to provide a loan to assist in funding operating losses or the purchase

of luxury assets for business owner.

Funding capital expenditure such as plant, equipment, vehicles, property and improvements

Increased working capital resulting from growth or to support increased stock holding

Replacement of existing equity with debt

Succession planning to provide an exit strategy for family members

Acquisition of another business or part of business

Research and development or commercialisation stage

Expand distribution or develop new markets

It is imperative to link the purpose of the loan to the overall business benefits that will be achieved

as a result of the additional funding. It is also important to state when the fund will be needed.

Thus make sure you submit your application with sufficient time for the assessment to take place.

2. The amount of the loan

The amount of funds required will be determined from your planning. It is good financial practice to

revisit your business plan when key elements of your business change.

In order to determine the total amount of funds required you will need to prepare a cashflow

forecast that is including the loan amount as if the loan has been successful.

3. Term of the loan

Through your planning, it will become obvious how long you will need the funds for. With cashflow

forecast this shows cash inflows and outflows, this should indicate when the business will be in a

position to repay the loan depending on the type of the loan (short term debt). Some types of debt

finance have a maximum term available, so again the cashflow forecast will assist in determining

what type of finance products you are able to consider.

4. Servicing the loan

The most important element of the funding application is to show the financier that the business

has enough cashflow to make the regular loan repayments over the life of the loan including the

costs of the loan. You must be in a position to make a strong case to the financier on how the

forecast cashflow will adequately support the repayment obligations of the loan within the

allocated time frame. Reviewing the financial ratios on your forecasted profit and loss statement

and forecasted balance sheet will help to get the information of future financial health.

5. Security of the loan

As part of your preparation for the application, make sure that you identify what security you are

prepared to offer the financier. For a successful loan application, it is important that the security

offered matches both the type of loan being made and the financier’s perception of the risk


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associated with the loan application. Thus, it is recommendable that you identify and provide

details to the financier of the security available as part of your loan application. By doing so, you

will be able to present your preferred security prior to the financier nominating his or her preferred

security.

The presentation

It is highly recommended that you present the prepared application in person. In doing so, you will

be able to present yourself, your business and your financial needs in a manner that will convey a

message of confidence and capability to the financier. This may well be the first step in developing

an ongoing relationship which will foster the growth of your business in the future.

The loan application package

One of the most important aspects of your loan application is to demonstrate to the financier that

you can organise your thoughts and ideas in writing and can support them with financial

information. Ensure YOU understand all the financial information before meeting with the financier

that has been prepared for the application though you got your accountant’s help for the

preparation.

Meeting with the financier

It is important to understand that the meeting with the financier will be as important as the

package that is presented. The financier will be looking at your confidence, management style and

capacity to understand any financial or other risks associated with your business. Your successful

presentation will confirm to the financier that you understand all the aspects of your business and

the requirements of the potential relationship between you and your financier.

In addition to the loan application package, be prepared to discuss certain aspects of your

business, competitors and industry. Be prepared for the financier to look at relevant financial ratios.

Make sure that these ratios on your forecasts are within the acceptable levels and that you

understand what the ratios mean.

The role of advisor

Accountants and business advisors can assist in preparing a loan application. They will be well

versed in translating your future ideas into financial forecasts. They will also be able to assist you

in your meeting preparation, as they will be able to emphasise the potential areas the financier will

focus on. However, it is important to remember that the financier will be looking at your ability to

manage the future growth of your business, so you must ensure that you fully understand all the

information that you present to your financier(HumphreyNicholas, 2004).


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Part II: Managing Your Business

In this part, we will briefly look at

Australian Tax System and review

the benefits of using computer

based business system. Import

and Export will be discussed for

the issues of marketing, funding,

trading terms and government

regulations and grants.

Risk management and financial

control is vital for business

management. We review the

areas of business risks and

financial control to avoid or

minimise the business hazards.

In Chapter 10, we will discuss

business financial management

and reporting to comply with the

law and practical approaches of

how to manage each account.

And we will discuss working

capital management in this

chapter.


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Chapter 6. Understanding Tax System

This chapter is a general introduction to tax, which is a complex and dynamic area of law.

You should obtain independent advice from an appropriately qualified tax adviser. To simplify the

explanation, we use a company as a tax payer for this chapter.

Tax structure

Whether you are buying an established business or franchise, or setting up a new business from

scratch, the tax and structuring issues for the purchasing entity need to be planned early and with

appropriate tax advice. Although this issue does not impact on your business in early stage, it may

have a very large impact down the track if the business is successful. Also, there will often be

significant taxes incurred in the process of changing structures later. For example, capital gains tax,

GST and stamp duty may be imposed.

Sole trader

An individual operating a business taxed at their marginal tax rate. An income in excess of

$180,000 will incur the top marginal tax rate of 45 per cent plus Medicare levy of 1.5 per cent.

Operating losses can be offset against other income earned by an individual, but if you also derive

income from different business activities, you need to check the loss quarantining rules that apply

to losses from non-commercial business activities.

Partnership

A partnership has to lodge a separate tax return, but each of the partners is still subject to tax, i.e.

each individual partner will result in being subject to tax at their marginal tax rate.

Trust

Discretionary trusts or fixed trusts will not normally be taxed. The income is to be distributed to the

beneficiaries (or unit holders) and subject to tax in their hands. The losses remain in the trust’s

hand and cannot be used by trust beneficiaries to reduce their income tax payable.

Company

A company is taxed at a flat rate of 30 per cent. When the net profit is distributed to the

shareholders after tax, then further tax can be payable by the shareholders (franked dividend). A

franked dividend paid to an individual will be taxed at that person’s marginal tax rate, with a

refundable franking credit given for the tax already paid by the company.

6.1 Income Tax

Income

A company will be required to pay income tax at the rate of 30 per cent on its profit. In simple term,

the income tax is calculated as following:

Company tax payable = Taxable income × 30 per cent of tax rate

Taxable income = Assessable income – Allowable deductions

Under the tax legislation, the definition of what is ‘assessable income’ is broad and includes a

range of different types of income your company could make, such as:


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Any fee income on any services you provided to your clients

Sales of stock

Dividends received from your shares

Rent received on any premises you rent out to other people

Interest you receive from financial institutions

Royalties received for licensing intellectual property or brands, or from franchisees

The gain you make when you dispose of any equipment

Figure 7. Assessable Income 1

1 Source: Foundation Tax – Introduction to the Australian Tax System, The Tax Institute 2009

Assessable Income

Ordinary

Income

Statutory

Income

Income from

Personal

Services

Income from

Property

Income from

Business

Activities

Derived from

personal

Exertion and

include:

Salaries &

Wages

Allowances

Commissions

Bonuses

Director fees

Key issues

include:

Treatment of

compensation

and insurance

receipts

Alienation of

personal

services income

Treatment of

reimbursement

s

Income from

disposal of

assets

Derived from

use and

enjoyment of

property and

include:

Rental & lease

income

Royalties

Interest

Annuities

Key issues

include income

derived from

use versus

disposal of

assets

Derived from

carrying on

business and

can include

gains from

isolated

transaction.

Key issues

include:

Identification of

an active

business

Nexus between

business and

income

Has business

commenced or

terminated

Treatment of

compensation

and insurance

receipts

Income which is

made

assessable by

specific

provisions of the

tax law.

Examples

include:

Capital gains

Recoupment of

tax depreciation

claims

Foreign currency

gains

Dividends


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Deductions

Your taxable income can be reduced by claiming allowable deductions. Allowable deductions are

certain types of expenses which you have paid during the year and which the ATO recognises as

being related to your business. In order to be deductable the expenses must:

Not be a personal in nature or capital expenses, and

Should be spent in order to earn income or have a close relationship with the earning of

income.

Sometimes an expense will be both personal and work related. In this case, you should

estimate the proportion of use for work purposes and only claim that portion as a

deduction.

Allowable business deductions are summarised below:

1. Business related expenses including,

Motor vehicle expenses

Bank charges

Business equipment

Home office expenses

Interest and borrowing expenses

Legal expenses

Accounting expenses

Membership and subscriptions

Business insurance

Salaries and wages

Internet

Work related travel expenses

Superannuation contributions for employees

Depreciation on plant and equipments

Black hole expenses (e.g. business setup but limited 1/5 each year)

2. Trading Stocks (Inventory)

The general taxation rules relating to trading stock can be summarised as follows:

Sales of trading stock give rise to assessable income

Purchases of trading stock are deductible. Note however, that a deduction is not available

for the purchase of trading stock until the year in which the trading stock first becomes on

hand or is sold to another

Where closing stock on hand is greater than opening stock, the difference is assessable

income.

Where opening stock is greater than closing stock on hand, the difference is a deduction.

The value of opening stock must be equal the value of last year’s closing stock.

Closing stock on hand can be valued using cost price, market selling price or replacement

cost. You can vary the valuation method year by year.

3. Business Losses

There are two different types of loss in taxation, revenue loss and capital loss. A revenue loss will

arise when your total deductions are greater than your income in a tax year. You are entitled to


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deduct revenue losses incurred in one year (the accumulated losses carried over) against

assessable income earned in later years. Revenue losses can be carried forward indefinitely.

A capital loss may occur when you sell an asset for less than its ‘cost base’. The cost base includes

the original purchase price plus any acquisition costs such as stamp duties and legal fees. Capital

losses may be offset against your capital gains, so are taken into account when you calculate your

net capital gain for the year. If you have a net capital loss, you cannot offset the loss against your

other income. Instead, the capital loss is carried forward indefinitely until it can be offset against a

capital gain. Please see capital gains section for more information.

Before a company can recoup tax losses sustained in prior years, it must satisfy a ‘continuous

ownership test’ that requires that more than 50 per cent of the company’s shares be owned by the

same persons in the period from the start of the loss year to the end of the year in which loss

recoupment is sought. Where there is insufficient continuity of ownership, the ‘same business test’

is applied. This provides that a company must be engaged in the same business in the year of

recoupment as that which was carried on immediately before the change in ownership if prior-year

losses are to be recouped.

4. Capital Expenditure and Depreciation

When you buy plant and equipment which has a useful or effective life of more than one year, you

cannot claim a deduction for the amount you spent to buy that plant and equipment, or the costs

associated with buying them. These are called balance sheet items which is subject to capitalise

and to be depreciated for the years of the effective lives. The following items are classified as

‘capital expenditure’.

Buying a computer, fax machine, desks or motor vehicle and the costs delivering and

installing those items.

Buying an investment unit or the conveyancing fees paid when you buy the unit.

Depreciation, also referred to as capital allowance, permits you to claim a portion of the cost of the

asset as a deduction over a number of years. For example, a laptop computer will have 3 years of

useful life before it becomes to obsolete or technologically out-of-date that you have to replace it. If

the laptop computer costs $600, you could claim a depreciation deduction of $200 each year for

the three years. The effective lives of capital items are published by ATO with which you can rely on

for the calculation of depreciation.

A low- value pool is available for all depreciating assets costing less than $1000. The low-value

pool is depreciated over four years using the diminishing value method.

There are special rules for small business taxpayers that meet certain requirements. For example,

there is an immediate write-off for depreciable assets costing less than $1000 that are fully used

for a taxable purpose.

A cost limit applies for depreciation purposes in respect of motor vehicles. That part of the

purchase price in excess of the cost limit is not deductible. Such vehicles are referred as luxury

vehicles. The cost limit for luxury vehicles 2011/2012 is $57,466.

Personal Services Income (PSI)

A business is generally entitled for income tax deduction (and GST credits) for the expenditures

incurred during the business in order for earning income. There must be nexus between income

earning and the expenditure to be deductible in tax purpose, and for certain expenditure, the

Commissioner of Taxation does not allow as deductions (e.g. entertainment, fines and meals etc).


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This is the general rule. So under this rule, you are entitled to claim tax deductions as well as GST

credits for what you incur for earning the business income under your business structure.

However, there is a special tax regime called personal services income (PSI) to prevent individuals

from reducing their tax by alienating their PSI to an associated company, partnership, trust or

individual (sole trader), or by claiming inappropriate “business” deductions.

Where it applies, the PSI regime has the following main effects:

PSI is included in the assessable income of the individual whose personal efforts or skills

generated the income, notwithstanding that it may have been alienated to another

interposed entity such as your company.

There are restrictions on the deductions that may be claimed by the individual or

interposed entity, so that they broadly correspond to the deductions available to employees,

e.g. expenses relating to the individual’s private residence, certain travel expenses and

payments made to spouses or other associates.

Interposed entities may have additional PAYG withholding obligations.

The PSI regime does not apply if:

The income is not PSI (income which is mainly a reward for an individual’s personal efforts

or skills is the individual’s personal services income (PSI), regardless of whether it is

income of another entity (e.g. a company, trust, partnership)

The income is derived as an employee or office holder, or

The income is derived as part of a personal services business. There is a series of tests for

determining whether such business exists.

Although the PSI regime is intended to level the playing field between an employee and a

contractor who has PSI, it does not deem contractors to be employees and does not alter the legal

relationship between the parties (ITAA97 s.84-10)

So the matter is:

“Whether your income is derived from personal services “BUSINESS” i.e. PSB”

To qualify for the PSB regime, you need to pass tests below.

1. Result Test

For an individual to satisfy the result test in a particular income year, the individual must satisfy the

following three conditions in relation to at least 75% of his or her PSI during the year.

The income is for producing a result.

The individual is required to supply the plant and equipment or tools of trade (if any)

needed to perform the work.

The individual is, or would be, liable for the cost of rectifying any defect in the work

performed. Where physical rectification is not possible, this condition will be satisfied if the

individual is liable for damages in relation to the defect.

2. The 80% Rule and Additional Tests

If the result test above is not satisfied, it is necessary to consider the 80% rule.


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If 80% or more of an individual’s personal services income (PSI) in the income is from one entity,

the income will be subject to the PSI regime unless the individual obtains a personal services

business determination from the Commissioner.

If 80% or more of the PSI is not from one entity, the income will be exempt from the PSI regime if

the individual satisfies any of the following tests:

1. The unrelated clients test

An individual or personal services entity meets the unrelated clients test in an income year if the

service provider gains income from providing services to two or more entities that are not

associates or the service provider

2. The employment test

An individual service provider meets the employment test in an income year if at least 20% of the

individual’s principal work for the year is performed by an entity or entities engaged by the

individual. The entities cannot be non-individuals that are associates of the individual.

The entity (PSE) meets the employment test where the 20% criterion above is met and the entity or

entities engaged are neither:

Individuals whose PSI is included in the PSE’s income, nor

Non-individuals that are associates of the PSE

3. The business premise test

An individual or a PSE (Service Providing Entity) meets the business premise test in an income year

if, at all relevant times during the year, the service provider maintains and uses business premises:

At which they mainly conduct activities from which PSI is gained;

Of which they have exclusive use (this would typically require ownership or a lease);

That are physically separate from any premises that the service provider or service

provider’s associate use for private purposes; and,

That are physically separate from the premises of the service provider’s client or client’s

associate.


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The following diagram shows the tests required to qualify as Personal Services Business (PSB).2

Step. 1 Personal Services Income

Does the taxpayer receive income tat is mainly a

reward for personal efforts or skills? No

Yes

Step. 2 Result Test

Does the taxpayer meet all of the conditions of the

result test? Yes

No

Step. 3 The 80% rule

Yes

Does 80% or more of the individual's personal

services income in an income year come from one

client?

No

Step. 4 Other tests

Does the taxpayer satisfy one of the following tests?

Unrelated clients

or

Employment Yes

or

Business Premises

No Not sure

The personal services

income legislation

applies unless the

taxpayer obtains a

personal services

business

determination from

the Commissioner

The taxpayer may need to apply to the ATO for a

determination that the personal services income

legislation does not apply

Not

Sure

The

personal

services

income

legislation

does not

apply.

6.2 Goods and Services Tax

The Goods and Services Tax (GST) was introduced on July 1, 2000. It is fair to say that most

businesses put in some effort to ensure that their systems and procedures were able to cope with

the change to a GST and it is also fair to say that many of those businesses have not looked at

their GST compliance since that time.

2 Source: Australian Master Tax Guide 2011, page 1580.


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The increase in ATO audit activity means that you need to be more aware of how the GST affects

your activities and how your business processes capture the GST payable and receivable to ensure

that the right amount of tax is being paid.

GST is an indirect tax and is fundamentally different to other direct taxes such as income tax and

capital gains tax. GST has been described as a multi-stage, credit offset transaction tax. It has also

been described as a tax on final consumer.

At its simplest, GST is a tax paid on transactions called supplies. Supply means all forms of supply

and not just sales of goods or services. It also includes the creation, grant and surrender of rights;

entering into obligation; agreeing to do something; and agreeing not to do something.

Note that a supply of money is not a supply unless the money is consideration for a supply of

money. That is, when you pay money for a newspaper there is only one supply, being the supply of

newspaper to you. The money which you give the newsagency is not a supply. However, the interest

you pay on a loan is supply since it is consideration for a supply of money.

There must be consideration for the supply. It needs not be in money but must be capable of being

expressed in money. Consideration includes goods, services and other things given in exchange for

a supply, such as in a barter or contra.

The supply must also be made in the course or furtherance of an enterprise that the entity making

supply carries on. It is the entity which is registered for GST.

An enterprise has a wider definition that a business. Taken together, an entity making a supply for

consideration in the course or furtherance of an enterprise has the widest possible meaning and,

in simple language, means that just about anything you do in your business is caught by the GST.

Unlike direct taxes, GST is normally paid by the recipient of a supply but the responsibility to collect

and account for the tax lies with the supplier. In most cases, the recipient is not concerned whether

or not GST has been properly charged. There are requirements imposed on the supplier to disclose

the GST charged and, generally, prices should be quoted on a GST inclusive basis.

The single most distinctive feature of GST is that the tax is creditable. Registered entities which pay

GST on acquisitions are entitled, in most cases, to offset that GST against the GST they are liable to

pay on the supplies they make. The GST actually remitted to the ATO is therefore the difference

between the GST payable on supplies and the GST input tax credits on acquisitions.

There are two main categories of GST exemption: GST-free and input taxed.

GST-free supplies

Certain food

Health

Education

Childcare

Exports and other suppliers that are for consumption outside Australia

Religious services

Non-commercial activities of charitable institutions, and raffles and bingo conducted by

charitable institutions, etc.

Water, sewerage and drainage

Supplies of going concerns

International transport

Precious metals (in specified circumstances)


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Supplies from inward duty-free shops

Grants of land by governments

Farmland

International mail

Input taxes supplies

Financial supplies

Residential rent

Existing residential premises

Precious metals (in specified circumstances)

School tuckshops and canteens

Fundraising events conducted by charitable institutions etc.

Registration

All entities carrying on an enterprise (or a number of enterprises) must register for GST if their

annual turnover exceeds, or is expected to exceed, $75,000 ($150,000 for not-for-profits).

Registration involves getting an Australian Business Number (ABN). Along with an ABN, GST-

registered entity must complete a Business Activity Statement (BAS).

The BAS is used to report not only GST but also PAYG Withholding tax, PAYG instalment, FBT

instalment, Wine Equalisation tax and Luxury Car Tax.

Accounting for GST

Entities with an annual turnover below $2 million, and some other entities in limited circumstances,

can opt to account for GST on a cash basis. Other entities will account for GST on an ‘accrual basis’.

Under the cash basis, GST is attributable to the tax period in which payments are made or received.

Under the accrual basis, GST is attributable to the tax period in which an invoice is issued or, if

earlier, in which any of the consideration is received. Under the accrual accounting, the entity

needs to pay close attention to control of debtors and creditors. Careful consideration of the timing

of the issue of invoices and of major expenditure can minimise the cashflow effect of the GST.

