- October 14, 2020
- Posted by: avaltos
- Category: Thought Leadership
The current global economic slowdown severely impacts companies that rely on price/earnings (PE) ratios as a significant driver for the calculation of market cap and valuations by investors. Large investment funds identified four strategic efforts that companies can make to improve valuation to make up for lost earnings and reduced financial performance. These strategies are value creation initiatives, cost optimization efforts, cash flow enhancement, and up-leveling operational excellence.
Value creation comes from a focus on initiatives that have a high positive impact on EBITDA. Time is of the essence. Booking earnings right now, during the short-term, is vastly more valuable than building earrings growth in some distant future. Every project initiative being undertaken by a company, which is either ongoing or planned, needs to be re-evaluated based on the projected earnings that can be generated, and the timeframe needed to garner such earnings.
The focus is very short-term and must be on initiatives that create a positive impact on EBITDA over the next fiscal year. The evaluation and ranking of initiatives need to be honest and reasonable in light of current market conditions.
This is best shown as an overview by using a matrix graph with the X-axis representing the positive impact on EBITDA (on a scale of one to 10) and the Y-axis representing the time needed for the initiative’s implementation (of one to ten months) with four quadrants, which are:
- Upper Left Quadrant – High EBITDA Impact/High Priority: These initiatives take less than five months to implement and have a very high (more than a five ranking on a scale of one to 10) impact on EBITDA. The absolute best projects will take less than one month to implement and have a 10 score as a positive impact on EBITDA. Few companies have such a beneficial project at hand; however, all other initiatives are graded according to this imaginary reference. Priority initiatives take less than five months to implement and score more than five for making a positive impact on EBITDA.
- Lower Left Quadrant – Low EBITDA Impact/Easy to Implement: These initiatives do not have such a positive impact on EBITDA and are ranked at less than five (out of 10) for EBITDA positive impact; however, they are very easy to implement. This means making efforts on them may be beneficial if there are not better alternatives that require the same resources.
- High EBITDA Impact/Difficult to Implement: These initiatives are worth considering due to the high positive impact on EBITDA when there are no other similar projects that are easier to implement.
- Lower Right Quadrant – Low EBITDA Impact/Difficult to Implement: Any initiative that ends up in this category should be avoided, postponed, or simply canceled. This is a source of major disruption from before when things were going along as usual, so it may be challenging to make these adjustments. Companies that can avoid working on such initiatives have a better chance of improving their valuations than others that do not make such an effort.
For initiatives that fall outside of the ten-month time horizon, they can be revisited to determine if there is any possible way to reduce the time needed to get the improved earnings benefit, even if only a partial benefit. Perhaps, the scope and depth of the initiative can be adjusted while keeping all the success parameters intact. For example, a national roll-out can be reduced to a regional roll-out or an in-person effort can be taken online as a virtual effort. The goal of this process is to make highly-positive initiatives more achievable in the short-term.
Consider the following factors in making the analysis:
- Can you speed up the timeline of any high-positive-impact initiatives?
- Can you reduce the difficulties for initiative implementation?
- Can you can adjust the scope or size of the initiative while maintaining a positive benefit?
Cost optimization is always an important factor in sustaining profitable operations. When earnings are hampered, it may require taking drastic measures to re-balance the cost structure of the operations. For example, product manufacturers may have a chance to improve purchasing strategies and production methods to improve the cost basis of their products.
One technique to consider is value engineering (aka value-added) cost structures. This method analyses product design, how a product is manufactured/sold/packaged, and looks for ways to improve the overall process. It may include altering components and materials used for product manufacturing. Under normal operations, these things have a tendency to be neglected, overlooked, or assumed to be too challenging to address.
To address these issues, it is usually better to hire outside consultants to review the manufacturing process from materials acquisition to the final product. They can more easily see the things that can be done and make recommendations for improvement. Consultants trained in value engineering look for design, materials, and manufacturing/sales process changes that can be implemented within a short timeframe using available resources. Similar efforts apply to service businesses and other organizations of all types.
In addition to cost analysis, value engineering techniques include:
- Outsourcing recommendations of external processes that can be used to better focus internal staff on core competencies.
- Components list analysis to help identify things that can be consolidated or removed.
- Competitive pricing analysis to discover opportunities for market share expansion.
- Gross margin analysis to uncover things that are more profitable.
Value engineering can start with a specific project initiative and then be applied across the entire organization.
Cash Flow Enhancement
Positive cash flow is the lifeblood of every business. Sufficient cash flow is needed to cover expenses, pay debt service, reinvest in the business, and pay dividends to investors. Cash flow enhancement comes from using the best practices for account receivables management to accelerate cash usage. The goal is to increase a company’s liquidity.
Eleven ways to improve cash flow are:
- Accounting: Send invoices immediately.
- Cooperatives: Create a buying cooperative for economies of scale.
- Credit Checks: Screen customers for credit worthiness.
- EFT: Accept electronic payments.
- Factoring Receivables: Take a cash advance on receivables to buy inventory at a discount and/or to increase sales volume and exploit profitable opportunities.
- Inventory Turnover: Increase inventory turnover and liquidate inventory that cannot be sold.
- Leasing: Lease equipment instead of making a capital investment.
- Leverage: Take advantage of leveraged opportunities by using as little money as possible and maximize the use of internal resources. Identify synergies between staff, processes, and enabling technologies.
- Payment Discounts: Offer discounts to your customers for the early payment of invoices.
- Raise Prices: Increase prices through value-pricing strategies.
- Supplier Discounts: Negotiate discounts with suppliers.
Operational excellence comes from focusing on what can make the greatest positive impact on EBITDA. Then, accelerate the implementation of those project initiatives. Every boost of EBITDA that can be accomplished in the short term thorough cost reductions, value engineering, and cash flow management should be fervently pursued by the company.
If possible, execute initiatives in parallel rather than in series to reduce the time needed to improve earnings. Move quickly and avoid any projects that could bog down without producing results. Track success and make this effort highly visible to staff so that everyone is in an “all hands on deck” mentality with the awareness their intense efforts right now can save the enterprise from failure.
It is time for companies to intensify efforts to improve earnings to recover lost value as rapidly as possible. The main takeaway from these suggestions is to focus on a shorter timeframe and improve earnings as fast as possible. Think about what can be done right now to improve EBITDA. Then, move rapidly and efficiently toward the initiative implementations necessary to accomplish that goal.