This month’s article is about the bowerbird manager, or the collector. He or she is a collector of assets on the balance sheet. Whether those ‘assets’ are worth anything is a big question, and if they are not, they may be the cause of many bad decisions.
To set the background, I met my first bowerbird manager just after I started in the industry – the director of a company that had recently been placed into liquidation. He was a nice older chap whose earthmoving business had finally gone under.
I ask him some of the usual questions about the assets of the company, including the debtors’ ledger. He said that the company had a good debtors’ ledger and some great debtors. They had been with him for years.
Unfortunately he did not mean the customers were good long term providers of ongoing work – they were providers of work for the company – but the director meant that the actual debts in the ledger had been with him for years – these providers of work just rarely paid for the work done. Most of the outstanding amounts were old and some of the debtors had closed and some had previously gone into liquidation themselves. But the debts remained in the ledgers.
In fact the greater majority of the debtors ledger as it stood at the time of the liquidation were more than 6 months old (many more than 2 years old) and our director had never either tried to collect the money, or written off the balances as uncollectable.
This business manager did not want to start demanding the money because he did not want to upset these great customers (remember: they were great because they ordered a lot – they just didn’t pay a lot). The result of not collecting amounts may have been collectable was that our company’s working capital was tied up in the accumulation of the debt. Essentially he was funding the other person’s business, and the lack of funds in his own business caused the failure. But he has a great looking balance sheet.
Our business manager also therefore deluded himself on the profitability of the business by not writing off the bad debts. His balance sheet showed a (prima facie) collectable asset, and the profit statement showed (prima facie) earned and recoverable income, neither of which was correct. He, and his bankers, continued making business decisions on this incorrect information. And this ultimately led to our appointment.
Who knows what decisions would have been made differently if the net assets on the balance sheet and the profits had been reduced by writing off these assets. A more conservative approach may have saved the company.
The other major value current asset in many businesses (retail or manufacturing) is stock. Old or unsalable stock in the inventory records can cause the same problems as old or uncollectable debtors in a debtors’ ledger.
Old unsalable stock uses shelf or warehouse space that could be stocked with other fast selling items that could increase turnover. It also ties up working capital that could be released by selling the old stock for whatever it can get. That money can then be used to – if nothing more – pay down debt and save an interest cost, or buy some of fast selling stock that can be sold profitably.
Holding this stock – like holding uncollectable debtors – gives an unrealistic view of working capital. Many small business owners will keep these items in their balance sheet at cost, even though it may be worth almost nothing. The unrealized loss from their sale is kept from the balance sheet and off their profit statement.
Trying to choose one or two instances where we have found significant old or unsalable stock in an insolvent company is difficult given their sheer number. Rarer is the opposite approach.
Mitchells/Richards is a suit shop in Connecticut, USA run by Jack Mitchell. It sells higher end suits and clothing to higher than average net worth people. That is its target market. That is, it does not try to compete with the Targets, the Wal-Marts of the world or even the more average clothing shops. One of its fixed policies is to sell its out of season stock to a ‘competitor’ as soon as the season is over. The parties they sell these older suits to are not really competitors, as they target slightly different people. They have different markets.
They sell this old stock quickly and in bulk to clear the shelves for the new season’s stock to come in, and to free up working capital to help pay for it. Selling the remaining cloths just after the season is over means that they can still get a reasonable price for it. If they held on to it for a few years, it would be worth considerably less. It also means that the current stock is always ‘fresh’. They also do not want to have to pay to store old stock that they no longer really want to sell (warehousing costs can be significant), and do not want the money tied up not working for them. Their approach – though it appears extreme – works for them.
This means however that any losses on that stock are realised and will lessen profit. They happily accept that consequence as it gives a true position of the business and that leads to better business decisions.
The bowerbird attitude shows that the business manager does not have a lean and mean, or simply tidy, attitude towards the business. It also means that the financial statements reflect a position that is not accurate. This may also be symptomatic of other wastes and excesses that they do not deal with.
Someone once put it quite correctly. “They are not historical financial statements, they are hysterical financial statements.”
More next month ..