There is on crucial issue in connection with invoices. Under the accruals system, GST is payable on

supplies in the tax period when an invoice is issued. An invoice is any document notifying an

obligation to make a payment. However, under both the cash and accruals systems, input tax

credits are only available if the entity holds a tax invoice in respect of the acquisition. A tax invoice

is an invoice that contains specific information: the words ‘tax invoice’, the name and ABN of the

supplier, the name, address or ABN of the recipient, the product or service supplied, and its GST

inclusive price.

Input Tax Credits (ITCs)

ITCs are available for the GST incurred on creditable acquisitions; that is, on taxable supplies

received by the entity. The acquisition must relate to the enterprise(s) that the entity carries on.

Creditable acquisitions might include stock for resale, capital expenditure on items such as plant

and equipment, property rent, lease charges, overheads such as utilities and stationery. Any

acquisition which is a genuine business expense, and on which you paid GST, is likely to be a

creditable acquisition.

However, there are three main categories of exception to this. ITCs are not available for GST

incurred on expenditure which:


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Is incurred on certain specified costs which would not be deductible expenses for income

tax purpose

Is of a private or domestic nature

Relates to making supplies which would be input taxed.

Where the input taxed supply is a financial supply, there is some leeway, in the form of a de

minimis limit called the Financial Acquisitions Threshold (FAT). The entity is still required to identify

the GST incurred on expenditure which relates to the financial supplies but, if that input tax is less

than the lower of $50,000 per annum or 10 per cent of total input tax for the year, full ITC can be

claimed.

There is further leeway if the financial supply is a borrowing, GST on acquisitions which relate to

borrowing is creditable if the borrowing relates to supplies that are not input taxed. For example, if

an entity borrowed money to purchase new equipment, an ITC would be available. However, if the

entity had borrowed the money to enable it to buy shares or a residential property, it would have to

consider the FAT.

Sale of Going Concern

Under normal circumstances the disposal of assets used in a business will be a taxable supply.

However, special provisions exist to provide GST-free treatment where the assets are disposed of

as a ‘going concern’. There are number of criteria to be satisfied but the principal one is that there

must be a written agreement between the parties that the supply is of a going concern. If there is

no written agreement, the supply cannot be GST-free under these provisions. In order to qualify as

a going concern, the seller must supply to the buyer all things necessary for the continued

operation of the business.

6.3 Capital Gains Tax

The capital gains tax (CGT) applies to the disposal of assets acquired (or deemed to be acquired)

after 19 September 1985. For assets acquired before 21 September 1999 and held for at least

twelve months, gains are calculated after indexing the asset’s cost base to the rate of inflation. Tax

on capital gains is levied at the taxpayer’s income tax rate. Individuals, trusts and certain

superannuation funds may qualify for a discount on the amount of gain included in assessable

income as long as the asset is held for at least 12 months. CGT assets are defined widely to

include most property and rights, and CGT applies to events such as disposal occurring in relation

to a CGT asset.

Rollover relief

The CGT legislation provides limited ‘rollover relief’ i.e. a deferral of CGT in some situations. The

rollover reliefs occur where:

An asset is transferred by an individual to a wholly owned company; or

A company is interposed into an existing business structure; or

Certain assets are replaced with similar assets.

Exemptions and concessions

In some situations where a capital gain would otherwise arise, an exception or exemption may be

available, to either reduce the capital gain or loss or allow you to disregard it. The most common

exceptions and concessions arise in relation to assets acquired before 20 September 1985, the

availability of the CGT discount and the disposal by non-residents of assets that are not ‘taxable

Australian property’. the other common exemptions are gains on disposal of:


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Your main residential home

Certain compensation or damages for any wrong or injuries suffered by the taxpayer

Winnings from betting, a lottery or other form of gambling, or a game with prizes.

Cars, motorcycles and similar vehicles

Collectables acquired for under $500

Personal use assets acquired for under $10,000

Assets used to produce exempt income

Inheritance, when received, by beneficiaries of a deceased estate.

There are also various CGT concessions available for small business (that is, where the net value

of the assets of the tax payer and connected entities is not more than $6 million) including:

An exemption from CGT for assets owned for at least 15 years

A 50 per cent reduction in CGT for active business assets

An exemption from CGT if proceeds of sale are used in connection with the tax payer’s

retirement

A rollover where the business is sold and another business is acquired

6.4 Fringe Benefits Tax

Fringe benefits are generally non-cash parts of an employee’s package, such as employer-provided

cars, free or low interest loans, free or subsidised residential accommodation or board, free or

discounted goods and services, and expenses paid on behalf of an employee. Currently, the FBT

rate is 46.5 per cent. The paid fringe benefit tax, however, is income tax deductible for the

employer.

6.5 Withholding Taxes

Withholding taxes generally apply to interest, dividends and royalties paid to non-residents.

Withholding taxes are withheld by the company that is to make the payment of interest, dividends

and royalties.

Interest

Interest paid by a resident of Australia to a non-resident is normally subject to a final withholding

tax of 10 per cent; this is a final tax and therefore the non-resident is not required to include

interest income in an Australian income tax return. If interest income is the only Australian source

income derived by the non-resident, no Australian returns is required to be lodged.

Dividends

Non-residents are subject to withholding tax on the unfranked portion of dividends they receive

from an Australian resident company. The dividend withholding tax rate is 30 per cent, subject to

Australia’s Double Tax Agreements (DTAs), which generally limit the rate to 15 per cent. For

example, the US Protocol provides for a rate of 0 per cent where a US corporate investor, satisfying

certain public listing requirements, holds 80 per cent or more of the voting power of an Australian

company; a rate of 5 per cent will apply where a US corporate investor holds direct voting interests

of at least 10 per cent in an Australian company, otherwise a 15 per cent rate will apply.

Royalties

Australian income tax law provides that tax is chargeable on all amounts received ‘as or by way of

royalty’. For purposes of income, royalties typically include amounts ‘paid or credited’ for the use of

or right to use copyright, patents, trademarks, industrial equipment, or for the supply of scientific or


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commercial knowledge or information. The term ‘royalty’ is broadly defined and can extend to

rental payments for the use of certain equipment.

All royalties that are expense of an Australian business, and are paid or credited to a non-resident,

are deemed to have a source in Australia. Therefore, a non-resident will be subject to Australian tax

on such royalties, irrespective of where the property giving rise to the royalties is situated, or where

the services giving rise to the payment are performed.

Australia has a system of withholding tax to collect tax on royalties paid or credited to non-

residents. The royalty withholding tax (at the general rate of 30 per cent) is a final tax. Where the

recipient is a resident of a country with which Australia has concluded a DTA, the terms of the

treaty will determine the rate. Most double taxation agreements to which Australia is party provide

a rate of 10 per cent royalty withholding tax. The US Protocol and the UK, Japanese and French

double taxation agreements provide for a general rate of 5 per cent of withholding tax.


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Chapter 7. Implementing Computer Based Accounting System

Processing business transactions using accounting system provides accurate and

reliable information for business decision making. Accounting systems for small and medium sized

businesses deliver many benefits including accurate transaction recording, tax calculation and

most of all information collections such as financial reports, account receivables and payables,

payroll report and many others. In this chapter, we will look at the softwares and their functions for

general business transactions including sales, purchases, inventory and payroll. Also this chapter

will briefly deal with report generations for tax and management reports. For the sake of easy

understanding, we use MYOB, QuickBooks and Xero for each subject of this chapter.

7.1 Understanding Business Accounting

Most businesses incur sales and purchases for daily basis. Some businesses (retail and wholesale

trading businesses) deal with inventories to buy and resell the items. Also, businesses need to

process payrolls for their employees. The below diagram describes the general transaction process

of a business.

In most business environment, businesses take orders from customers then process the sales by

delivering goods and/or services. If this involves delivery of goods (inventory), then you should have

enough goods on hand; or you need to back order the goods required from the suppliers in order to

issue an invoice from the system. Inventory management system allows users to do this job. With

this function, you can maintain systematic business inventory management with cost information

(refer Cost of Goods Sold).

When a business purchases inventory or any other items (such as non-inventory parts), they issue

purchase order to suppliers and receive goods based on the order. Unit prices and quantities must

be checked before entering into the system.

Managing payroll could be very time consuming and complex job without proper system. With the

system, managers can easily calculate the tax (PAYG Withholding tax) for each employee as well as

accumulation of annual and personal leaves for each employee. Users of payroll system have to

ensure that each employee’s payroll encounter eligible leave entitlements based on awards or

Federal governments regulations. Most systems allow managers to print out PAYG Payment

Summary for each employee at the end of each payroll year.


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Figure 8. Computerised Accounting Transaction Process

Figure 9. Dashboard of QuickBooks Enterprise Version 2011-2012

Account Sales Inventory Purchases Payroll

Banking

POS WMS

Chart of

Accounts

Lists

Tax

Sales Order

Sales

Invoices

Receipts

Cheques

Credit Cards

Reconcile

Purchase

Order

Purchase

Invoice

Payments

Time Sheet

Payroll

Leave

Entitlements

Super


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Figure 10. Dashboard of MYOB Premier Version 19.5

Figure 11. Dashboard of XERO


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7.2 Implementing Accounting Systems

Chart of Accounts

When a business is setup the accounting system for the first time, it is also required to setup chart

of accounts for the business. Chart of accounts is for the allocation of business transactions based

on accounting standards and income tax calculation. Accountants and business tax advisers use

the chart of accounts and trial balances when they prepare financial statements and income tax

return for the business at the end of financial year. Thus, businesses should seek professional

support when this is not certain for them as rectifying business transactions in later time could be

quite costly and time consuming. Chart of accounts are divided by below categories:

Assets

Liabilities

Equity

Income

Cost of Goods Sold

Expenses

Also, a proper tax code must be pre-designated to each account item before starting entering

business transactions so that GST can be easily traced to Business Activity Statements.

Figure 12. Sample Chart of Accounts with Xero

Sales

When your business takes customer orders, the details of the order should be entered into the

computer system including item code, descriptions, quantities of each item, unit price and tax

codes. The computer system then calculates the total order value and tax amount. If there is no

enough stocks on hand (in the warehouse or shop floor), then the item required to sell must be


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ordered (back order) from the suppliers. Sales invoice must be issued once the ordered goods and

services are delivered. The computer system allows issue of the tax invoice according to the format

specified under the tax administrations act. This must include the sales detail, invoice date,

customer detail, supplier’s details including ABN and GST.

Most computer based systems allow users enabling to design the format with business logos and

send with emails without printing out the invoice. This enables saving time and costs (posting) for

the business. Once sales invoices are issued, then the amounts of outstanding will be under

Account Receivables (Debtors) account until the amount is received and allocated to the invoices.

If the amounts of sales are not received by the promised (or agreed) due dates, then you need to

contact the customers by sending reminder statements or calling them directly. Managing debtors

accounts directly relates to the business cashflow (see the chapter 10).

Figure 13. Issuing a Sales Invoice using MYOB


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Figure 14. Sample of a Sales Invoice with MYOB


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Purchases

Businesses buy goods and services from other businesses to generate revenue and profit. Process

of purchasing with computerised system can be systematically managed and controlled.

Businesses need to tightly manage the purchases especially in terms of timing and amount. If you

do not have enough stocks in your warehouse when needed, then sales will be negatively affected.

On the other hand, if you purchase goods more than you need for short term, your cashflow will

suffer.

Processing purchase is quite similar with issuing sales in computer system. You need specify the

item (or service), quantity, agreed unit prices and tax.

Figure 15. Processing a Purchase Bill with MYOB

Once recorded as a bill, the amount will be allocated to Account Payables (creditors) account until

it is fully paid. Once payment is made, you are required to send a remittance advice for the amount

you paid to help reconcile with the supplier’s debtor account. Often, business neglecting this

process put themselves into unnecessary dispute and lengthy communication with suppliers about

the payment reconciliation.


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Figure 16. Sample of Remittance Advice using MYOB

Inventory

Inventory management is one of the challenging tasks for most trading (wholesaling and retailing)

businesses. As explained in other chapters later, the complexity of stock treatment in tax

calculation with cost of sales figure and its cashflow effect, it is important to have proper

procedure and management tool to control inventory in terms of its physical condition (and

whereabouts) and maintaining value.

With computerised accounting system, businesses have better control over inventories. By nature,

inventory account is connected with Purchases (adding inventories) and Sales (disposing

inventories), and most computerised accounting systems have the linked function between these

accounts.

Trading businesses are required to count inventories at the end of each financial year

(recommended once a month) to reflect exact quantity and value of inventories on Balance Sheet.

If there is a discrepancy, then the reason must be investigated before adjustment is made.

Warehouse Management System (WMS) in addition to the controlling accounting software can help


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better management of stocks with features like bar-coding of each item and tracking their

whereabouts.

Figure 17. Inventory Control Panel with MYOB

Payroll

Processing payroll based on regulations and awards is another area that business owners and

managers should put extra efforts. Gross salary must be agreed before the employee commences

work. PAYG Withholding Tax must be deducted and collected by the employer to report and pay

with its business activity statements. Payslip must be delivered to each employee with each payroll.

Superannuation Guarantee (at least 9% of gross salary) must be shown on the payslips and paid by

the employer on behalf of the employee. Also, leave entitlements must be managed for each

employee. At the end of payroll year (same as financial year), PAYG Payment Summary (also

previously known as Group Certificate) must be delivered to each employee within 14 days after

the end of financial year.

All of above functions can effectively be delivered by using computerised accounting systems.


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Figure 18. Payroll Control Panel with MYOB

Figure 19. Processing a Payroll with MYOB

Report Generation

Using computerised accounting systems such as MYOB or QuickBooks, you can generate many

reports that provide meaningful management information. Balance sheet, Profit and Loss

statement and GST report are basic but most popular reports among businesses. However, there


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are many other useful reports that allow you to get valuable information for your daily business

running:

Sales

Purchases

Inventories

Payroll and Employees

Tax

Cashflow and bank

Other performance Monitoring

Figure 20. MYOB Report Centre


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Figure 21. QuickBooks Report Centre


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Chapter 8. Exporting & Importing

Businesses that import or export goods or services are often faced with the

additional challenges from dealing with international transactions, and you should consider to

various matters in managing the risks when undertaking international trade.

8.1 Export

Exporting is challenging and time consuming, as you will not only have to run your normal business

but also master the complexities of international trade and the intricacies of foreign languages and

cultures. Furthermore, the business basics which satisfy domestic consumers may not apply, as

international customers can be far more demanding.

Planning

Before embarking on a costly and time consuming export program, it is important to undertake

preliminary market research and planning. There is an enormous amount of work to do in

preparing for exporting, and buying your airline ticket should be the last preparatory step. The key

issues to consider in planning an export program are:

Is there an overseas market for your goods and/or services?

Is the product acceptable in its current form?

Does your business have the right infrastructure to export?

How will you distribute your product?

How will you manage foreign exchange risk?

1. Is there an overseas market for your goods and/or services?

In determining whether there is an overseas market, your must consider the ‘who, where, when

and why?’ of your potential customers as well as other market forces such as potential competitors

and regulatory issues. In particular, the following issues must be considered:

Customers – who are your potential customers? Where are they? When will they buy? Why will they

buy your product or services? How much will they buy? How often will they buy?

Market – consider the general economic conditions in that country. Is the economy stable? What is

the nature of currency fluctuations? What are the trading preferences of that region (payment and

trading terms)?

Regulatory – are there any import duties, tariffs, quotas, local regulations or quarantine restrictions

which will affect sales?

Competitors – who are your existing or potential competitors in that market? What can you offer

that is different from your competitors? How competitive are you in terms of price and quality?

Gathering this information will require extensive research. It can be obtained from a variety of

sources including trade and industry associations, Austrade, freight forwarding agents, Australian

Bureau of Statistics, Custom brokers, chambers of commerce, government department, trade

journals, potential suppliers and even potential customers.

2. Is the product acceptable in its current form?

It is important to consider the changes that might need to be made to your product before you can

export (and the cost of those changes). They might include:


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Labelling requirements

Foreign language requirements (instruction manuals, labels)

Safety regulations and other government regulations

Cultural factors

Electrical voltage

Tastes and trends vary enormously between countries so it is vital that you factor in cultural

differences. Make an effort to understand the local culture, otherwise, you risk offending

customers and distributors by using inappropriate language, branding, marketing and labels.

3. Does your business have the right infrastructure to export?

Your plan should seek to answer the following questions:

Capacity – what is the production capacity of your (or your supplier’s) existing plant and equipment?

Is it sufficient to cope with the increased volume which export orders are likely to generate? You

may need to increase capacity, reconsider the efficiency of current plant layouts or find new

suppliers.

Controls – are quality control procedures effective? In particular do they account for foreign

regulatory requirements?

Staff – do you have enough personnel to manage the influx of new orders? Are they suitably

trained and qualified to deal with the complexity of issues arising from foreign trade (such as sales

tax, Customs clearance/duties, cultural issues, freight, etc)?

Funding – do you have working capital facilities in place to deal with the increased funds required?

Manufacturing for export will require substantially more raw materials and updated equipment.

Other expenses include overseas travel, freight, training of staff and holding costs caused by

delays on the waterfront.

Supplies – do you have access to sufficient raw materials? Exporting requires a great deal of time.

If you already have a hectic schedule running your domestic business, how are you going to find

the time to meet the demands of the export-related business, such as travelling overseas to meet

potential customers and distributors?

4. How will you distribute your product?

There are a number of different models for distributing your product overseas. You can appoint

exclusive or non-exclusive distributors for different regions, or open branch offices. It is obviously

far less risky to simply appoint distributors than to open a fully-fledged branch office. You will save

the costs of hiring staff, leasing premises, buying plant and equipment, etc. On the downside, the

distributor will take a significant cut of all sales in that region, and your will also lose control of the

customer relationship.

5. How will you manage foreign exchange risk?

It is important that you understand foreign exchange risk and implement a system for controlling it.

In most cases, your customers will pay for your exported products in their local currency. You must

understand the volatility of foreign exchange rate movements and the effect that they can have on

your business. The Export Finance and Insurance Corporation (EFIC) may be able to assist you with

this.

Cultural issues


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You need to explore the cultural features of the region, and take the time to understand the

language requirements. Consider the following:

Check what is the most appropriate greeting – in some regions, hugging or kissing is

frowned upon, unless you know the person quite well. In Japan, it is customary to bow; if

the person you are bowing to is more senior, you bow lower than they do.

Australians tends to address people by their first names immediately after an introduction;

this may offend some Asian businesspeople.

In cultures where family ties are important, you should get to know the family members of your

foreign clients and suppliers. Bringing small gifts from Australia for their children will greatly

strengthen your relationship.

In most foreign countries, it will be well received if you or someone on your team can speak their

language.

Export Quotation

A quotation is a formal offer and its acceptance constitutes a binding contact of sale. Take care

when drafting quotations because, once accepted, they can be difficult to cancel or amend. To

enable an importer to fully evaluate an offer, you must provide the following essential information:

Price – the importer needs to know the price at which the goods are being offered, the currency in

which the price is quoted and for how long the offered price will be held firm.

A detailed description of the goods – to enable the importer to correctly classify the goods for

Customs duty purpose.

Trading terms – indicate what is (and what is not) included in the quoted price. The most

commonly used trading terms are explained later in this chapter. For example, Free on Board (FOB)

includes all charges incurred in cartage and loading the goods on to the ship; Cost and Freight

includes all FOB charges plus freight up the port of discharge.

Packing specification – to enable the importer to calculate cartage, handling charges and freight,

etc. on the imported cargo.

Payment terms – indicate the method by which payment will be made to the exporter. There is a

range of payment terms ranging from cash in advance to payment after the goods have been

received by the importer.

The Export Finance and Insurance Corporation

The Export Finance and Insurance Corporation (EFIC) is Australia’s official export credit agency and

assists exporters with medium to long-term finance and insurance, where traditional sources are

not available. EFIC supports several billion dollars’ worth of exports every year to more than 150

countries.

