Business Blog: The dawning of the age of conservatism

Tim Vieyra, Business Development Actuary, Cobalt Solutions for Businenss Owners Tim Vieyra, Business Development Actuary, Cobalt Solutions for Businenss Owners
Conservatism, as a concept in business, has long been the Cinderella of an entrepreneurial strategy. Growth, risk-taking, marketing, innovation, all stand in line before it. Yet if there is one lesson to take from the recent global slow-down, it is that businesses need to grow and take on risks in a disciplined way if they are to survive.

Conservatism is defined as "the disposition to preserve what is established." In the business context, this means protecting the value that has been created in a business and ensuring, first and foremost, that a business is positioned to survive tough times. It is no use having a spectacular year, only to go out of business in a subsequent year. Incidentally, operating in this way also ensures that when great opportunities to grow the business come along, it is ready and able to take them on.

At no time has this message been clearer than during the recession of the last few years. Small business has been particularly vulnerable in this time and many who were already sailing close to the wind were left exposed. Credit dried up and market demand declined drastically. In some places, such as the property market, movement stopped completely. This left small business owners scratching their heads about how to stay afloat.

If one lesson can be taken from the whole episode, it is that an element of conservatism in the way businesses are run is best in the long run. And many have learnt that lesson the hard way.

In practical terms, the specific areas where conservatism should influence decisions include the following:

Strategic planning Often the operational details of running a business mean that management can lose sight of the big picture. Regular management sessions should be held to "zoom out", and look at the broad risks and opportunities that may exist in a business. The impact of factors such as market changes, amendments to relevant legislation and the economic outlook, as well as how the business will respond should be discussed. This will help the business pro-actively adapt to the environment, and ensure that the value built up is protected and grown. The help of an outside advisor could help with this process.

Growth A growing business is a wonderful thing. But caution should be exercised in the manner and rate at which a business grows. A business that grows too quickly can put strain on its people, processes and finances, and ultimately compromise the quality of product or service. This ironically can bring about the demise of a promising business. It is important to plan growth around the available resources, and ensure that a disciplined path is followed to building sustainable value in the business.

Debt - While a certain level of debt in a business is instrumental in achieving the right level of growth in a business, too much debt can overburden a business and mean significant financial strain in difficult periods. The Asset/Liability Ratio can be a useful quick tool in evaluating debt levels - specifically the Current Asset/Current Liability Ratio. This ratio gives an indication as to the business's immediate borrowing ability and also tells a story about current cash flow. The trend in this measure is also important. Ideally, the Current Asset/Current Liability Ratio should be at least 2/1 or greater.

Overheads The overheads, or fixed costs of the business, should be kept as low as possible (though of course, not too low!). Caution should particularly be exercised if the business is growing, because then the temptation exists to increase the overheads to a level that the business cannot sustainably support. Things like variable remuneration contracts in areas where it makes sense and outsourcing of certain non-core functions to external suppliers can help to reduce overheads. This will mean that the business will be nimble enough to respond to changes in market conditions, and avoid the kind of continuous losses that occur when gross profit can no longer sustain large overheads.

Cashflow Cash is the life blood of the business. Planning the cashflow position of the business under various scenarios is important in ensuring that the business is robust enough to withstand adverse events. Usually, a 12 month cash flow projection should be sufficient to highlight potential peaks and valleys in cash balances. It is also important not to extract excessive cash in the form of dividends, loans or large salaries for the owners. While this will take discipline on the part of the owners, it allows for an important cash buffer that will shield the business, as well as enabling the business to take those all important growth opportunities when they arise.

All of this by no means says that conservatism should be the driving force behind a business's strategy, and success continues to hinge on the kind of dynamism and flair that entrepreneurial SME's demonstrate. What it does say, however, is that it should be tempered by a degree of caution and a disciplined path to growth should be followed in order to maximise the long term value in the business.

Tim Vieyra, Business Development Actuary, Cobalt Solutions for Businenss Owners