1. Export Credit Insurance

In certain ‘risky’ countries, there are a range of economic, political and legal factors which are

outside the direct control of your customers. So, even creditworthy customers with honourable

intentions can sometimes fail to pay. There will also be times when normally ‘safe’ markets have

problems; indeed more than half of EFIC’s claims relate to North America and Europe.


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EFIC’s Export Credit Insurance provides cover for payments owed to Australian exporters by

overseas buyers. The insurance provides cover for non-payment arising from particular commercial,

political or legal events. This allows exporters to secure new export business by offering more

attractive payment terms and to minimise balance sheet risk and protect cashflows.

2. Finance Products

EFIC also provides a range of products aimed primarily at supporting exports of capital goods

including export finance, performance bonds and working capital guarantees.

Export finance helps overseas buyers to purchase Australian exports. EFIC also provides direct

loans or an export finance guarantee which assists banks to provide finance to the overseas

buyers.

Performance bonds and guarantees may be required of Australian exporters by overseas buyers of

capital equipment as security for advance payments or in support of their performance obligations

under a contract. EFIC will issue the bond directly to the overseas buyer or will provide your bank

with a guarantee and they will issue the bond.

Working Capital Guarantee can help exporters access finance when they have a large export order

but cannot secure the working capital needed to complete it. EFIC provides a guarantee to your

bank, which can then lend the funds.

The Export Finance and Insurance Corporation can be contacted via their website: www.efic.gov.au

8.2 Government Grant and Assistance

Austrade

Austrade is the Federal Government’s export assistance agency. It is represented in 140 locations

in 60 countries, including an extensive domestic network throughout Australia. Austrade offers

following services:

1. Advisory services

Austrade offers market intelligence, practical advice and ongoing support (including financial) to

Australian businesses looking to develop international markets:

Market intelligence – Austrade can assist with detailed information on competition, prospects,

cultural considerations, distribution systems and government regulations.

Advice – Austrade can help businesses determine whether they are ready to export; identify

potential distributors, buyers or agents around the world; provide advice on which overseas

markets hold the highest sales potential for their product; and pass on specific business

opportunities as they arise.

On-the-ground support – in overseas countries, Austrade offices can assist with a number of

services including arranging appointments with distributors or other useful contacts; organising

interpreters; attending meetings to help overcome language or cultural barriers; and organising

product launches and promotional material.

Investment opportunities – Austrade also provides advice and guidance on overseas investment

and joint venture opportunities, and helps put Australian businesses in contact with potential

overseas investors.

http://www.efic.gov.au/


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2. New exporter services – TradeStart

Austrade and TradeStart offers a package of free services, designed to assist small and medium

sized Australian companies with launching and developing their businesses overseas.

Austrade can be contacted by via their website: www.austrade.gov.au

3. Export Market Development Grant

Austrade offers exporters financial assistance through the annual $150 million Export Market

Development Grant (EMDG) scheme. EMDG is targeted at small to medium sized exporting

enterprises, who spend at least $10,000 every year on export marketing. To be eligible your firm

must have a total business turnover less than $50 million.

Before a business can qualify for a grant, it must spend $10,000 of its own money on export

promotional activities and marketing. Your first EMDG claim can combine two years of expenses.

Eligible marketing expenses include:

Visiting overseas markets

Producing product samples

Trade fairs, brochures and advertising

Hiring consultants

Communication costs

Assistant in a single export market is limited to eight years. Extensions are available for three years

for each new market entered. First-time applicant must register with Austrade by June 30 and

lodge applications between July 1 and November 30.

8.3 Import

Costing

While you may recognise a market opportunity for an imported product, it is difficult to assess the

size of the market for the product until you have calculated the selling price, a key driver of which

is the costing. The main cost components are:

The exporter’s selling price – what is the exporter’s price, and which elements of the

transport costs are included in that price?

Inland transport to the point of loading – obtain this cost from exporter or importer’s

forwarding agent, shipping company, airline or loading Customs agent. Typically, port

charges at both loading and discharge points are included in freight rates.

Freight from the point of loading to point of discharge – obtain from the forwarding agent,

shipping company or airline.

Clearing charges – obtain a quotation from your Customs agent for the work involved in

clearing the goods from Customs control.

Customs duty – seek advice from your Customs agent or ask Customs the rate of duty

which would apply to the goods you wish to import.

Fumigation/Inspection charges – obtain (if applicable) from your Customs agent.

http://www.austrade.gov.au/


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Inland transport to importer’s premises – obtain this cost from the cartage company,

forwarding agent or Customs agent.

Insurance against loss or damage – this is arranged by most forwarding agents or through

insurance brokers.

If possible, obtain import quotations and invoices in Australian dollars to minimise exposure to

fluctuations in foreign exchange rates. If this is not possible, consider arranging with your bank for

a forward exchange contract.

Planning and research

You should study the Australian market to ensure there is sufficient demand for the product you

are seeking to import. Consider:

Is there a market for the product? How big is this market (revenue in dollars and unit sales)?

Is the product currently being made in Australia or imported into Australia? If so, will your

product be price competitive?

Who are your existing and/or potential customers? Where are they? When will they buy? Why

will they buy your product or service over alternatives? How much will they buy? How often

will they buy?

Are there any import duties, tariffs, quotas, local regulations or quarantine restrictions which

will affect sales?

If the product you intend to import is already on the Australian market, study the product and take

note of presentation, packaging, labelling, quality and retail price.

Once you have established that there is a market for the product, bring a test sample into the

country and approach your potential clients to gauge their interest in the product.

Finding products to import

Finding products for import used to be a time-consuming process that involved wading through

dozens of brochures just to find the names of companies. Thankfully, that exercise has been

simplified, as chambers of commerce and Austrade now have computer databases listing not only

the companies but the range of products they manufacture and contact names, numbers and

email addresses. You can also contact overseas based industry associations for the product

manufactures you want to contact.

Australian Bureau of Statistics

The Australian Bureau of Statistics may have statistics on the product you with to import, including

quantities currently being imported, total dollar values and individual unit prices. This data is

invaluable in assessing the level of competition, and gives you a good feel for the level of market

activity. Further, it will help you to benchmark the price asked for by the overseas supplier.

Finding an overseas supplier

When importing, it is important to have reliable overseas suppliers. If they become insolvent,

provide products late or supply poor-quality products, it is your reputation which suffers.

You must ensure that your supplier is willing to comply with any special requirements that might be

necessary, such as special labelling/packaging and any product modifications required to meet

Australian standards or tastes.


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When selecting a potential overseas supplier, ask for references from other importers who have

dealt with them. Your lawyer may be able to organise a credit check to assess the supplier’s

financial stability. The advent of electronic commerce has made the threat of fraud ever-present.

Do not simply relay on the Internet for all your market research. Remember that while a web site

may take some time to create and look professional, it can disappear (with you money) instantly.

You should also visit the supplier yourself.

Placing an order with a supplier

When placing an order with a supplier, ensure that the terms and conditions of the contract of sale

are in writing and as detailed as possible, including:

The product

Part or product numbers

Price per unit

Description and specifications

Quantity

Labelling, packaging and marking requirements

Embarkation point and destination

Trading terms

Payment terms

Shipping method

Required documentation

Australia has many requirements for imported goods, so know the requirements before placing an

order. For instance, if you import medical devices or other health related goods, you need to have

pre approval from Australian Therapeutic Goods Administration (TGA).

Upon arrival, the goods received should be thoroughly examined for quality, quantity and condition.

If the quantity and quality of the goods is inadequate, you must contact the supplier immediately. If

the goods have been damaged in transit, you will need to contact your insurance company.

Financing your order

A key part of the transaction is how you will finance the purchase of the goods. An importer will

often be required to make payment to their suppliers before receipt of payment from the ultimate

buyers. Importers need to manage this mismatch in cash flow by:

Negotiating trading terms with suppliers and buyers that will more closely match

the timing of payments against expected receipts; and

Seeking financing from financial institutions

8.4 Payment & Trading Terms

Payment Terms

These will always be the subject of some negotiation between exporter and importer. Common

methods of payment in import/export transactions are:

Cash in advance – payment by the importer prior to shipment


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Letter of credit – an undertaking given by a bank (on behalf of the importer) to pay an

exporter an amount of money at sight or at a determinable future date provided that

certain terms and conditions are fulfilled. A confirmed irrevocable letter of credit cannot be

cancelled or amended without the consent of the beneficiary.

Bill of exchange- the shipping documents under cover of a bill of exchange are either drawn

at sight or at a fixed or determinable date and are delivered by the exporter to their bank,

who transfers them to the importer’s bank. The importer’s bank will surrender the

documents to the importer upon payment of the face value of the bill of exchange or an

undertaking to pay when the bill matures.

Open account – the exporter sends the documents directly to the importer who makes

payments by means of cheque, telegraphic transfer, etc.

Trading terms

Common trading terms are:

Ex-works – the price quoted only covers supply of goods at the exporter’s warehouse and

does not include any element of the cost of transportation or insurance.

FOW (free of wharf) – includes cartage to wharf but excludes wharfage.

FAS (free alongside ship) – includes cartage and wharfage but not the cost of loading on

board the vessel.

FOB (free on board) – includes all charges incurred in cartage and loading the goods on

board the vessel.

CFR (cost and freight) – includes all FOB charges plus freight up the port of discharge.

CIF (cost insurance freight) – includes all charges including freight and insurance up to the

port of discharge.

CIFC (cost insurance freight and commission) – includes the CIF price plus a commission

payable to the exporter’s agent

FIS (free into store) – includes all charges incurred in delivering the goods to the importer’s

premises, including wharfage duty and inland cartage

Foreign currency payments

When importing or exporting goods or services, you need to pay or receive in a foreign currency

that fluctuates in the market. In this case, businesses are exposed to falling revenue or increased

costs and have little control over this impact. However, there are number of bank products that can

assist business to minimise this impact.

1. Forward foreign currency agreement

To minimise the impact of foreign currency fluctuation, you can enter a forward rate agreement

with your bank if your business qualifies. This agreement allows you to “lock-in” a pre-agreed

exchange rate for a set date in the future. The benefit is that you have certainty of how much you

pay or receive in Australian dollars. Once agreed, you are required to settle the transaction on the


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agreed date. You will need to ensure that you either have the foreign currency to buy the Australian

dollars (importer) or have received the foreign currency to sell for Australian dollars (exporter) on

the settlement date. Thus, you need to make sure that your international trade transaction is

confirmed and payment date accurate before entering the agreement.

2. Foreign currency option

Unlike forward foreign currency agreement that bound the business pre-agreed rate with the bank

and therefore could be unfavourable to the business, foreign currency option will protect the

importer from downward movements in the value of Australian dollar but allow the importer to

benefit from favourable movements in the Australian dollar. So if the Australian dollar increases in

value, the importer can abandon the option. If the Australian dollar decreases in value the importer

can rely on the rate in the option. However, the importer needs to pay the premium on the option.

3. Foreign currency bank account

If the business has both cash inflows and outflows with foreign currency, it can net its currency

exposures using foreign currency bank account. With this facility, the timing is the important issue.

Although the perfect scenario is where inflows are received at the same time as outflows, this is

rarely the case. The timing issues can be managed by depositing surplus foreign currency in a

foreign currency bank account for later use, or by borrowing now to pay for foreign currency

purchases, and then using the foreign currency receipts to repay the loan.

4. Negotiating to pay / receive in AUS dollars

With pre-agreement, your business may able to transfer the foreign currency fluctuation risk to

overseas suppliers and customers. Alternatively, you can agree to pay for the goods importing at

the foreign currency rate at the time. However, this also means that you will have to fund the goods

for a longer period of time whilst waiting for the goods to arrive.

It is best to speak to your bank to determine the best alternative to manage foreign currency trade.

When trading internationally, there can be a real strain on your cash flow. If you can negotiate with

your supplier or customer to use trade finance, then your cashflow will be freed up to use on other

parts of the business.

International Trade Finance

1. Letter of Credit (L / C)

This is a guarantee by the bank that international payment will be made. This is beneficial to

exporter as they are guaranteed the payment from the date the L / C is entered into. To the

importer that the goods received will be in accordance with the terms and conditions set out in the

L / C documentation.

2. Documentary Collections

This facility is used to minimise the risk on inaccurate documents that can impact on the delivery

of goods and hence payment. Also this facility ensures that goods are shipped and payment will

not be released until documents are confirmed. A deposit to secure the facility is not required, but

there is no payment guarantee from the bank.

8.5 GST Issues


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In general exports of goods and services from Australia are GST-free. Exporters are entitled,

however, to claim input tax credits on the materials and supplies required to produce the goods

and services exported.

Most imported goods are subject to GST, calculated at 10 per cent of the value of the taxable

importation. This value is not simply the purchase price but is the sum of the Customs value,

Customs duty, the amount paid to transport the goods to Australia and transit insurance.

The goods are subject to GST at the time of entry through Customs and, as such, input credits

relating to imported goods are claimable in the tax period in which GST was paid.

To manage your GST, consider:

Bringing the bulk of your imports through Customs at the end of your tax period or

attempting to sell the goods at the beginning of your tax period so you can fund the GST

Minimising stock on hand by importing only when sales have been secure

Using a bonded warehouse, which allows goods to be held at Customs (GST would not be

payable until the goods are released and entered through Customs).

8.6 Customs and Quarantine

Australian Customs Service

In general, most goods exported from Australia must be declared to the Australian Customs Service.

Customs Information Centres are able to advise of any export restrictions, permits or regulatory

requirements for commodities being exported from Australia.

All goods imported into Australia (whether by air, sea or post) must be cleared by Customs. While

imports of low value will generally be released by Customs for delivery direct to consignees,

importers are responsible for obtaining Customs clearance for consignments of goods valued at

$1000 or more.

1. Duty

Rates of duty payable by an importer are determined by the classification of goods within the

Australian Customs Tariff. In some circumstances, anti-dumping (where goods sold into Australia

are cheaper than in the home country) results in additional rates of duty.

2. Regulations

The following goods are subject to import control:

Certain drugs and goods containing those drugs

Hazardous and health-related manufactured articles and substances

Animals and animal products

Food and plant imports

Firearms and other weapons

Protected wildlife and related products

Protected cultural heritage

Motor vehicles

Permission to import must always be obtained prior to the goods arriving in Australia. Failure to do

so may result in the forfeiture or destruction of the goods.


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The Commerce (Trade Descriptions) Act 1905 details all the information and requirements for the

correct marking of trade descriptions for the correct marking of trade descriptions on imported

goods. Customs officers may examine and inspect goods to ensure that they comply with the

requirements of this Act. Goods that do not comply with the Act’s requirements will not be released

until the problem is rectified. As a general rule, trade descriptions must be in English, in legible

characters and on a principal label attached to the goods in a prominent position and in a manner

as permanent as is practicable. The Act also requires importers to retain commercial documents

relating to a transaction for five years from the date of entry.

3. Customs brokers

Customs brokers can assist you with the myriad of complex import and tax regulations. The broker

will also arrange the pick-up and delivery of cargo to an importer’s store.

The broker will process Customs entries using the documentation received from the importer. They

will check the documents for accuracy and ensure that what is said to have been shipped has

actually been shipped, so that duty is neither overpaid nor underpaid.

Brokers will collect the documents directly from the freight forwarder and pay the relevant charges

such as:

Freight

International terminal fee

Airline documentation and handling fees

Air cargo automation fee

When choosing a broker, ensure they are a member of Customs Brokers and Forwarders Council of

Australia – members are required to hold professional indemnity insurance. The Customs Brokers

and Forwarders Council can be contacted via their website: www.cbfca.com.au

4. Duty Drawback

You may be eligible for a refund (known as Duty Drawback) of Customs duty and GST paid on

imported goods if they are subsequently exported from Australia. It can be claimed if the goods are

exported in the same form as they were imported or if they have been incorporated into another

product. For example, duty paid on imported fabric can be claimed when shirts, blouses and other

garments produced from that fabric are exported.

Contact the Australian Customs Service for more information via: www.customs.gov.au

Australian Quarantine and Inspection Service (AQIS)

Consider whether you need to obtain clearance from the Australian Quarantine and Inspection

Service (AQIS). Certain products are not allowed into Australia.

If you intend to import animals, food, plants or associated products, you will need to apply to AQIS

for an import permit, to ensure that the threat of bringing in pests or other disease risks is

minimised.

AQIS establishes import conditions and modifies them appropriately when necessary. A review may

be prompted by interested parties presenting information that justifies further risk analysis.

Alternatively, AQIS may decide to initiate an analysis on the basis of information gathered from its

own sources.

http://www.cbfca.com.au/

http://www.customs.gov.au/


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There is a provision within AQIS for appeal on the decision-making process following a

determination on whether or not an item is allowed to be imported(HumphreyNicholas, 2004).

The Australian Quarantine and Inspection Service can be contacted via: www.daffa.gov.au/aqis

http://www.daffa.gov.au/aqis


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Chapter 9. Risk Management & Financial Control

9.1. Risk Management

SMEs are always exposed to various risks, and this can be affecting business operations

and its performance. Though most businesses are thinking they are covered with insurance to

mitigate (or to avoid) business risks, there are many other risks often ignored and / or overlooked.

Managing theses risks can prevent possible business losses or at least minimise the impact of the

risks.

Identifying the possible business threats is the first step for the risk management. Then planning

and implementation of risk prevention or mitigation must come to action.

Solid risk management can bring the benefits of:

Lower insurance premium

Reduced chance that the business may be the target of legal action

Reduced loss of cash or stock etc

Reduced business down time(CPA Australia, 2009)

Identifying risks and responding them

Every business has different business risks with it so does industry. Identifying risks start with

identifying events that has potential loss and disruption to the business. These events should be

analysed to ascertain the extents of possible loss and likelihood of occurring. Building a matrix will

help to prioritise the risks.

Once you identified and prioritised the risk events, then attend to the most likely and most

expensive events first. For each possible event, develop procedures commensurate with the level

of risk the business is willing to accept. Once it is put in place, then it should be monitored to

ensure it is properly implemented and is effective.

Areas of Risks

1. Customer Related

Heavy dependant on a small number of major customers.

Customers that take up a lot of resources (time, costs, etc) but are less profitable than

other customers.

Risk mitigation strategies:

Locking in major customers through long-term service contacts, regularly visiting them, or

continually asking their views about the business’s products and services.

Spreading the risk by developing smaller customer base and developing existing minor

customers to larger customers through leverage.

Seeking lower –cost ways of servicing the less profitable customers.

2. Supplier Related


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If your business is heavily dependent on a small number of major suppliers (a supplier providing 30%

or more of the total product requirements), production, profit and cash flows are likely affected if

one of them fails or stops supplying.

Risk mitigation strategies:

Locking in major suppliers through long-term service contracts.

Seeking alternative suppliers capable of supplying similar items.

3. Staff Related

High staff turnover could result in disruption to the business and costs of employing and training.

Retaining key staff. If an employee is critical to the business’s success, then sales and

profits may suffer if the employee is the in the competition position by moving to

competitor or setting up a business for himself in the same industry.

If some employees are largely autonomous when dealing with key suppliers or customers,

there is a risk of fraud or collusion, or there could be significant disruption to the business

if they leave.

Occupational Health & Safety Issue. Are your employees working in a dirty or hazardous

environment, or do they travel extensively by car?

If staff works in dangerous environment, the business could face fines and penalties, and

absenteeism with injury or even death.

Risk Mitigation Strategies:

Implementing recruitment procedures for finding right employees.

Confidentiality agreement put in place and / or reasonable restraint agreements signed by

key staff.

Implementing a robust performance development system for communication of

performance expectations and goals, monitoring performance and setting remuneration.

Providing ongoing training for staff consistent with the needs of the business.

Allocating several people to fulfil key tasks and provide backup in the event of illness or

sudden departure.

Rotating employees through various functions or departments to familiarise them with

other areas of the business.

Implementing suitable OH&S policies to minimise risks.

Using equity/interests, profit sharing or other incentives to help retain key personnel and

let them share the success they created for the business.

4. Location Related


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If the business heavily dependent on its location to generate sales, a move to premises outside the

immediate vicinity of the current location may disrupt the business by affecting customers, staff

and supplier access. Another risk is physical damages by fire, flood and other natural disasters.

Also, businesses should have a plan for expansion when their current locations cannot meet the

needs of the business as they grow.


Seeking a number of alternatives for customers, staff and suppliers.

Where the current premises suit the business’s long-term requirements, then consider take

a long-term lease or right of first option when the lease expires.

Managing the business to predict future space requirements yearly.

Consider to purchase the current premise if only the current premise meet the business’s

long-term requirements including future expansion.

5. Goodwill and Market Reputation Related

If there is a large scale of product recall, fraud, or any similar incidents, the business reputation in

the market could be in danger. This could cause immediate distress and disruption to the business

with trouble and costs or reworking.


Incorporating robust review of process and quality assurance systems.

Investing in research and development and keeping up-to-date technological advances.

Compulsory training and development programs for staff.

6. Information Technology Related

If the business heavily relies on information technology (IT) to operate, business might not able to

operate without it.

Do all the software applications work as it intended? Are they all accurate (IT Service

delivery)?

Do you try to integrate IT solutions into daily work processes so that the business runs

more efficiently (IT solution delivery)?


Protecting computer devices in the premise

Keeping data safe by backups and locating the backups offsite

Using the internet safely

Protecting networks


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Securing the line of business applications

Ensuring appropriate IT support is available within an acceptable timeframe

Having an uninterrupted power supply unit (UPS)

Conducting appropriate IT training for staff

7. Financial Transactions Related

Liquidity Risk

If business is running out of money for operations, there could be significant risks to the business

and its owners and directors being personally liable for the debts of the business.


Managing and monitoring cash flow on a daily, weekly and monthly basis

Forecasting cash flow including ‘what if’ analysis

Seeking a committed line of credit from at least two financial institutions

Maintaining a strong relationship with a banker or financial institutions to ensure they

understand your business and kept up-to-date with potential loan requirements

Monitoring market conditions to anticipate seasonal fluctuations in cash flow (do not too

optimistic)

Put significant efforts on debtor collections

Credit Risk

Debtors may not able to pay, and this may result in slow receipt of cash or even write off a bad

debt


Checking the credit status of the customer before making the sale

Checking publicly available registers to verify that the customer’s business is real and to

find out who is behind the business

Ensuring the customers sign a ‘terms and conditions of trade’ prior to supplying goods and

services to them

Imposing credit limits to restrict your firm’s overall exposure; obtaining personal

guarantees where possible

Including a ‘retention of title’ clause for the goods you supply

Maintaining strong relationships with the debtor to ensure their current liquidity status is

always known


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Foreign Exchange Risk

If a business uses and receives foreign currency, then it is exposed to fluctuations in the value of

foreign currency values.


Consulting your bank for assistance in managing foreign currency exposure

Matching FX revenue and FX expenses through FX bank account

Buying or selling foreign currency in advance by locking in the FX rate

Interest Rate Risk

If the business is dependent on borrowed funds income generated from savings, every change in

interest rates will affect the overall profitability of the business through increase in interest

expenses or reduction in income from interest.


Consulting your bank for assistance in managing interest rate exposure

Borrowing or investing at a fixed rate to provide certainty of interest expenses or income

Matching interest income against interest expense to net the exposure

Commodity Price Risk

If buying or selling commodities is a key input or output of the business, fluctuations in commodity

prices can adversely affect the business’s financial performance


Consulting your bank on how to manage commodity price exposure

Entering into fixed price contracts with suppliers or customers

Using a number of financial market instruments provided by financial institutions

8. Competitors Related

Every business has competitors. Competitors can be threats by locating nearby (location threat),

reducing prices (price competition), or launching new products in the market (product competition).

Thus, a business needs to prepare for the risk from its competitors.


Researching consumer trends and tastes to respond to the change

Continually testing the market to see consumer preference and sentiment

Promoting products and services that sell better during economic downturn


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Promoting goods and services that sell well and are profitable

Using financial statements to benchmark financial and operational performance against

industry benchmarks

9. Risks from Business Owner or Key Members

If there is no plan to deal with the departure of the business’s owner due to death or incapacity,

the business might have to close or be sold to a competitor to avoid putting undue pressure on the

remaining owner or new owners.


Consulting professional advisers who can assist in business succession, will and estate

planning

Preparing a business succession plan and a will that is consistent with the plan

Undertaking insurance policies covering income or a capital invested in the event of death

or incapacity of the owner or key members

Consider a buy / sell agreement and funding the agreement for the eventual transfer of the

business if there are two or more owners

Documenting key processes and critical information so that other people can continue the

business operations

Training employees so that more than one person knows how to perform each task

9.2 Internal Financial Control

Businesses are required to ensure that you have right policies and procedures in place to make

sure that the financial information you are using is accurate and that you can protect your

investment in the business. To achieve this, you need to implement good financial controls.

Internal financial control is a procedure to detect and / or prevent errors, possible fraud, and make

sure the business is in line with the corporate governance imposed by the law. Implementing right

financial system helps to perform this procedure in an effective manner.

Each financial control procedure is designed to fulfil at least one of these eight criteria:

Completeness – that all records and transactions are included in the reports of business

Accuracy – the right amounts are recorded in the correct accounts

Validity – that the invoice is for work performed or products received and the business has

incurred the liability properly

Existence – of assets and liabilities. Has a purchase been recorded for goods or services

that have not yet been received? Do all assets on the books actually exist? Is there correct

documentation to support the item?


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Handling errors – procedures to ensure that errors in the system identified and rectified

Segregation of duties – to ensure certain functions are performed by different staff

Presentation and disclosure – timely preparation of financial reports

Financial information must be recorded in accurate manner so that management make decisions

based on accurate information. A proper financial control ensures that the business runs more

efficiently, resources aren’t lost and there are fewer unpleasant surprises (BarnedJan, 2008)

Advantages of Financial Control

Good financial control will:

Help align objectives of the business – to ensure thorough reporting procedures and that

the activities carried out by the business are in line with the business’s goals.

Safeguard assets – ensuring the business’s physical and monetary assets are protected

from fraud, theft and errors and allowing the systems to identify those errors quickly.

Encourage good management – allowing the manager to receive timely and relevant

information on performance against targets, as well as key figures that can indicate

variances from target.

Reduce exposure to risks – minimising the chance of unexpected events.

Ensuring proper financial reporting – maintaining accurate and complete reports required

by registration and management, and minimising time lost to rectifying errors and ensuring

resources are correctly and efficiently allocated.

Areas of Financial Control

General Areas

Is a chart of accounts used?

Is it detailed enough to give adequate information?

Is a double entry bookkeeping system used?

Who approves journal entries?

Do you understand the form and contents of the financial statements?

Do you use budgets and cash projections? And are they compared to actual results?

Are major discrepancies investigated?

Are comparative financial statements produced?

Are the books and records kept up-to-date and reconciled?

Are reasonable due dates imposed?

Is staff cross-trained in accounting functions?

Are storage facilities safe from fire, etc?

Is access to accounting records restricted when appropriate?

Is insurance covers regularly reviewed?

Revenue

Is there a policy for credit approval?

Are credit files kept current?


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Are credit checks done regularly?

Are sales orders approved for price, terms and credit limit?

Are all sales orders recorded on pre-numbered forms and are all numbers accounted for?

Are sales invoices compared to shipping documents?

Are sales invoices recorded promptly?

Are credit notes pre-numbered, accounted for and approved?

Do you review the monthly statements for outstanding balances?

Is account receivable subsidiary ledger balanced monthly to control account?

Do you authorise write-offs and other adjustments to customer accounts?

Cash Receipts

Do you or a responsible employee other than the bookkeeper or person who maintains

accounts receivable detail:

- Open the mail and pre-list all cash receipts before turning them over to the bookkeeper?

- Stamp all cheques with restrictive endorsement “for deposit only” before turning them

over to the bookkeeper?

- Compare daily pre-listing of cash receipts with cash receipt journal?

Are cash receipts deposited intact on a daily basis?

Are cash receipts posted promptly to appropriate journals?

Are cash sales controlled by cash registers or pre-numbered cash receipt forms?

Cash Disbursements

Are all disbursements except for petty cash made by cheque or electronic payments?

Are cheques pre-numbered and all numbers accounted for?

Are all payments recorded when made?

Are all unused cheques safeguarded, with access limited?

Are voided cheques retained and mutilated?

Are all cancelled electronic payments reviewed?

Do you sign / authorise or view all cheques and electronic payments?

Are supporting documents, processed invoices, receiving reports, purchase orders,

presented with a requestion for payment and reviewed by you before payment is made?

Are supporting documents for payments properly processed to avoid duplicate payment?

Are signed cheques mailed by someone other than the person who signed the cheques?

Are bank reconciliations prepared monthly for all accounts by someone other than the

person authorised to sign the cheque or make electronic payment?

Are bank reconciliations reviewed and adjustments of the cash accounts approved by you?

Are all disbursements from petty cash funds supported by approved vouchers?

Are petty cash funds kept in safe place, controlled by one person and regularly counted by

someone other than the custodian?

Account Payable

Are vendor invoices matched with applicable purchase orders and receiving reports?

Are vendor invoices reviewed for correctness?

Are all available discounts taken?

Is there written evidence that invoices have been properly processed before payment, e.g.

stamped?

Are there procedures which provide that direct shipments to customers, if any, are properly

billed to them?


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Do you verify that the trial balance of account payable agrees with the general ledger

control account?

Are expense reimbursement requests submitted properly, adequately supported and

approved before payment?

Receiving

Are all materials inspected for condition and independently counted, measured when

received?

Are receiving reports used and prepared promptly?

Are receiving report copies promptly provided to those who perform the purchasing and

accounts payable functions?

Payroll

Are all employees hired by you?

Are individual personnel files maintained in safe place?

Are wages and salaries, commission and other payment rates approved by authorised

person?

Is proper authorisation obtained for payroll deductions?

Is gross payment determined using authorised rates and:

- Adequate time records for employees paid hourly?

- Piecework records for employees whose wages are based on production level?

- Are piecework records and sales commission reconciled with sales records?

If employees punch time clocks, are the clocks located so they may be watched by

someone in authority?

Are time records for hourly employee approved by a foreman or supervisor?

Do you maintain proper leave application process and authorisation beforehand?

Are leave entitlements records kept up-to-date and reconciled with the leave provision

accounts?

9.3 Insurance

One of the most effective ways to protect the business against risks is to undertake sufficient

insurance covers. Before buying insurance policies for your business, you may have to decide

which risks you need to cover with insurance and how much.

Building and Contents Insurance

This insurance covers the business buildings as well as contents including inventory against loss.

Business interruption or loss of profit cover

This insurance covers business loss due to property damages by fire or any other insured perils.

The cover should ensure that ongoing expenses are met and that anticipated net profit is

maintained through a provision of cash flow.

Public Liability Insurance

Public liability insurance covers the owner and business against the financial risk of being liable to

a third party for death or injury , loss or damage of property or economic loss resulting from the

business’s or the owner’s negligence.


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Worker’s Compensation Insurance

It is compulsory to maintain appropriate accident and sickness insurance for all employees and

certain contractors you engage in your business.

Product Liability Insurance

This insurance covers for injury of damage caused by goods the business sells, supplies or delivers

– even in the form of repairs or services.

As the type and level of cover needed requires an assessment of the particular business needs, it

is necessary to seek an advice from an insurance specialist to ensure your business is adequately

protected.


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Chapter 10. Financial Management & Reporting

10.1 Profit and Expenses

It would be fair to say that no matter what your business objective is, all businesses need to

make a profit to achieve those objectives. Profit is the amount left over after selling your goods or

services and paying all overhead expenses. The higher the profit, the more return to the owners

eventually.

Profit information

Most small businesses rely on cash in the bank as an indication of the profitability of the business.

The truth is that the cash balance does not necessarily match with your business profit. This is due

to the timing differences between your sales and collection and purchases and your payments (see

cashflow section for more information). Therefore it is important to have the right information that

will tell you if your business will be profitable and therefore successful.

Review your profit information for at least the last twelve months to identify the problems have

arisen. Some of the potential areas could be:

Discounting eroding sales revenue

Increased cost of stock

Increase in expenses

Check each line item against the same line item for each month and make a list of all the

problems identified. Then prepare a plan to address each of the items identified and review

against each future months profit information to ensure that your plan is working.

Getting started

It is reasonable to expect that most businesses will also have a good idea of the costs to operate

the business. If the business is starting up, then a list of all the anticipated day to day expenses for

at least one year should be complied. For existing businesses, they can refer to previous records

for this information. Once these expenses are complied, further work needs to be done to separate

this information into various categories to assist in managing profitability.

Direct costs (Cost of goods sold)

You first need to separate the expenses into those that directly relate to sales. There are called

“Cost of Goods Sold”, “Cost of Sales” or “Direct Costs” depending on your business type. Any stock

purchases for resale, freight costs, direct labour (e.g. wages and salaries to manufacturing workers)

will be included here. Remember some costs here will be fixed and some are variable against the

sales revenue. Calculating the cost of goods sold varies depending on the type of business. A

retailer or wholesaler would calculate their cost of goods sold with calculating inventory levels as

following:

Opening inventory

Add: Purchases

= Goods available for sale

Less: Closing inventory

= Cost of Goods Sold

In manufacturing, it involves finished goods inventories, plus raw materials inventories, goods in

process inventories, direct labour and direct factory overhead costs.

Overhead Expenses


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You then take the rest of the expenses listed. These expenses are generally not directly

attributable to the purchase of stock. With this list, you need to separate into fixed and variable.

Fixed expenses are those expenses that remain the same when your sales increase. Examples of

fixed expenses are:

Rent

Payroll for administration workers

Utilities such as water, telephone and internet

Variable expenses are those expenses that move directly with the amount of sales you make (can

be either up or down).

Delivery charges

Electricity in manufacturing facilities

Sales commission

So now you have some information to work out how to achieve the anticipated profit. For existing

businesses, this information will be obtained in the profit and loss statement. Profit and loss

statement (or income statement if you prefer to call this) is a summary of a business’s income and

expenses over a specific period of time.

Profit and Loss Statement

OZ Medical Equipments Pty Ltd

Statement Date 30/06/2010 30/06/2011

Period Length 12 Months 12 Months

Analyst Ben Youn Ben Youn

Revenue 2,956,543 3,520,810

Sales 2,926,399 3,517,533

Currency Gain 1,874 3,277

Rent Income 28,270 0

COGS 1,464,626 1,520,815

Gross Profit 1,491,918 1,999,995

Overheads 1,450,219 1,317,721

Amortization 14,050 12,663

Depreciation 14,658 12,385

General Expenses 394,862 181,118

Finance Charges 29,569 32,831

Freight Paid 141,924 171,421

Employement Expenses 419,639 590,008

Office Expenses 24,733 18,476

Rent & Lease 130,704 118,568

Travel 71,113 87,320

Motor Vehicle Expense 21,597 23,196

Marketing 28,812 2,823

R & D Expenses 151,957 66,913

Fringe Benefit Tax 6,602 0

Net Operating Income/(Loss) 41,698 682,274


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Other Expenses -14 -172

Interest Received (-) -14 -172

EBIT 41,712 682,446

EBITDA 70,420 707,494

Interest Expense 14,084 23,150

Net Profit 27,628 659,296

Taxes 11,554 0

Extraordinary Items 0 0

Net Income 16,074 659,296

Dividends 0 0

Adjustments 0 0

Retained Earnings 16,074 659,296

Figure 22. Sample Profit & Loss Statement

Maintaining profitability

Pricing

An obvious part of the profitability for every business is the selling price of products and services.

When determining prices, it is important to ensure that prices and sales volumes allow the

business to be profitable. Good practice will include a business having a pricing policy that is

regularly reviewed in line with costs.

Business owners and managers should also take into account how pricing balances out across the

entire range of products and services. For example, a loss-leader (which makes a small profit or

even none at all) can be offset by other, more profitable products. Pricing should also take into

account the level of competition and relative pricing.

Discounting products or services can entice higher sales volume, however, this will erode the

profitability of the transaction. It is important to understand the impact of discounting has on profit

and customer demand. Discounts should be recorded separately and monitored regularly.

Using the two tools to monitor pricing – mark-up and margin – allows for the business to ensure

that the pricing strategy continues to contribute to profitability. Ensuring prices covering fixed and

variable costs is equally important.

Tips for improving pricing

Include comparisons of both gross and net margins against previous periods and industry

benchmarks in the review of sales.

Fully understand the impact on profits and customer behaviour before offering discounts.

In addition, record all sales discounts separately to provide transparency on sales invoice.

Consider alternatives to discounting to maintain profitability.

Implement and regularly review a mark-up policy to ensure current selling prices match

that policy.

Analyse sales regularly, with a focus on identifying those sales that provide the highest

margin.

Use key financial ratios to identify potential operational issues that may impact sales. The

relevant key financial ratios are cost of goods sold margin, gross margin, average stock

turn, mark-up, destroyed stock as a percentage of stock held and staff productivity.


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Volume

Improving profitability can also be achieved through an increase in volume sold. There are two

ways in which this can be achieved.

Increasing level of sales to existing customers (leverage)

Sourcing new customers

For existing customers, an increase in the overall volume of purchase is generally achieved by

marketing techniques to entice further sales. In addition, many businesses overlook the

opportunity to “up-sell”, and business owners and managers should ensure that staff are well

trained to look for further sales opportunities.

Setting targets for sales staff will assist in monitoring overall performance and enhance profitability.

A break-even calculation can be used to ensure that any sales strategy implemented will cover all

costs and allow for realistic targets to be set that ensure profit is maximised.

Tips for increasing volume

Understand the buying patterns of existing customers

Set marketing strategies in place that increase sales volume

Introduce marketing strategies that encourages customers to increase their volume of

purchases, such as loyalty programs, and increase the customer base through referral

rewards

Train staff to “up-sell” products and services and ensure they are aware of what high

margin products and services to offer.

Use break-even calculations to set sales targets for staff

Use visual display by placing products in groups or consider special offers such as

discounting bulk buys to entice volume buying.

Undertake regular research to tap into new markets and customer base.

Customers

Good customer service is imperative to keeping existing customers and enticing new customers to

the business. Understanding what customers want and how to deliver to their needs is a simple

step in improving the performance of the business.

Every business should have a policy that addresses the needs of existing customers and allows for

sourcing of new customers. Such a policy should include receiving feedback from customers, good

customer service and a marketing strategy that encourages new customers to the business.

A customer relationship management (CRM) system will provide a vast array of information on the

behaviour of customers as well as other information that can be utilised to increase the potential

selling power of the business. This system can be purchased as software or could be as simple as

detailed notes on each customer of the business.

Tips for improving customer service

Develop a system that will assist in understanding the needs of the business’s customers

and use this information to develop improved customer service.

Measure customer service levels by implementing feedback or surveys for customers,

monitoring items such as complaints and returns, sales by individual staff members and

delivery processes.


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Reward customers for loyalty. A loyalty program can also be used to increase sales volume

and create a new customer base.

Keep records of requests from customers, including new products or services, packaging

and delivery services. Often these requests are “lost” and can be useful when the business

is looking to develop a new offer for customers or gain market share.

Consider using a “mystery shopper” to monitor customer service by your staff.

Keep the business “top of mind” with the customer through regular contact through

newsletters, special offers and reminders.

Once you know what the cost of your goods are for the sales that you are making or buying from

other suppliers, and operating expenses associate with making these sales, then you can use the

following tools to ensure that you know:

That your profits are not being eroded by increasing prices in stock or expenses – Margin

How to set new selling price when stock costs increase – Mark up

How much you need to sell before the business making a profit – Break even analysis

Margin

There are two margins that need to be considered when monitoring your profitability, gross and net.

For service business, only net margin would be relevant, as it is unlikely that there would be a

direct cost of service provided.

Gross Margin is sales dollars left after subtracting the cost of goods sold from the net sales. Net

sale is calculated by deducting any discount given from the sales revenue. By knowing what your

gross margin is then you can be sure that the price set for your goods will be higher than the cost

incurred to buy the goods.

The margin can be expressed either in “dollar value” or in a percentage value. Gross margin is

calculated as below:

Dollar value = Net Sales less Cost of goods sold = Gross Profit

Percentage value = Gross Profit dollars / Net sales dollars × 100 = Gross Margin (%)

Net margin is the sales dollars left after subtracting both cost of goods sold and the overhead

expenses. The net margin will tell you what profit will be made before you pay any tax.

Net margin can be calculated as below:

Dollar value = Net sales – (cost of goods sold + overhead expenses) = Net Profit

Percentage value = Net profit dollars / Net sales dollars × 100 = Net profit margin (%)

Mark up

Mark up is the amount that you sell your goods above what it cost to purchase those goods. It can

be useful to use mark up calculation to ensure that you set the selling price so as to cover all costs

incurred with the sale.

Mark up is calculated as follows:


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Percentage value = Sales less Cost of Goods Sold / Cost of Goods Sold × 100 = Mark up

Figure 23. Profitability Scenario Test

Break even calculation

The break even calculation shows how many sales have to be made, in either dollars or units,

before all the expenses are covered and actual profit begins. This simple calculation is used to find

where profit really starts. The break-even point is calculated as below:

Dollar value = Overhead expenses /

1- (Cost of Goods Sold ÷ Total

Sales)

= Total sales value needed

before a net profit will occur

Number of Units =

Overhead expenses /

(Unit selling price – cost to

produce)

= Total number of units

needed to be sold before a net

profit will occur

Discounting Sales

Discounting your goods or services to entice customers to purchase will erode your profits. Tough it

is sometimes beneficial (faster cashflow cycle), it is important that you understand the impact

discounting will have on your profits before you decide to offer discounts. Where discounts are

offered you will need to sell more goods in order to achieve your gross margin.

Cost Management

Every business needs to cover costs in order to make a profit. Essentially there are two types of

expenses in business – fixed and variables. Further, effective supplier management is important in

managing expenses.

Except for government cost-plus contracts or where a monopoly exists, the market determines the

selling price. Regarding cost reduction, any business should be concentrating on reducing cost for

the entire enterprise, not for individual products.


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In the end, every enterprise is trying to profitably use its resource to provide customers with

products or services that are competitive in terms of cost, quality and delivery.

Today, the typical manufacturer probably has a cost structure that is more like 60 per cent material

content, 10 per cent touch labour and 30 per cent overhead. This shift from higher direct cost to

higher indirect cost is principally the result of automation and its corresponding larger capital

equipment component. Consequently, using traditional allocation method leads to potentially

significant distortion in calculating product cost.

Managers who work for cost management will also find their attention turning to issue like product

design. In most organisations, there is an appalling lack of valid information flowing between

people in marketing, product design and process engineering. The results are products designed

without customer input and that do not consider manufacturing’s needs or limitations. This means

that many new products are put into production with designs that are hard to make, creating

production inefficiencies and failing to achieve desired profit levels.

Fixed Costs

Fixed expenses are those that remain relatively constant regardless of the level of sales. Examples

can include rent, salaries and insurance.

Profitability can be impacted where sales decrease and fixed costs remain constant. Additionally,

although termed “fixed”, these costs can increase in line with changing economic and other trading

conditions.

Tips for improving the management of fixed expenses

Regularly review all fixed expenses and compare against other suppliers’ pricing to ensure

that the business is paying competitive prices for goods and services.

Salaries and wages are often classified as fixed expenses, however staffing levels should

be reviewed regularly to keep these expenses in line with business activity.

Compare fixed expenses to industry benchmarks regularly to ensure that the business is

not experiencing “cost creep”.

Variable Costs

Variable expenses are those that move relative to sales. Examples can include freight, marketing

and casual labour.

Monitoring costs is critical to profitability. Where sales remain flat or decrease, it is important to

manage variable costs in line with sales to avoid erosion of profits.

Tips for improving the management of variable expenses

Business owners and managers must recognise which expenses contribute to sales. If

profitability is declining, then reducing marketing expenses should be approached with

caution.

Regularly review margins, mark-up and break-even. This will highlight potential problems

with variable expenses.

Consider using part-time, casual or job-share staffing arrangements to provide flexible

expense against changing trading conditions.


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Supplier management

The relationship with suppliers, if handled well, will provide clear benefits to any businesses. By

keeping suppliers abreast of the business operations, they can often provide useful information

and advice including new products and/or services.

A solid supplier relationship will enhance business operations by minimising sourcing issues and

increasing the business reputation for efficiency and good management. Payment terms with

suppliers will be an important part of maintaining the relationship. Good communication with

suppliers will ensure that the business is seen to be a solid reliable customer.

Tips for improving supplier management

Leverage good relationships with suppliers to ensure that the business is receiving quality

service and products at competitive pricing.

Implement a supplier selection policy that identifies the priority the business has in place

for a supplier, such as quality, timely delivery and advice on new products.

Ensure your systems have good controls so that suppliers are not:

- Paid early or late

- Overpaid

- Paid twice

Continually review supplier contracts for opportunities such as:

- Improved pricing

- Effective discounting

- Improved delivery

Meet regularly with suppliers to discuss trading conditions and other industry-specific

issues.

Good management of general expenses of the business will contribute to increasing profit and ROI.

By monitoring business expenses you may able to identify where costs are increasing and take

action to ensure that you maintain your net profit margin.

When monitoring expenses, make sure to identify the expenditure that keeps you in business and

keep these at sustainable levels. Marketing and staff training expenses are examples of these.

To maintain constant rigour on expenses, continual review will help identify where costs are getting

out of control. Some other ideas to manage expenses is to consider joining forces with other

businesses to benefit from group buying, investing using companies that provide access to

discount services for bulk orders and seek out quotes for different services to ensure that you are

paying the best possible price for your expenses.

10.2 Balance Sheet Items

The balance sheet provides a picture of the financial health of a business at a given moment in

time (usually at the end of a month or financial year). It lists in detail the various assets that the

business owns, the liabilities owed by the business, and the value of the owner’s equity (net worth

of the business).


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Assets are the items of value owned by the business whereas liabilities are the amounts owed to

external stakeholders of the business. Owners’ equity is the amount the business owes the owners.

The equation below indicates their relationships in the balance sheet.

Assets – Liabilities = Equity

Assets can include cash, inventory, plants and equipments, furniture, funds at bank, money owed

by customers and others and intangible items such as patents and trademarks.

Liabilities can include funds acquired for the business by way of loans, overdrafts, owed to

creditors for purchasing inventory and expense items.

Owner’s equity (shareholder’s equity) is money put into a business by its owners for use by the

business in acquiring assets and paying for the (sometimes ongoing) cash requirements of the

business. As time goes on the retained net profits are added to the equity.

Balance Sheet


(Whole Units)

Statement Date 30/06/2010 30/06/2011

Period Length 12 Months 12 Months

Analyst Ben Youn Ben Youn

Accounts Tax Return Management Account

Cash at Bank 92,808 149,216

Accounts Receivable 160,568 214,027

Inventory 224,629 214,345

Other CA 218,934 236,141

Current Assets 696,939 813,729

Fixed Assets 153,249 184,539

Investments 0 0

Other NCA 0 0

Non Current Assets 153,249 184,539

Total Assets 850,188 998,268

Short Term Debt 178,104 71,473

Accounts Payable 414,698 238,477

Other CL 290,948 7,144

Current Liabilities 883,750 317,095

Long Term Debt 0 0

Other NCL 0 0

Non Current Liabilities 0 0

Total Liabilities 883,750 317,095

Share Capital 87,410 142,849

Other Equity 0 0

Accumulated R/E -120,972 538,324

Equity -33,562 681,173

Liabilities & Equity 850,188 998,268

Figure 24. Sample Balance Sheet


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10.3 Working Capital Management

Your financial survival depends on that there is adequate cash flow to meet all of the short term

obligations. Working capital management is about setting up strategies to ensure that there is

enough cash in the business to operate on a day to day basis without facing a cash crisis.

Working capital in business is comprised of stock management, payment to suppliers, work in

progress and collection from the customers.

Figure 25. Working Capital Cycle for a product provider

Between each stage of the cycle there is time delay. For some businesses this could be a

substantial length of time to make and sell the product; for these businesses, a large amount of

working capital is required. For service providing businesses, the length is shorter and requires less

working capital. The quicker the ‘cycle’ turns, the faster you have converted your trading operations

back into available cash. This means your liquidity level is high.

The key aspects of managing working capital cycle are:

Managing Inventory

Managing your suppliers (creditors)

Managing work in progress

Managing your customers (debtors)

Managing Inventory

Inventory management in relation to working capital management is about maintaining the right

level of stock to satisfy the needs of your customers and managing the stock to identify excess or

aged stock. It is important to ensure that your business use minimum level of financial resources

(cash) to fund the stock level that is, ensuring that stock is held for the shortest possible time. Also

Cash

Purchase

Supplier Payment

Work in Progress

Sales

Debtors


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maintaining stock comes with a cost (usually 10% to 30% of value of stock) with storage, insurance,

keeping and tracking records and controlling to avoid theft or damage.

Tips for managing stock

1. Review current stock levels and sales volume of stock items

Determine the current level of stock held and the value of stock.

Look at sales record to find out which items are good sellers and which are slow

moving.

Work out which items of stock sold make the most gross margin (focusing more

resources and energy on these sales for improved profit.

Make a list of slow moving, aged and excess stock items and develop an action

plan to move this stock immediately. This will generate cash to invest in new stock

that will move more quickly.

Update your stock records with the current levels and then implement a policy to

track all movement of stock. This will help with reordering stock only when needed

and also highlight any theft or fraud that may occur.

2. Establish a buying policy

Identify stock that you simply must never run out of in order to maintain sales

momentum and ensure customers are not disappointed over the basic products in

your range.

Tighten the purchase of stock. Knowing the volume sales per stock item will help

you buy the right amount.

Negotiate deals with suppliers but avoid volume-based discount especially when

cashflow is tight. Instead of volume discount, try to negotiate discounts for prompt

settlement or negotiate for smaller and more frequent deliveries from the suppliers

to smooth out your cash.

Don’t let discount prices drive your stock buying decisions. Buy stock your can sell

at a point in a reasonable time frame.

3. Identify other areas of the business that can impact stock management:

Supplier service can assist in stock management through access to stock only

when you need it and good delivery service. By ordering less more frequently and

arranging better delivery schedules stock quantities can be reduced saving

valuable cash resources and improving liquidity without reducing sales – Lean

Principle.

Promotional campaign could impact on your inventory level. Ensure that you have

adequate stock or can source adequate stock before launching a promotion. It is

always good to have a backup plan if things not going as planned (i.e. in case of

unsuccessful promotion).

Sales policy can also have a strong influence on stock levels and should be

managed with a view not just to achieving maximum sales but also to minimise the

investment in working capital.

4. For fast moving stock, negotiate with suppliers for delivery when required (Just-In-Time),

eliminating the need to hold large store of stock to meet customer demand.

5. For aged and excess stocks, either sell at whatever price to move it, or use as a donation to

a charity or community group – don’t forget to advertise that you have made a donation.


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6. Keep accurate stock records and match the records to a physical count regularly – at least

once a year. If there are large variances, do more often and identify why there is variance

and fix it.

7. Understand your stock, which one move quickly and which ones are seasonal etc. This will

help you know how much of each line of stock to keep on hand and when re-order is

required.

8. Use stock management system to tack stock items. This will help with both:

Automating re-order requirements

Matching different stock items to sales and identifying high margin sales easily

Managing Suppliers Payments

The payment of suppliers will impact your cashflow. Often start up businesses will have to pay

suppliers in cash upon delivery of goods or services because it is difficult to purchase the goods

and services on credit. Making full use of your terms of trade with your supplier is effectively an

interest free loan. Therefore, it is important that you manage your suppliers and the payments to

them in the same way as you manage the other key components of the working capital cycle.

1. Supplier Selection

Determine what is the priority from your supplier – is it quality, reliability, returns

policy, price, terms or a combination of some these factors.

Prepare a list of preferred suppliers.

Undertake credit and trade references for each on the list.

Select supplier/s based on the priority and results from credit and trade checks.

In the event that you chose one main supplier, be sure that you have an agreement

in place with an alternative supplier to cover any risk that the chosen supplier

cannot provide the agreed service at any time.

Regularly monitor the selected supplier/s against your profits – as the business

grows, often the priorities change.

2. Payment terms

Negotiate the payment terms with suppliers before entering into the transaction.

Document standard payment terms on each purchase order.

Calculate benefit of taking discount for early payment.

Ensure that all suppliers are paid on agreed terms, not earlier.

Where damaged goods or unsuitable goods are supplied have an agreed process

on place. Do not hold payment without communicating to the supplier that there is

an issue.

Review the terms with each supplier regularly – if you find an alternative supplier

that can provide better terms, discuss this with your existing supplier before

changing over – your existing supplier may be able to match this and will

appreciate the loyalty you have shown.

3. Maintain Creditor Relationship

Meet regularly with main suppliers to discuss progress of your business especially

for credit terms and new products.

Ensure that agreed payment terms are adhered to.


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Ensure that there are processes in place when suppliers are not paid on time i.e.

they can contact someone to discuss.

Where payment to suppliers need to be delayed, communicate with them and if

possible, set up an agreed payment arrangement – and make sure you stick to it.

Be seen as a solid, dependable customer.

Tips for working capital cycle

Extend payment terms.

Lengthening the payment days from 30 days to 45 days could assist in smoothing out

fluctuations in cash flows.

Some larger companies may accept quarterly payment, which can help in forecasting cash

flow requirements.

Payment terms should specify that payment terms commence from complete delivery.

Where goods are returned either:

- A new invoice should be raised and this is the invitation of the payment terms.

- Or disputed invoices held over until a credit note is received.

Initiate a structured payment run, usually once a month (i.e. on the last day of the month)

and stick to it.

Ensure that your systems have good controls so that suppliers are not:

- Paid early – where financial systems are used, ensure that payment date is automated

from approved supplier details and no changes to automated date is possible without

authorisation.

- Over paid – all received goods are checked to purchase order and totals on invoices

checked.

- Paid twice – pay only on statement.

Continually review supplier contracts for opportunities such as:

- Improved pricing

- Effective discounting

- Improved delivery

- Removing any incremental pricing included

Managing work in progress

Work In Progress (WIP) is where an order has been taken from the customer and you are in the

process of “working” to complete the order. You will be required to have efficient and effective

management systems in place to do this process in a manner to maximise the return.

Managing Work In Progress is vitally important because the quicker the job can be completed,

earlier the invoice can be raised and hence the cash received for the job.

Productivity

Focusing on each element of the cost of doing business will lead a team to look more clearly at

each of the resources consumed. In order to have productivity increase, there must be physical


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change. Productivity cannot be improved through financial engineering. The principal thrust is to

eliminate waste that is relentless, never-ending pursuit of eliminating waste in all of its forms.

Without calling it waste, most workers accept their wasteful practices as a normal routine.

Eliminating waste, therefore, requires an organisation-wide mindset that:

1. Admit all processes contain waste

2. Puts tools in place to identify it in a non-blaming environment

3. Allows employees to eliminate it.

The right performance measurement system must:

• Support the company’s strategy

• Be relatively few in numbers

• Be mostly non-financial (quantities not dollar)

• Be structured to motivate the right behaviour

• Be simple and easy to understand

• Measure the process, not the people

• Measure actual results versus goals

• Not combine measures of different things into a single index

• Be timely, e.g. weekly, daily or hourly

• Show trend lines

• Be visual

The goal of performance measurement should be to manage processes, not result. In

organisations that manage results tend to accommodate the symptoms of problems by adding

more non-value added activities, distorting the system and achieving results at the expense of

other areas. In most cases, managing results creates self-deception. In the worst cases,

organisations go as far as creating false financial statements.

Once an organisation changes its orientation from managing results to managing processes – and

is supported by an intelligent performance measurement system – employees will feel free to

publicly identify defects and waste without fear. This is about establishing a robust mechanism for

instituting process improvement and creating an environment in which true long term

improvements can be achieved.

Good record keeping system

Ensure that all orders are recorded when taken and all relevant details are noted i.e. when

order is due, any deposits are paid, any progress payments to be invoiced, how long the job

takes to complete, additional costs incurred in completing the job, etc.

Have procedures in place to track all outstanding orders and rank by priority. The

procedures should highlight any actual or potential delays and have steps outlined for

action when delays occur.

When an order is completed, ensure the invoice is raised immediately ready to go with the

goods.

The record keeping system should provide details of expected completion, delivery, invoice

date and therefore provide information on cash receipt to assist in cash flow forecasting.

Tips

Only order stock when ready to use, effectively reducing the number of days held (and

hence paid) before production begins – LEAN “Pull” System.


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Identify any “bottle necks” in the production process and look for improvements.

Look at the process, including the physical layout of goods, and identify possible

improvements to “speed up” the movement through WIP process.

Ensure you know how much stock you need to have on hand to complete the order before

accepting the order – delay in receiving goods is delay in preparing the sale.

Review WIP procedures regularly to identify possible procedures or technology that could

improve in the progress life cycle.

Where specific materials are required for the customer order, ensure including in your

order an agreement for the customer to pay a deposit front before order is commenced.

Managing Debtors

Sales income is the driver of all businesses and converting the sales into cash is one of the most

important processes in any business. Where sales are offered on credit, financial systems will refer

to the amount outstanding as a “debtor.” Managing the payments from debtors can consume a lot

of wasted effort if there are no proper procedures and control in place. Also it is important to

ensure that you have good procedures in place to encourage your customer to pay on time and the

correct amount.

1. Setup Credit Control

Undertake a credit check for all potential customers. Have a system in place that

documents each credit check to ensure that the process has been properly undertaken.

Rank all customers by credit risk. This could entail length of time they have been in

business, quality of credit reference from their bank, credit limit allowed for each customer

etc.

Have a process in place that will set appropriate credit limits for each customer. The limit

should be set in accordance with credit risk rating as set above.

Set regular review periods for credit checks of all existing customers – during tough times,

it is likely that their credit status may change.

Make sure that your system track customers’ outstanding credit and notifies relevant staff

if the limit has been exceeded – ensure that this notification happens before the next sale.

Document procedures that need to be undertaken when credit limit is exceeded and

ensure that all relevant staff are aware of what needs to be done.

2. Establish payment terms

Document standard payment terms on each invoice.

Ensure all staff (including sales representatives) are aware of the payment terms and that

they stick to them.

Implement systems to ensure that all payment terms are met. Send out regular reminders

and follow up on late payments.


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Have a policy and process in place for returned goods to ensure that payment is not held

over for any length of time.

3. Maintain Customer Relationships

Meet regularly with your customers – sometimes visiting their premises will help you

understand their business requirements and financial position.

Review the actual payment with the agreed terms for each customer regularly – if you find

a customer is continually paying outside of the agreed terms, meet and discuss this issue.

Ensure that there are processes in place for customers when products or services are not

provided as expected (returned goods). Have a policy that covers how to correct this issue.

Where an order or delivery is going to be delayed, communicate with them and discuss

alternative solutions.

Be seen as a solid, dependable supplier to your customers.

Tips for working capital cycle

Send out invoices as soon as work is completed, not at the end of the week or month.

Provide incentives to pay early – discount but know the impact on profit margin.

Make it easy to pay – direct debit arrangements, EFTPOS or credit card.

Where commission is paid to sales staff, pay on amounts collected, rather than on total

sales amount booked.

Run regular reports to identify when payments are due – aged debtors report.

Identify slow paying customers and make contact early to discuss any issues – faulty goods,

inadequate service, inability to pay etc.

Make arrangements for non-paying customers – payment plan to clear the debt.

Monitor non-paying customers and keep in regular contact.

Have a policy to stop supplying customer until all debts are cleared.

Send letters of demand for long outstanding debts.

If necessary, use a professional debt collector.

Consider cancelling credit agreements if they are unreliable with payment.


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Cash Conversion Rate

Days stocks + Days Debtors – Days Creditors

Regularly calculate your cash conversion rate and implement improvement to your working capital

to “free up” idle cash that is being used within the business. This will reduce the requirement to

borrow additional funds to support the operations of the business, hence reducing the reliance on

funds from financiers and also reduce any interest expense incurred.

10.4 Cashflow Management

Cash on hand or at bank in your business does not match with the profit. This is due to credit sales

and purchases. It is all about timing. Profit of a transaction is calculated when sale is made. If you

are in business that offers goods or services on credit, then the profit is assessed at the time of the

sale, but you may not receive the cash until sometime later.

Cashflow drivers in your business

Identifying the drivers of cashflow in your business, it will be easier to manage your cashflow. For

most small businesses, this will be sales. However, it could be some other factor or multiple factors.

Accounts receivable (Debtors)

The collection of the cash from sales is the critical aspect to ensuring that you have cash in your

bank. Hence, it is important to ensure that there are good procedures in place converting the sales

to cash as quickly as possible.

Accounts payable (Creditors)

Where the supply of stock or services is critical to your business, then managing your supplier

relationships will be important. Ensure that you pay them on time and maintain a good relationship

will be critical.

Stock

Maintaining the right amount of stock will have an impact on cashflow.

Capital expenditure

Where a business is reliant on having the most up to date technology in order to keep market

share, then spending on capital expenditure can be a key driver of cashflow. Investing on R & D

activities, purchasing production machineries are the examples.

Liquidity Management

The basic requirement of cashflow management is to preserve the liquidity of your business so that

debts can be paid as and when they fall due. Therefore, there is a need to keep tight control on

movement of cash and forecasting changes in cash availability. To achieve this goal, you need to

prepare strategies to deal with any sudden, unexpected liquidity crisis. This includes regular

cashflow monitoring through cash flow management plan and ensuring that you have access to

finance in case of emergencies.

The cash management plan should cover all expected cashflows over a selected period. For most

businesses, a cash management plan should be done at least once a month. With cashflow

forecasting and variance analysis (the difference between forecast and actual), you should have


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better management on your cashflow. For more information for cashflow forecasting, see chapter

10.5.

Capital Investment

It is important for any business to secure long-term growth and viability by investing capital into the

business. Capital investment supports the allocation of resources that are required to undertake

business activities.

To ensure that business performance operating effectively and efficiently, continual capital

investment should form part of the overall long-term objectives of the business.

Keep an asset register that records all important information of each asset, including

purchase date, maintenance records and effective life to identify when the asset may need

to be replaced.

Ensure that capital investment (both assets and other resources such as staff) are a

separate item considered during each strategic planning stage.

Understand which capital items contribute to the improvement of business performance.

Figure 26. Cashflow Goal setting and “What If Scenario” test

10.5 Budget & Forecast

Cashflow forecasting

A cashflow forecasting is the most important tool for business. The forecast will predict the ability

of your business to create the cash necessary for expansion or to support the operations of the

company.

There are few ways to use a cash flow forecast as a planning tool:


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Short term planning to see where more cash than usual is needed in a month, for example,

when several large annual bills are due, and the cash in the bank is likely to be low

Business planning (long term planning) to find where cash flow could break the business,

especially when the business wants to expand.

The easiest way to prepare a cashflow forecast is to break up the forecast into smaller areas and

then bring all the information together at the end.

The five steps to preparing a cashflow forecast are:

Preparing a list of assumptions

Prepare the anticipated income or sales for the business (sales forecast)

Prepare detail on any other estimated cash inflows

Prepare detail on all estimated cash outflows

Prepare your cashflow forecast by combining all the details together

Assumptions

To ensure that your forecasts are going to give you a useful tool to use, you need to plan what you

think is going to happen in your business in the future. When determining your assumptions, it

would be best to use realistic targets that you believe will be achievable. Using your historic

financial information and looking for any trends in this information is a good place to start. Also,

any industry information provided by independent reputable companies will give your assumptions

credibility.

Make sure that you write down all of the assumptions that you have used in preparing your

financials and attach them to your forecast. This way, you will remember what you anticipated to

happen and when reviewing your forecast against actual, this will help to figure out why the actual

may not be the same as you forecast. When listing your assumptions, if you believe that there is

some risk that the event may not occur, include this detail with the assumption and any actions

that you may have thought of in the event that a particular assumption turns out to be incorrect.

That way, you will already have an action plan in place.

The below table shows some examples of assumptions that may be taken when preparing your

forecasts.

Assumption Forecast Source Risk Action Plan

Sales Increase by 2.5% Prior 3 years

&

Industry Outlook

Sales remain flat

or decrease

Strengthening

marketing

program; Review

stock holdings

and operating

expenses; New

product

developments

Cost of Goods

Sold

70 % of sales Refer to table

prepared

Stock price

increase

Source new

supplier; Review

productivity

Salary Expenses Increase by 5% Prior year

historical data

and new

recruitment plan

Increase greater

than 5%

Review staff

productivities;

Process

improvement


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Sales forecast

Estimating sales is one of the most difficult in the forecast process. Business sales will be

dependent on many variables including the types of customers you have, the terms you offer your

customers, economic events or competitions with other businesses. Although it is difficult to

forecast, it is possible that you focus on determining a ‘realistic’ figure for the sales of the business

over the period for which the forecast will be prepared.

For existing businesses, the best starting point will be looking at the last year’s sales records and

determining a ‘realistic figure in this forecasted period. Once you have determined the sales for the

period, the next step is to break these numbers up into ‘sales receipts.’ If the business is purely a

cash business, then the sales will be equal to the ‘sales receipts’ number. However, where credit

terms are the proceeds from the sale and this is where we need to estimate the timing of receipts.

For this, looking at the past receipt pattern is helpful to predict future sales receipts. Following

example is prepared to help you understand better.

Sales receipts collected in month following sale 60%

Sales receipts collected in 2nd month following sale 30%

Sales receipts collected in 3rd month following sale 10%

By following above procedure, you can calculate the estimated ‘cash receipts’ from sales as shown

below example.

Monthly

Credit Sales

Totals

$ Jan. 2012 Feb. 2012 Mar. 2012 Apr. 2012

Dec. 2011 50,000 30,000 15,000 5,000

Jan. 2012 60,000 36,000 18,000 6,000

Feb. 2012 50,000 30,000 15,000

Mar. 2012 70,000 42,000

Total cash

receipts

30,000 51,000 53,000 63,000

Other cash inflows

To complete the cash inflow information, you will need to account other cash inflows apart from

receipts from sales. This could be another source of income or proceeds from loan. Below is the list

of possible source of cash inflows.

Tax credits

Proceeds from sale of assets

Dividends income

Government grants

Insurance payout

Cash outflows

When you prepare sales forecast, it is suggested to calculate cost of goods with it. By doing this, if

you need to change your sales numbers, an automatic change to the cost of goods sold figure

should be available. If the sample business exampled above accounts 70% of sales as cost of

goods sold, the following table shows how they then forecast their cost of goods sold.

Sales ($) Cost of goods sold

as % of sales (%)

Cost of Goods Sold

($)

Dec. 2011 50,000 70 35,000


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Jan. 2012 60,000 70 42,000

Feb. 2012 50,000 70 35,000

Mar. 2012 70,000 70 49,000

Total Sales 230,000 161,000

Expenses

Expenses are those cash outflows that relate to the operations of the business that are not

included in the calculation of cost of goods sold. The type of expense will depend on the type of

business. Classification of expenses into variable and fixed is important part of expense forecast.

Variable expenses are dependent on sales level (volume) while fixed is not. For example, sales

commission based on sales figure is variable but rent is fixed.

Other cash outflows

In addition to cost of goods sold (or direct costs) and operational overhead expenses, the business

may have other cash outflows during the operations of the business exampled below:

Purchase of assets (capital investments)

Loan repayments

Dividend payout

Unexpected warranty expenses (products recall)

Tax (GST, Income tax etc)

Finalising the cashflow forecast

Once you collected all the information specified above, then you are ready to prepare cashflow

forecast statements. First, you need to determine the time period of the forecast to cover, then

take account the opening cash balances for the cashflow. The closing cash balance at the end of

each period (usually a month), will become the opening balance of next coming month.


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Chapter 11. Managing Business in Tough Times

11.1 Financial Health Check

Regular check of your financial position is vital especially in difficult times as it only

gives you whether the business you are running is viable and maintains the position for future

growth. Have sometime with your financial statements from your software and do some simple

calculation such as liquidity ratios, debt cover ratios and ROI. This will give you the preview of your

business performance in these uncertain days of time. If you don’t understand what the ratios are

telling you, then arrange a meeting with your accountant. He or she will have no problem to

interpreting the numbers and will tell you what to do with your business. 11.2 Cash Flow

In tough times, it is normally more difficult to collect outstanding debts, but it is necessary you to

survive. Please discuss with your debtors in early stage especially if you believe they are in

financial risk now. Preparing regular cash flow forecasting will help you to outlook the cash position

of your business in short term and long term. Also it could be wise for you if you use full terms of

trade with your suppliers or renegotiate with the major suppliers about the payment terms. Having

excessive stocks are not a good idea as they are holding your cash until they are sold. Lean

management tells you why. If you can sell some NOT-REALLY-NECESSARY assets, sell now if your

forecast is telling you that your business will have some tough time. Have a chat with banks or

financiers like debtor finance to source your cash needs.

11.3 Profitability

A profitable business is a successful business. Along with sufficient cash inflow, make sure you

work for profit with the tips below:

Prepare regular financial statement to check your performance (what can be measured is

more likely to be achieved).

Focus sales with highest sales margin.

Don’t discount unless you can achieve the same or better gross profit through increased

volume.

Control costs.

Be flexible with your staffing.

11.4 Updating Marketing Plan based on Opportunities

Your marketing plan must be reviewed and is focused on achieving key objectives to get you

through the tough times.

Focus on chasing sales that have a high margin and bring in the cash quickly.

Reward staff for sales of higher margin products and when payment is received.

Measure the success of each promotional activity or campaign and focus on encouraging

customers to pay at the point of purchase or to pay early.

11.5 Risk Management Strategy

Review your business position and conduct risk analysis particularly if you are one of below points:

Relying too much on a small number of major customers and suppliers

Selling on credit

Reduction in demand for your goods and services


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Fraud

11.6 Exiting Your Business

If you believe that your business will not survive with this tough time, then consider winding up your

business. There are several ways of business winding up including selling, passing on the business,

merging, closing down and liquidating(CPA Australia, 2011).

Selling the business

If your business has been any sort of a success, you probably had to pour most of your resources

and a lot of time into your business. A business is therefore a big part of the owner’s and owner’s

family’s life. It may be difficult to imagine life without the business.

Whatever the business owner’s situation, selling the business is still one of the most important

things that they will ever do because this decision is a final one and there will be only one chance

to put the anticipated price tag on it.

The major issues that need to be addressed when it is time to sell your business include the

following:

Valuation of the business – from the owner’s point of view, the aim is to maximize the gain

that is obtained from the disposal of the business, but is constrained of course by what the

market perspective as the value.

Who will buy? – the owner may need to consult a business broker or other professional to

arrange the sale so that it is put before as many potential buyers as possible.

Selling issues – all the issues involved in the sale such as the time to sell, what is sold or

what assistance to give after the sale will have to be settled.

How the deal is structured – the terms of the deal such as payment terms and taxation

implications will need to be brought into the calculation.

Financing the sale – a decision has to be made as to whether the owner will leave some

financing in the business or whether this will be a clean all cash deal.

Completing the sale – The full process from the initial letter of intent through to the final

closing of the deal should be made very clear to the owner so that there is no room for

confusion.

Make the offer known

There are number of ways to let buyers know your business is for sale. The best channels will

depend on the business and the circumstances but the following methods are among those that

are commonly used:

Use of business brokers or real estate agents

Newspaper advertising

Trade publications and other trade contacts such as suppliers, distributors,

manufacturers etc

Word of mouth


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When you decided to sell your business, you should also decide on whether to reveal the pending

sale to your customers, employees and suppliers before the sale is completed. Sometimes prior

publicity of the sale can harm the future of the business making it less attractive to a prospective

buyer and less profitable to the seller. One of the best ways to arrange a sale is to deal through

business brokers or real estate agents who specialize in selling businesses because they can

handle the complete transaction confidentially and professionally.

Handling the buyers and closing the sale

The seller’s ability to present the business in the right way and handle the transaction properly will

enhance the chance of obtaining a good price and protection.

The seller should do the following:

Consult a competent accountant and lawyer and discuss their requirements.

Define the strong points of their business so that these can be emphasised in negotiations.

Make sure that business records are tidy and complete and available for inspection when

necessary.

Ensure that time is not wasted on non-serious buyers and those without sufficient capital

or the background and experience to carry on the business.

Check the track record and reputation of the serious prospects because if the next owner

fails to make a success of the business it could mean final balance owing to the seller may

be lost.

Check the proposed financing arrangements and ensure these are clearly outlined in the

agreement.

Make sure that other matters such as the transfer of hire purchase agreements on assets

etc have been cleared. If not cleared, an adjustment should be made in the calculation of

the purchase price.

Close the whole deal through a competent solicitor and obtain professional tax advice to

the tax implications by correctly structuring the arrangements.

Main Point when Selling

Reasons for selling

The amount of business worth

How is the sale to be finalised

Reasons for selling

There are many valid reasons that bring a business on to the market. Some of these are:

Retirement of the owner because of age or ill health.

Another opportunity that has come up in a different field and therefore the present

business need s to be sold.

Advancement of technology that current owner is unable to cope with the latest changes

and thus prompt him to find something else.

Declining business.

New competition affecting the turnover.

Expiry of a lease or franchise.

The facilities becoming obsolete and thus not being able to efficient enough to compete.

The bad reputation of the owner which may have caused a drop in sales.

A new shopping centre is being planned a short distance away and this will affect the

future of the business.


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There are many reasons that a seller could offer and the cautious buyer would assess fully the

situation before committing to buy. This assessment may involve canvassing the area to find out

from other traders what is happening and having discussions with the local council and real estate

agents as to proposed change, which may affect the operation.

The reasons for selling therefore need to be in order so if you are selling up, be aware of this.

What is your business worth?

The industry in which the business is operating develops it is own rules of thumb by which a

business is to be valued. These rules of thumb or formulas can be used to arrive at the

approximate value of a business.

The sale of a business involves a long-term investment of both time and money by the buyer with

no immediate guarantee of return. Therefore one of the most important things that must be

considered when calculating the value of a business is its future earning profitability. This is the

main point in assessing the attractiveness of a business and it should be the basis on which the

selling price is weighted or measured when considering fairness and acceptability.

To estimate the potential earnings power of the business the buyer will try to find out about past

profits, past sales and operating ratios. To evaluate all this information properly the buyer may

need an experienced accountant who can investigate and analyse this information. The accountant

will need to obtain copies of financial statements and other records of the business for past three

years plus the income tax returns for the business to make sure that the figures being shown have

also been the figures that have been supplied to the Tax Office. See more information about this in

Chapter 2.3 Due Diligence.

What will the buyer analyse?

The detailed breakdown of sales and operating costs for the past years can be analysed by the

potential buyer to indicate the trends in the business. They will then be compared to other similar

businesses in the same trade. The buyer is well aware that there are people that ‘cook the books’

when they are looking for a sale so approach the sale with honesty.

The buyer may believe that records have been arranged to suit the seller’s purpose. Show business

tax returns to prove that tax has been paid on the high profits that are claimed to have been

earned. This is not a good idea that you give evasive answers to the buyer’s questions or providing

excuses. The potential buyer will know that refusal to give full explanations and information, or to

have figures audited or examined by an independent advisor means that it would be better to walk

away and cancel the whole deal.

What the buyer will check over

The first thing that a buyer must do in assessing the business that is available for purchase is to

review its track record and history and the way it operates. This includes a full investigation of the

financial records, as well as its staff, customers, suppliers, competitors and its marketing

procedures.

The things that the buyer will look at are:

Financial records

Debtors and creditors

Employees

Customers


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Premises

Location

Competitors

Lease

Patents and trademarks

Outstanding legal matters

Insurance

Marketing methods

Licences and permits

Stock

Fixed assets

Three things you will want from buyers

A seller is not obliged to complete a deal with a buyer without knowing a little about the buyer’s

background and the ability to meet commitments. The seller will be concerned that the buyer is the

right person, otherwise the buyer could destroy the business and seller finance will be lost if the

seller is financing part of the price.

It is up to the business broker to provide details to the seller about the buyer’s situation. However,

there are three main things that the seller requires from the buyer.

1. Background and financial position – the seller must be convinced that the buyer is

someone of good standing who will take over the business and look after the clientele and

staff in the normal way, if the buyer has been a bankrupt or has a history of business

collapses, or perhaps a criminal record, then these matters will be of concern and will

affect the seller’s decision to proceed or to close off negotiations. The buyer needs to

provide evidence to the seller via the broker of financial net worth.

2. The seller wants a good offer – the seller of the business will want as high price as possible

and the buyer naturally will be wanting to outlay as little as possible. During the

negotiations, the parties should arrive at a fair offer that can be taken as the fair value of

the business. This fair offer may differ dramatically from the price originally listed and may

be influenced by the appraisal of the business by the broker or by a separate valuation that

has been commissioned by the buyer. In any event the deal will have more chance of

succeeding if the offer is a fair one.

3. A good deposit – the buyer must be able to put down a fair deposit in order to obtain the

confidence of the seller. Generally a deposit of up to 10 per cent of the purchase price is

expected. If the deposit is too low, then the seller will always feel that, should the buyer

breach obligations, the amount at risk is not sufficient for the buyer to comply with the

terms of contract. For a seller to be seriously interested, the buyer must make a

commitment by coming up with a reasonable deposit.

How is the sale to be finalised

The seller will want the greatest return of the years of hard work put into the business in the past.

The buyer however is interested only in the future and thus both parties can put a different price on

the same business while both are being quite reasonable. Negotiation between the two parties is

the process by which the gap between the two prices narrow.

Before carrying out the final negotiations the buyer will be fully aware of the book value of the

assets and the maximum amount of money that he or she can pay for the business to obtain a

return on the investment required. The investment return needs to equal or better the buyer’s

salary plus a return on the equity (ROE).


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Remember that negotiations will not be entirely in money terms. Other details such as the name of

the business and job security of the staff etc should also be brought into discussion. Other main

points to be finalised include terms of payment, assistance by the seller during transition, and the

conditions on terms to be included in the contract for sale and purchase.

Terms of payment

It may be best to put a low value on the assets (stock, plant etc) and make the goodwill figure a

high amount because goodwill is not taxable as such. The buyer however, will try and get the

reverse due to tax consequences.

One way of bringing this conflict between the two parties is to have the assets valued highly and

then the seller work in or act as a consultant to the new business after the new owner has taken

over. The wage paid will be tax deductible to the buyer and the seller will have to pay tax on income,

but because of this saving to the buyer it may be possible to give the seller a higher wage to make

up of the tax paid. Usually in finalising the terms of payment the two parties through their

accountants arrive at a fair compromise.

Assistance during transition

The buyer may want to have the seller assist for a short period after the sale so that the new owner

can be introduced to important customers and be shown the procedures of how to operate the

business in the most profitable manner.

The sale and purchase agreement

As a safeguard against any costly errors, legal advice should always be obtained before any

agreement is made up and signed. The agreement should always be drawn up by a lawyer to

ensure that all essential points are covered and that both parties know exactly where they stand.

Among some of the points that should be included in a typical sale and purchase contract are:

A description of what is being sold.

The purchase price.

The method of payment.

A statement of how adjustments are to be handled.

The buyer assuming responsibility for the business from a certain date.

Warranties by the seller, if any.

The covenant of the seller not to compete within a certain time period or within a certain

area.

The time, place and procedure for “closing the deal”.

Closing down the business

Closing down simply involves closing the door, selling of all the assets of the business, paying off

all the debts and whatever is remaining goes back to the owners. This is not a usual choice unless

the business is not doing very well.

The scenario for closing will often be:

Set a date for closing and cut-off of everything.

If the business has a lease or premises, then arrange it so that closure is at the end of the

lease, or come to an arrangement with the landlord.

Advise all suppliers and associates that the business will be closing on such and such date.


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Advise all customers of the same details, although make sure that they are advised a few

days before actual closure so that the business obtain maximum benefit of profitability

right up to the time that the doors are actually closed.

Sell off all the assets of the business and pay off all the bills.

Arrange for everything to be disconnected, such as telephone, power etc if applicable.

File all the necessary returns and financial accounts through your accountant.

Close the doors, take the balance of the money remaining after paying all the debts and go

and have a holiday.

Business Succession

If the business is a family business, then the current owner may wish to just pass it on to the next

members of the family. Succession is a process that requires proper planning and teamwork

between the owner and family members. Succession also could mean the sale of the business to

loyal employees or to others like that who have worked with the owner for many years and are

entitled to have first choice of taking over the business with the owner gone. However, the greater

incidence of succession involves the transfer of ownership to the family so that everything is kept

within the family.

Generally a succession plan will have two main factors:

1. Transfer of power – the management and control of the business is transferred over the

‘anointed’ family member chosen.

2. Transfer of assets – the wealth concentrated in the business operation is transferred to

family members in the normal way.

When transferring a family business from the older generation to the younger generation, the older

generation must get the value they deserve out of the business. One of the best ways of achieving

full value for the older generation is simply selling the business off to family members.

In this case, a proper professional valuation will need to be put together so that both parties are

happy. If selling the business in this way, it is important before the completion of the sale to

organize what structure the buyers will run the business under. Forming a family trust to own and

operate the business would be an option that should be considered because of tax implications

and other advantages.

This type of procedure is often used where the owner may want to gift the business to the children,

yet still run it through a family trust, to enable proper structuring for the maximum benefit of the

new acquisition.

Planning

A business is considered for transfer to family members, then the plan needs to be prepared early.

For smooth succession, there are number of factors that should be considered.

Family – to avoid any sort of favoritism, many owners leave the businesses to their children,

all in equal shares. Unfortunately, what happens is those family members often don’t see

each other and the differences of opinions and arguments can hurt the business.

Qualification – the successor needs to qualify by having the experience and hopefully

working their way up in the business.

A Board – before the business is handed over, it is advisable to set up a board of directors

consisting of non-family members. The incoming family owners should then take advice


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from the board and because they are not involved in the family the business is

strengthened and hopefully a lot of the problems that come through family arguments will

be taken care of.

Take your time – Plans for succession need to be well thought out and the replacement

managers must be made very clearly aware of their responsibility in continuing the

business along the same successful lines as it has been done in the past.

Merging

A merger is when two companies agree that they want to go forward as a single operation rather

than being two separate entities. Mergers are often driven by the competitive landscape. When

times are difficult, strong companies seek out other companies to see if the combination of the two

will create a more competitive, cost efficient operation than either one currently is (Synergy Effect).

Often what happens is that these parties contact one another to see if a merger can be effective

and to see if some of the business and staff can be retained. The whole idea of the merger is that

the CEOs agree that continuing the business alone is not the best thing for either company, but by

merging with each other both should benefit.

Some of the benefits come through from efficiency gains resulting from combining administration

and other similar functions. There will also be better cost efficiencies and the combined group will

end up with a much higher profile in the industry, which gives more confidence to those with whom

their new operation deals.

An acquisition of one company by anther is a little different from a merger but does not vary by

much. All of the above reasons for combining the two companies apply, but instead swapping

shares or consolidating under a new corporate entity, one company simply buys the other company.

It is also called ‘takeover’,

In an acquisition a company can buy another company out with cash or with stock., or with a

combination of the two. The difference between the merger purchase and an acquisition purchase

depends on whether the purchase is friendly and announced as a merger, or whether it is

announced as an acquisition and whether the purchase is unfriendly, in which case it is always

called an acquisition(HumphreyNicholas, 2004).


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Part III: Financial Health Check &

Improving Value

In this part, we examine the

importance of financial health

check along with business

evaluation to increase business

value. Various financial ratios are

used to check business viability.

ROI can be increased via

improving business process and

control.


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Chapter 12. Business Health Check & Evaluation

We humans are sometimes have symptoms that require doctor’s attention. In general, the

earlier you identify your symptoms, the higher the chance you have to fix the ill-health. Businesses

are same. When a business has symptoms of ill-health, it should be checked and needs to take

required actions to make the business healthy.

Business health check is a process reviewing your business in general, and this includes inside

and outside of the business. The general symptoms to look for are:

Customer / Supplier relationship

Internal checks including staff performance level, financials and policies

Whole business direction

Customer / supplier relationships

Customer requests and orders get misplaced or not following through

Quotes and invoices contain errors or are not sent out

The word ‘sorry’ becomes a common part of the conversations with customers and

suppliers

Invoices are not paid on time

Requests for credit references are rejected

Limited credit purchase or shortened credit terms

Reduction in the amount of contact you are receiving from customers and suppliers

Internal Symptoms

Employee job satisfaction is low with increased sick-leave, late arrivals and early departure

Finger pointing culture

High staff turnover

Tight cashflow

Lower profitability in unit level and whole business level

Business directions (reality check)

What the business actually is vs. what you hoped it would be

Short term and long term future of the business

Understanding the economic and competitive environment

Actions required

Rather than scratch the itch, take the time to understand why it is there.

Customer feedback and assessment about price, product / service range, service levels,

communication and relationship management.

Take action on their (customer’s point of view) – customer value oriented.

The principle that the organisation and every position in it exists because what is required

to be done takes more than one person to do it – organisational change.

If you discovered that the business is no longer the business you thought it was, then you have two

choices. Change it back, or adjust to the new reality. Either way, working through the customer and


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supplier feedback and reviewing the internal business processes will improve the health of your

business.

If you have discovered your business is in no fit shape for the challenges ahead, then it is time to

review your company’s direction. Alternatively, it may simply be that you are no longer prepared to

go the distance, in which case it might be time to consider selling the company while it is still in

good shape.

12.2 Business Evaluation and Value Increase Strategy

Evaluating the business performance is one of the pivotal management tasks as it identifies the

potential business problems and alarms the positive and negative signs of business performance.

Business owners and managers will have the credible information through the evaluation process

to rectify the problem areas of business and plan future business activities for successful growth of

the business.(CPA Australia, 2011)

When evaluating the business performance, it is important to understand how the business

operates along with its own key drivers of business performance. When you evaluate the business

performance, it is highly recommended to use the most recent financial data including recent

financial reports and Business Activity Statements lodged to ATO. If you have highly reliable

business software, you can easily extract the information required for the evaluation. More

frequent evaluation is required if the business is undertaking a project to improve the financial

health and overall business performance to guide the project under control. By doing this, business

owners and managers will become more proactive in their business decision making processes

with well defined road ahead.

Business evaluation is not necessarily limited to financial performance of the business, rather, it is

highly recommended to undertake non-financial performance evaluation as this eventually impacts

business financially. The non-financial key drivers could be the lead time for certain business

processes or employee absenteeism rates during particular period of time.

Business evaluation involves business assessments from various information sources in order to

identify the true pictures of the business operations and the key drivers of the business. Collecting

information from interviews, physical observation, policies and procedures and financial record is

essential part of this assessment stage.


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Figure 27. Graphical Presentation of Return on Investment 3

Above diagram indicates the relationship between ROI and each part of business. The reality is that

ROI is merely the complex reflection of all the activities of every individual on every day of the

period being measured. In other words, ROI is the attempt to encompass everything in one number.

It becomes clear that if we focus on measuring improvements in how people work those

improvements will roll up into an improved ROI.

Employees can more easily relate to processes, since every person uses some type of process

every day. So we focus on improving the process by highlighting performance measures that are

focuses and less all-encompassing than the final ROI. This focus on improving the individual

elements of the process, by eliminating waste and increasing velocity, has great impact on the

bottom line, but only when we are not focused exclusively on that bottom line. The winners will be

companies that focus on process first, not results. (CunninghamJean & FiumeOrest, 2003)

Information Analysis

Once you obtained all the relevant information regarding business operations and the key business

drivers, then a review of the information should be conducted to analyse below:

The past three years of financial statements

Documented policies on key operational areas such as pricing, buying, inventory

management, internal control, supply chain management, staffing etc.

The value stream map4

3 Source: Real Numbers: Management accounting in a Lean Organisation 4 You will be more familiarised with value stream map once you read Chapter 13. Increase ROI with Lean Six Sigma.


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Employee job descriptions

Compliance documents and any agreement signed for contract entered for the business.

Industry information. This is particularly important as the business need to be compared

with industry benchmark. The information can be both financial and non-financial. This

comparison will provide measurable information in the same industry

Developing an Evaluation Model and Measures

With the information collected and analysed in previous step, then this information should be

compared with current financial and non-financial information of the business to see the trends of

the business performance which is very helpful for planning the future progress of the business.

The five key areas below is the most important indicators of business success(CPA Australia,

2011):

Profitability

Cashflow, liquidity and solvency

Efficiency

Business planning, both financial and operational

External issues and trends

Although each of these areas are interlinked each other, it is preferred to separate each area so

that the each part can be analysed and clarified before looking at any casual relationships within

the outcomes.

Profitability MeasuresNo index entries found.

The success of any business comes with profitability, and this is the managers’ the most important

task. A profitable business should ensure the business operations are in line with the overall

business strategy.

Measuring business profitability can be done by applying the information to various financial ratios

specified below.

Measurement Formula Description

Gross Profit Margin Gross Profit / Net Sales * 100 The percentage of sales

dollars remaining to pay

overhead expenses after

deducting cost of sales (Cost

of Goods Sold). This analysis

will assist you assessing the

efficiency of pricing, stock

purchasing procedures and

handling as well managed

stocks

Mark-Up Gross Profit / Cost of Sales *

100

The percentage difference

between the actual cost and

the selling price. It is to ensure

the business sells the

products covering all the costs

incurred with the sales

EBIT Margin Net profit before interest and

tax / Net Sales * 100

EBIT stands for Earnings

Before Interest and Tax, and

this measure can be useful

when comparing against

industry benchmark figures.


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Interest and tax are excluded

when comparing against

benchmark as each business

has different figures

regardless of their business

performance.

Net Profit Margin Net Profit / Total Income *

100

Unlike EBIT margin, net profit

margin includes interest and

tax. This is useful figure when

comparing with different

periods within the business.

Break-Even Analysis Overhead Expenses / 1- (cost

of goods sold ÷ net sales)

This figure tells you that how

many sales dollars achieved

before all the expenses are

covered and actual profit

begins and useful to set sales

targets for the business or for

sales employees. Table 1. Profitability Measures

Cashflow and liquidity measures

A business must have enough cash to run the business, particularly to pay the bills coming in

everyday and the debts the business may already have. A lot of businesses went out of business

due to liquidity problem, and this could be a legal issue for company directors in relation to

insolvency trading. Cashflow, liquidity and solvency must be regularly monitored for this reason.


Cashflow Forecast N/A This provides information on

future cash resources and

how the cash will be applied to

the business. This is integral

part of business planning that

indicates additional funding

requirements in advance so

the business owners and

managers can be prepared.

Working Capital to total sales Total current assets less total

current liabilities / Total sales

This figure indicates how

much working capital per

dollar of sales the business

should be maintaining. The

right percentage of the

working capital per sales

dollars vary business by

business depending on the

item price and inventory

turnover level

Current Ratio Total Current Assets / Total

Current Liabilities

This measures whether the

business hold enough current

assets to meet the debts level

with a margin of safety, and

the acceptable ratio is 2:1

generally though it varies

depends on the industry.


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Quick (acid) Ratio Total current assets less

inventory / Total current

liabilities less bank overdraft

This is the best measure for

liquidity. As it excludes

inventory from the calculation,

it shows the real liquid assets

of the business.

Leverage (gearing) Ratio Total Liabilities / Total Equity *

100

This ratio shows the level of

debt financing against equity

to fund the assets of the

business. Generally, the higher

the ratio, the more difficult to

get further finance.

Debt to Asset Ratio Total Liabilities / Total Assets

* 100

The portion of assets being

financed by liabilities.

Generally, the ratio should be

below 1. Table 2. Cashflow & Liquidity Measures

Efficiency Measures

A business must ensure that it is efficiently utilising and controlling its assets and liabilities. The

measures can be used for this purpose.


Inventory Turnover Cost of Goods Sold / Average

stock held for the period

This indicates the number of

times the stock in the

business has turned over, and

the lower the rate, the longer

the stock is taking to turn

over. This brings issues about

aged and / or over (excess)

stock holdings for the

business resulting liquidity

issue.

Total stock on hand to total

assets

Total stock on hand / Total

assets * 100

This measures percentage of

stock on hand included in the

overall assets of the business.

If high rate of assets is tied up

in inventory and the inventory

turnover is relatively low, it

could be a signal of inventory

mismanagement.

Days receivables Total debtors × days in the

period / Total credit sales of

days in the period

This measure indicates how

fast accounts from the credit

sales are being collected. If

this figure exceeds the trading

terms of the business, it will

be indications of slow paying

customers and potential bad

debts.

Days payables Total creditors × days in the

period / The total cost of

goods sold for the period

This shows how well account

payables are being managed.

If suppliers are being paid on

average earlier than the

trading terms, cashflow will be


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negatively impacted. The

opposite case will be possible

relationship damage with

suppliers.

Total asset turnover Net Sales / Total Assets This measures the ability of a

business to use its assets to

generate sales. The lower the

total asset turnover ratio, the

more sluggish the business

sales are. Each asset item

should be separately reviewed

to identify the problem areas.

Return on Assets (ROA) Net profit before tax / Total

assets * 100

This ratio indicates how

efficiently profits are being

generated from the assets

employed in the business

comparing with the

benchmark ratios.

Return on Equity /Investment

(ROI)

Net profit before tax / Total

equity * 100

This could be the best

indicator for business

performance. This indicates

how well the business efforts

transferred to business

returns. If ROI is lower than

investment returns of others

(such as bank term deposit),

this raises the ultimate

question for the investment

itself. Table 3. Efficiency Measures

Below is a sample variance analysis for the company’s performance against industry average.

Medical Equipments Wholesaling Industry 2011

Statement Date 30-06-2011

Period Length 12 Months

Analyst Ben Youn

Auditor

Accounts Management Account

Benchmark Value Variance %


Drivers

Revenue Growth % 19.09 6.87 177.81

COGS % 43.20 0.00 0.00

Price Change % 0.00 0.00 0.00

Overheads % 37.43 0.00 0.00

Effect Interest % 18.55 0.00 0.00

Effect Tax % 0.00 30.04 (100.00)

Days Receivable 22.19 40.81 (45.63)

Days Inventory 51.44 54.19 (5.07)


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Days Payable 57.24 21.52 165.96

P/E Multiple 0.00 0.28 (100.00)

WACC % 0.00 0.00 0.00

Results Gross Margin % 56.80 0.00 0.00

Profitability % 19.38 0.00 0.00

Net Profit % 18.73 3.62 417.28

Interest Cover 29.48 3.35 779.97

Working Capital % 5.39 0.00 0.00

Current Ratio 2.57 1.31 95.89

Total Liab/Equity 0.47 0.00 0.00

Equity / Total Assets 68.24 0.00 0.00

Asset Turnover 4.68 1.64 185.24

Cashflow 163,038 0 0.00

Borrowed Funds 71,473 0 0.00

0 0 0.00

Debt to Equity 0.10 65.78 (99.84)

ROCE % 90.67 13.11 591.63

Valuation 0 0 0.00

Value Added 0 0 0.00

Figure 28. Industry Average Variance Analysis


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Chapter 13. Increase ROI with Lean Six Sigma

13.1 Business Value (ROI) and Service Process Improvements

Principles of Lean Six Sigma

Lean arose as a method for optimising automotive manufacturing (e.g. Toyota); Six Sigma evolved

as a quality initiative to eliminate defects by reducing variations in processes in the semiconductor

industry (e.g. Samsung).

Fundamental truths of Lean Six sigma:

Quality improves speed and speed improves quality

Reducing complexity improves speed and quality

A study found that approximately 30 to 50 percent of the cost in a service organisation is caused

by costs related to slow speed or performing rework to satisfy customer needs. The development of

value calculations provides the means for mathematically proving that only a fast and responsive

process is capable of achieving the highest levels of quality, and that only a high-quality process

can sustain high velocity. Lean creates process speed (by reducing cycle time) and efficiency

(minimal time, capital invested, and cost) in any process.

In service industry or in service providing departments of any other industry, the costs related to

work that adds no value in your customers’ eyes (“non-value-add”) is higher than in more than in

manufacturing, in both percentage and absolute dollars. The revenue growth potential of improving

the speed and quality of service often overshadows the cost reduction opportunities. For example,

work that adds no value in your customers’ eyes typically comprises 50 per cent of total service

costs.

Lean Six Sigma for services is a business improvement methodology that maximises shareholder

value (ROI) by achieving the fastest rate of improvement in customer satisfaction, cost, quality,

process speed, and invested capital.

Six Sigma:

Emphasises the need to recognise opportunities and eliminate defects as defined by

customers

Recognises that variation hinders our ability to reliably deliver high-quality services

Requires data-driven decisions and incorporates a comprehensive set of quality tools

under a powerful framework for effective problem solving

Provides a highly prescriptive cultural infrastructure effective in obtaining sustainable

results

Lean:

Focuses on maximising process velocity

Provides tools for analysing process flow and delay times at each activity in a process

Centres on the separation of “value added” from “non-value added” work with tools to

eliminate the root causes of non-value added activities and their cost

Provides a means for quantifying and eliminating the cost of complexity

The two methodologies interact and reinforce one another, such that percentage gains in Return

on Investment (ROI) is much faster if Lean and Six Sigma are implemented together.


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One of the central tenets of Lean Six Sigma is that unnecessary complexity adds costs, time and

enormous waste.

Making the manufacturing-to-service translation

From a Lean viewpoint, the unavailability of money in a service environment is just like

unavailable production capacity in a factory, with the same type of consequences. Machine

downtime coupled with variation in demand caused large amounts of work-in-progress (WIP) and

subsequently long delays in completing that work. In the same way, the unavailability of money

had the same effect: projects whose costs varies on the high side had to remain as work-in-

progress (delaying completion) until the funds became available. (George Michael, 2003)

Does Lean Apply to You?

Lean methods and tools apply to anyone who:

Chases information in order to complete a task (an “information shortage” in service

is equivalent to material shortage in manufacturing)

Must jump through multiple decision loops

Is constantly interrupted when trying to complete a task

Is engaged in expediting (of reports, purchases, materials, etc.)

Does work in batches (collect a certain number of items requiring the same kind of

work before embarking on the pertinent tasks)

Finds work lost in the “white space” between organisational silos

Doesn’t know what they don’t know

Why services are full of waste and Ripe for Lean Six Sigma

Service processes are usually slow processes, which are expensive processes. Slow processes are

prone to poor quality, which drives costs up and drives down customer satisfaction and hence

revenue. You may be committed too much time to non-value-adding works in customers’ eyes.

Service processes are slow because there is far too much “work-in-process” (WIP), often the result

of unnecessary complexity in the service/product offering. It doesn’t matter whether the WIP is

reports waiting on a desk, emails in your inbox, or sales orders in a database. When there is too

much WIP, work can spend more than 90 per cent of its time waiting, which doesn’t help your

customers at all and, in fact, creates or inflicts substantial waste (non-value-add) in the process

(MYOB PO subscription example).

In any slow process, 80 per cent of the delay is caused by less than 20 per cent of the activities

(bottle neck in the process). We only need to find and improve the speed of 20 per cent of the

process steps to effect an 80 per cent reduction in cycle time and achieve greater than 99 per cent

on time delivery.

Identify and quantify the non-value-added waste, eliminate it using Lean Six Sigma, and the results

follow as the day follows the night.

The concept of linking Lean Six Sigma efforts to shareholder value is critically important. There is

huge value leverage in increasing ROI. Besides increasing ROI by lowering costs and capital


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investment, Lean Six Sigma has an important role to play in revenue growth. As Warren Buffett

says,

“The value of any business is determined by the cash inflows and outflows – discounted at an

appropriate interest rate” (Berkshire Hathaway Annual Report, 1992)

The notion of discount value is important because it affects the value of revenue growth, which

must be captured as the “discounted value of growing cash flows”. For example your projection of

$100000 increase in sales revenue in next year could mean $95000 increase in real value at 5%

inflation.

Defect-free services

The outcomes of any process are the result of what goes into that process.

Y= f(X1, X2, X3…)

This equation holds true at the organisational level as well: any output (Y), such as profit, ROI is

dependent on the process variables (Xs) such as quality, lead time, offering attractiveness, non-

value-add costs, etc., that go into it. In order to improve the result Y, we have to find and focus on

the critical Xs that affect that result.

Want to increase profits? What inputs do you have to affect to do that? Want to improve quality of

one of your services? What are the key inputs to the service that affect quality the most? The more

that leaders appreciate this equation, the more they start to change their behaviour. They will no

longer simply call for a 10% improvement in results. Rather, they will support Lean Six Sigma

efforts so people can study and improve the processes that produce that result.

Core elements of the Six Sigma Prescription

CEO & Management Engagement: The speed, quality, and cost advantages provided by

Lean Six Sigma are the drivers of ROI. That is why the CEO has to be out front in the

support of the initiative and why failure of a P&L manager to “get on board” is not an option.

You have to allocate appropriate resources (staff and time commitment) to high-priority

projects.

Everyone affected by or involved in Six Sigma should receive some level of training: all

executives and managers need to be educated about Six Sigma. The extent of the training

depends on how directly the group or individual will be involved in selecting, guiding,

managing, or implementing improvement.

Variation has to be eliminated: Variation in meeting a customer Critical-to-Quality (CTQ)

requirement is regarded as a key indicator to guide the improvement process. Attacking

and eliminating variation is accomplished by the Define-Measure-Analyse-Improve-Control

(DMIAC) problem-solving methodology and supporting tools that require management to

make data-driven decision.

Lean Primer

1. Lead time and process speed

Lead time is how long it takes you to deliver your service or product once the order is triggered.

Understanding the drivers of lead time is much simpler than you might think using below equation

called “Little’s Law”.


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Lead Time = Amount of WIP

Average completion rate

This equation tells us how long it will take any item of work to be completed (lead time) simply by

counting how much work is sitting around waiting to be completed (work-in-process) and how many

“things” we can complete each day, week, etc. (average completion rate).

Knowing what our delivery or lead time is important, let alone what the variation is. Now we can get

a reasonable estimate of any of the factors in this equation if we have data or reliable estimates of

the other two. i.e., if you know your WIP and completion rate, you can estimate lead time. if you

know your lead time and completion rate, you can estimate the amount of WIP in your process.

2. WIP (work-in-process)

Those works can be customer requests, cheque waiting to be processed, phone calls you have to

return, reports you need to complete etc.

3. Delays/queue time

Whenever you have WIP, you have work that is waiting to be worked on. In Lean speak, this works

is said to be ‘in queue’; the time it sits around waiting is “queue time”. Any time that work sits in

queue is counted as a delay, no matter what the underlying cause.

4. Value-add and non-value-add

As you begin to track the flow of work, it soon becomes obvious that some of the activities add

value in the eyes of your customers (and hence is called value-added work). Another way to look at

value-added work is to ask yourself whether your customers would be willing to pay for it if they

were given the option of whether to pay for it if they knew it was part of their purchase price. If they

would like refuse to pay if given the choice, or would take their business elsewhere to find another

supplier who didn’t have those costs, then that work is non-value-added.

“Please pay for this. The price was set based on our valuable works

such as….. discussing how much we need to charge for you, failing

trials etc… fixing our computer system…. “

“No, I wouldn’t pay for it! By the way, how much it would cost to you

for what I asked only?”


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5. Process Efficiency

The critical metric of waste for any service process is what percentage of the total cycle time is

spent in value-added activities and how much of it is waste. The metric used to answer this

question is process cycle efficiency (PCE), which relates the amount of value-add time to the total

lead time of the process:

Process Cycle Efficiency (PCE) = Value-add time

Total lead time

6. Waste

Waste is anything – time, costs, work – that adds no value in the eyes of your customer. All

organisations have some waste that, because of how their processes operate today, is required to

compensate for internal weaknesses. The amount of waste at each activity is proportional to how

long it delays the work.

Part of the Lean discipline is the “7 forms of waste”; here’s how they translate for services:

Waste #1: Over-processing (trying to add more value to a service/product that what your

customers want or will pay for): the basic theme of over-processing is doing more than is

absolutely necessary to satisfy or delight your customers. There are two elements to over-

processing:

(1). If you don’t know what your customer want, you could end up adding more ‘value’ than what

they are willing to pay for (e.g. wrapping each clothing item in layers of tissue paper might be

seen as value-add in a high class boutique but would be seen as unnecessary delay at many

retail stores).

(2). Allowing non-value add work to creep into a process. For example, examine a process in your

organisation that involves approval steps, or may be a lot of handoffs. Think critically about each

approval process or handoff. Would they be just as happy if the item only needed one signature,

one handoff, so it could get them quicker? If so, then you are over-processing!

Waste #2: Transportation (unnecessary movement of materials, products or information): Excess

transportation is important because every move from one activity to another takes time, and

creates a queue at the receiving activity. In many service processes, paperwork loops back on

each activity several times and waits in queue each time. Transportation in service process

almost always manifests itself as people constantly walking down hallways to collect or deliver

materials, or the actual or virtual chasing of information. Eliminating excess transportation can

involve combining steps to eliminate loops; at the other end is the option to rearrange the

workplace to match the flow of process.

Waste #3: Motion (needless movement of people) – “transportation” refers to the movement of

the work; “motion” involves movement of the workers. Both are much harder to see in service

environments than in manufacturing. Solutions can involve everything from rearranging people’s

desks to purchasing ergonomic furniture and equipment to using software that performs tasks

offline (so information is waiting for your staff rather than vice versa).

Waste #4: Inventory (any work-in-process that is in excess of what is required to produce for the

customer): any work-in-process in excess of the amount actually needed causes non-value-add

downstream costs of waiting, long lead times (refer Little’s law), and the failure to meet customer

expectations. Besides, it increases the probability that the sequence in which work is done will


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not match the sequence in which it is needed downstream. This will cause additional queue time

and more motion or expediting to meet a need-by date. In service, you need to look for physical

piles of forms, a list of pending requests in a computer email program, calls on hold, people

standing in line, and the like. This excess inventory of WIP is often the result of overproduction.

Waste #5: Waiting time (any delay between when one process step/activity ends and the next

step/activity begins): Because so much of the work in service process is invisible to the naked

eye, process mapping techniques (and especially complexity value stream mapping) are essential

for finding delays in a process. Such maps highlight where work sits around waiting for someone

to do something with it. This highlights queue time and process time data that was previously

invisible.

Waste #6: Defect (any aspect of the service that does not conform to customer needs): In

services, a defect can be anything from missing information to missed deadlines that causes the

customer to be unhappy with the result. Some defects are caused by activities upstream, such as

when operators are given the incorrect version of process documentation (instructions, order

forms, applications, etc.), others by a change in suppliers or supplied information/material. A

defect is usually detected by a downstream person who either has to rework it or pass it back to

the activity that made the error. The cost of fixing a service defect may be as small as a

keystroke, but the opportunity cost downstream may be enormous, such as losing a customer to

a competitor. So it is important that when first creating a complexity value stream map, make

sure it includes the steps used to fix or repair defect-related mistakes.

Waste #7: Overproduction (production of service outputs or products beyond what is needed for

immediate use): how can overproduction be a waste? Overproduction causes long lead times,

downstream shortages, and waste.

Basic Lean Lessons

Lean Lesson #1: Most processes are “un-lean”

You probably won’t be surprised to learn that in “un-lean” service processes, most of the work –at

least 50% and often more – is non-value-added. This point is easily illustrated by using colours or

other techniques to visually separate value-added from non-value-added work on a process map.

Won’t speed hurt quality?

All of us have been in situations where exhortations to “work faster” only led to quality problems,

and likely slower processes as well. so the natural concern is that Lean’s focus on process speed

will hurt quality. But that doesn’t happen. Why? Because Lean practices reduce time by reducing

non-value-add activities, eliminating queues, reducing the time spent between value-add

activities, and so on. The key steps that your customer values are generally left untouched by

Lean tools. Application of Six Sigma tools to value-add activities can help reduce defects, which

in turn can speed up value-add steps. Speeding up value-add work has relatively little impact

until after the non-value-add activities are eliminated.

Lean Lesson #2: A primary goal should be reducing WIP

The Little’s Law equation above has a lot of practical implications. First of all, it shows that the two

ways to control lead time are either limiting work-in-process (WIP) or increasing the average

completion rate. In any operation that doesn’t deal directly with customers – that is, where WIP is

orders or calls or emails or reports, not people – controlling WIP is much easier than improving


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completion rate. In fact, you can speed up any process and reduce lead time by reducing the

amount of WIP, even if you do nothing to improve completion rate.

Wherever and whenever possible, people simply have to limit how much work they allow into the

process at any given time. Why should we focus on WIP first? It only costs intellectual capital to

reduce WIP. It takes the investment of financial capital or payroll to increase the average

completion rate, both of which hurt ROI and hence shareholder value. Lean tools can reduce the

work-in-process and eliminate waste, hence boosting ROI.

Lean Lesson #3: How can we reduce WIP? The Pull System

Look around your workspace. Is your inbox stuffed to overflowing? Do you have a long list of new

emails that will take you days to get through? Is you voicemail box rejecting new message? Are

people waiting for your work output?

All of those items represent WIP, work that someone else – a co-worker, a customer- is requesting

of you. You know that WIP is like cars on a freeway: adding more cars doesn’t speed up a

congested freeway! But how to do it?

For any work that isn’t an actual customer standing in front of you, the secret to reducing WIP is

found in Little’s Law. In a Lean service process, there is a step that precedes the actual process, a

step where input (work requests, orders, calls etc.) are collected together. Someone then controls

the release of these “materials” into the process.


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Case example:

The independent distributors for one company needed to get proposal information from the

marketing department in order to quote construction jobs. The distributor were unhappy with the

2 to 3 weeks it took marketing to develop the needed information. The required turnaround to

delight these customers was 3 days.

A team collected data over a few weeks that showed the marketing staff could process an

average of 20 quotes per day. The distributors wanted a reliable 3 day turnaround; the date

showed that because of variation in the process, the marketing staff would have to aim for a

target closer to 2.4 days in order to meet that customer request.

How much WIP could they allow in the process? They turned to Little’s Law and plugged 20 into

the completion rate and 2.4 days into lead time, to come up with a maximum WIP of 48 quotes in

process at any time:

Lead Time = 2.4 days = Amount of WIP = 48 quotes

Average completion rate = 20 quotes/ day

To manage this system, they created a visual board that showed how many quotes were in

progress. The cap on WIP was 48 requests, so unless the number dipped to 47, no additional

quotes could be delivered by the clerk, as shown below.

Pull System for Sales Quotes (Design to Order Quotation)

Pull System

Production

WIP Limit = 48 units of Work

Exits = 20 Units per day

Input

Used to manage

staffing requirements

A Pull System in service environments means making deliberate decisions about the timing of work

released into process. Just how you make those decisions is critical; it gives you another

opportunity to live out a focus on “value”. For example, in the above case, the question was which

request will be released into the process when another request is completed. “First in, first out”

didn’t cut it here because some requests represented highly likely, high dollar potential orders;

others were much less likely to be accepted, represented difficult bids, or were for smaller orders.

1

2

4

4

3

6

5

1

5

1

5

5

1

5

5

5

5

5

3

1 2

2

3

Average Cycle Time = Quote WIP/Exit Rage

= 48 Units / 20 Units per day = 2.4 Days


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The answer lies in triaging the bid opportunities. Each request was rated on a scale of 1 to 3 on

each of three criteria:

Difficult to bid

Competitive advantage

Gross profit margin

The scores for each criteria were multiplied for each bid opportunity. Those with the highest rating

would be the next to be released into the process – even if there were other bid opportunities that

had been waiting in line longer. Using this system, the same number of marketing staff is able to

sell more revenue and gross profit. An alternative would be designating a marketing staff handling

the less likely bid work.

Creating your own Pull System

1. Identify/confirm the service level you want to achieve (ask your customers what service

level they want)

2. Determine your work group’s completion rate based on data

3. Use Little’s Law to determine maximum WIP

4. Cap the active work in the process at the maximum WIP

5. Put all incoming work into an input buffer

6. Develop a triage system for determining which incoming work should be released into the

process next

7. Continue with other process improvements so you can improve completion rate and further

reduce lead time

The contribution of Lean Six Sigma in situations like this is two-fold: for the first time, data (on

demand variation, WIP, and completion rate) are captured in a service environment and used as

the basis for decision making. Secondly, speed and quality tools can then be brought to bear by

people who have the time and energy to drive home the results.

But be careful that you don’t treat customers like inventory or raw materials!!

When the “things” in the process are customers, you can’t put them in inventory, nor can you make

them wait longer to receive service, hence the lead time cannot increase. Looking at Little’s law,

we can tell that the only option left is increasing the average completion rate.

One challenge of customer-facing operations is they show high variation in demand, with customer

numbers bunching up at some hours and slacking off at others. If the pattern is predictable, you

can increase completion rate by changing staffing patterns, having additional staff at peak times

much like call centres do.

Lean Lesson #4: Process Cycle Efficiency allows you to quantify the opportunity

Typical cycle efficiencies in services run at about 5% (see the table below), meaning that work

spends 95% of its ‘in process’ time just waiting. And it is not just delays that are a problem. The old

adage is true: the longer the work stays in process, the more it costs. A Lean process is one in

which the value-add time is more than 20% of the total cycle tome of that process.

Application Typical Cycle Efficiency World-Class Cycle Efficiency

Continuous Manufacturing 5% 30%

Business Processes (Service) 10% 50%

Business Processes

(Creative/Cognitive)

5% 25%


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Process Cycle Efficiency can be dramatically displayed by differentiating value-add times from non-

value-add times on a Time Value Map. A Time Value Map is generated by tracking a work item

through the process and tracking where it spends its time. Only work that is seen as value-added

by the customer is plotted above the midline; everything else is waste in their eyes.

Site A Material Purchase Order Observed Time

10

0

15

0

23

0

45

0

57

0

68

0

78

0

90

0

11

00

12

42

14

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18

00

Day1

Day 2

Day 3

Value-added

Required waste

Figure 29. A Time Value Map: Separating value-added from non-value-added

The concept of a Time Value Map is simple enough. Just track any work item as it flows through the

process and classify the time into one of three categories: (1) Value-added work, (2) waste that is

required for business reasons (work the customer doesn’t necessarily want to pay for, but is

needed for accounting, legal or regulatory reasons), and (3) delays/waste. Then draw a timeline

and mark off the time segments for each of these categories. You need to maximise value-added

work, but minimise the waste but required. But the delays and wastes must be eliminated as much

as you can.

Lean Lesson #5: 20% of the activities cause 80% of the delay

The only way to achieve the primary Lean goal – speed- is to remove anything that is slowing a

process down. Mapping a process and collecting data on cycle time, variation, and complexity

allows you to calculate the delay time that each activity contributes to the process. Experience

shows that in any process with a cycle efficiency of 10% or less, 80% of the process lead time is

chewed up by less than 20% of the activities – another example of the Pareto effect in action.

These 20% are called Time Traps, which becomes very obvious when creating value stream maps

and can be visually depicted in a Time Value Map.

Lean Lesson #6: Invisible work can’t be improved

Unlike manufacturing environment, work is largely invisible in services. Someone hits a computer

key and a report zips though circuits to anther office down the hall or across the world. Someone

else hits a button on a phone and a customer is transferred from one workstation down to another.


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It’s not just the work flow (process) that is harder to see in services; it’s just as hard to judge the

amount of work-in-process. It is much more common to have the “work” be something less visible:

an electronic file of reports or orders waiting to be processed, 20 emails awaiting responses, 10

customers “on hold”.

Even though it can be difficult to visualise flow in service environments, understanding the flow of

work and being able to evaluate WIP are prerequisites for applying Lean concepts to improve

speed and reduce waste. Different types of process maps are typically employed to “make the

invisible to visible”, including a variety called “value stream map”.

Visual management

The benefits of having WIP, waste, and employee ownership visible are why Lean encompasses so

many visual management tools used to:

1. Establish and display work priorities

2. Visually display daily process performance

3. Support communication within a work area or between management and staff

4. Provide feedback to team members, supervisors, and managers and make it possible for

all employees to contribute to continuous improvement

At its simplest level, visual management can include things like posting process maps that

document how the process should operate, or posting data charts on a bulletin board so that

everyone and anyone in the work area can see how well or poorly the process is performing.

Lean Six Sigma to optimise service

The fact is that Lean Six Sigma is a powerful tool for executing the CEO’s strategy and a tactical

tool for P&L managers to achieve their annual and quarterly target. If executives aren’t engaged in

Lean Six Sigma, the company will likely be out-competed by companies whose executives embrace

Lean Six Sigma.

Blending the key themes of Lean and Six Sigma provides us with five “laws” that provide direction

to our improvement efforts. Here are the “laws” of Lean Six Sigma.

0: The Law of Market: Customer Critical-to-Quality defines quality and is the highest priority for

improvement, followed by ROI and Net Present Value. We call it the Zero Law because it is the

foundation upon which all else is built.

1: The Law of Flexibility: The velocity of any process is proportional to the flexibility of the process.

2: The Law of Focus: 20% of the activities in a process cause 80% of the delay

3: The Law of Velocity: The velocity of any process is inversely proportional to the amount of work-

in-process. Little’s Law states that:

The number of things in process in turn is increased by long setup times, rework, the impact of

variation in supply and demand, time, and the complexity of the product offering.

4: The Law of Complexity and Cost: The complexity of the service or product offering generally adds

more non-value-add costs and WIP than either poor quality (low Sigma) or slow speed (un-Lean)

process problems.


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