Equity Capital Update: BP

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

(This article is published concurrently at the “Integrated Profitability” blog.  Please visit for the full series of articles.)

The final article on capital and equity was posted at the end of July: Equity Capital: In Conclusion. Since then, one of the most written-up examples of the need for equity capital to cover adverse conditions has published 2Q10 financial results: British Petroleum.

The explosion on the Deep Water Horizon, killing 11 people; its subsequent sinking; the ruptured oil well; and wide-spread environmental damage has added huge expenses related to fixing and cleaning up the problem. It is for exactly these types of disasters that capital and equity are needed.

A quick review of BP’s 2Q10 results highlights the following:

Income Statement

● Production and manufacturing expenses*:

Increased to $38.0 billion (from a ~$6.0 billion quarterly run-rate)

● Taxation:

Received offsetting credit of ($7.2 billion) (from a ~$2.5 billion quarterly tax run-rate)

● Profit (loss) for the period:

Became a ($17.0) billion loss (from a ~~$6.0 billion quarterly run-rate)

*: Footnote to Production and manufacturing expenses:

“Second quarter and first half 2010 include a charge of $32,192 million in production and manufacturing expenses, and a credit of $10,003 million in taxation in relation to the Gulf of Mexico oil spill.”

Source: Excel download from investor relations portion of BP’s website; “Copy of FOI_quarterly_ifrs_full_book”

Balance Sheet

● Trade and other payables

Increased to $45.5 billion (from $38.1 billion at the end of 1Q10)

● Provisions

Increased to $13.4 billion (from $1.6 billion at the end of 1Q10)

● Other payables

Increased to $16.3 billion (from $3.2 billion at the end of 1Q10)

● Deferred tax liabilities

Increased to $11.0 billion (from $20.2 billion at the end of 1Q10)

● Total liabilities (includes the above items)

Increased to $162.3 billion (from $135.7 billion at the end of 1Q10)

● BP shareholders’ equity

Decreased to $85.5 billion (from $104.1 billion at the end of 1Q10)

Notice the Income Statement’s 2Q loss ($17.0 billion) and the Balance Sheet’s decrease in Shareholder equity from 1Q to 2Q: $18.6 billion.

Which re-emphasizes the desirability of having adequate equity-capital.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 84

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Trends: Why important?

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

(This article is published concurrently at the “Integrated Profitability” blog.  Please visit for the full series of articles.)

Trend reporting is important because it provides a dynamic component to the static “point in time” reports of the Balance Sheet (e.g., end-of-month/quarter/year) and “period in time” reports of the Income Statement (e.g., the month of July; the 3 Qtr; full year). Trends indicate how the financial numbers are moving over time.

Assuming comparable data, the longer the time period, the more insight that can be garnered.

In a very simple example, let’s say you have $10,000 to invest in the stock market. Which is more revealing:

● A single intra-day stock quote

● Three months’ worth of daily end-of-day closing prices

● Five years’ worth of daily end-of-day closing prices

● Five years’ worth of daily opening, intra-day, closing prices

These include peaks and troughs during each day

● Five years’ worth of daily opening, intra-day, closing prices; adjusted for actions affecting the stock such as splits

The more trend data you have, the more you will know about how the stock price behaves, when it goes up/down, and by how much. A graph of the data will indicate certain cycles, and will give hints as to which way the price may be heading. Of course, anyone in the market knows that:

1. “past performance is no guarantee” of future performance and

2. it is incredibly difficult to forecast tomorrow’s price

The point is that with a sufficient amount of history and comparability, you are in a much better position to have an informed opinion about where the price may be heading. Without the information, it’s like flying a plane from a cockpit that has no windows and no instruments. You can do it for a while but the likelihood of a crash goes up astronomically.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 83

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Finance: Measuring their performance

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

(This article is published concurrently at the “Integrated Profitability” blog.  Please visit for the full series of articles.)

Given what Finance people do, their accountability, and the information they use while doing their jobs, what are some of the ways to measure how well they are performing?

Given that Finance accountabilities cover significant internal and external ground, measuring their performance needs to include both. Here are a few common approaches, by the three major functions:

● Accounting

- Accuracy of booking entries

- Findings from internal and external auditors; regulators

- Promptness of the monthly close

- Timeliness of submitting regulatory and investor reporting

● Finance

- Accuracy of the financial plans

- Accuracy and business-relevance of variance/performance explanations

- Accuracy of the forecasts

- Timeliness of financial reports after accounting close

- Use of reports and analyses by business partners

● Market-related

- Net-profit from proprietary trading

- Amount of idle funds

- Adequacy of liquidity

- Net value of hedging activities

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 82

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Product Management: Measuring their performance

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

(This article is published concurrently at the “Integrated Profitability” blog.  Please visit for the full series of articles.)

Given what Product Managers do, their accountability, and the information they use in performing their jobs, what are some of the ways to measure how well they are performing?

Given that Product Management accountabilities cover significant internal and external ground, measuring their performance needs to include both, irrespective of how much weight is given to the various components. Indeed, this weighting will depend upon each organization’s current situation, which will dictate what the most critical deliverables, and hence performance, will be (e.g., the weight given, at any particular time, to external benchmarks versus internal project milestones, cost control, risk mitigation).

Here are a few common approaches:

● Project deliverables

-         On time

-         On budget

-         With the features & functionalities originally included in the project

● Availability

e.g., on a 24-hour clock, how much time is the product available to customers?

● Operational Service Level Agreements (SLA’s)

e.g., are specified times, timing, amounts fully met?

● Customer satisfaction

● Market share

● Profitability

Product Management may also share a few performance measurements with Sales, such as:

● Penetration

e.g., the degree to which a customer’s known business needs are being met by your company’s products and services

For example, a bank may be a counterparty with a corporation’s foreign exchange (FX) trading activity. Penetration is increased if the bank becomes the settlement bank for that corporation’s FX transactions.

● Share of wallet

e.g., the amount of a customer’s known spend-for-products/services is being met by your company’s sales to them

For example, a corporation might buy all of a particular raw material from one supplier; or a bank might handle all letters of credit for a corporation.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 81

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Sales: Measuring their performance

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

(This article is published concurrently at the “Integrated Profitability” blog.  Please visit for the full series of articles.)

Given what Sales people do, their accountability, and the information they use in performing their jobs, what are some of the ways to measure how well they are performing?

The task of measuring sales performance and the subsequent rewarding of that performance is a deep, board, and constantly changing topic. Sales people are exquisitely tuned to the structure of sales incentives and are very quick to adapt to the way any incentive program is structured to maximize their personal reward. Thus, the construction of sales incentive plans must anticipate the ways that the plan will cause sales people to react in terms of what, how, when, and to whom they make sales.

Here are a few common approaches:

● Amount of Sales revenue, based on signed contracts ($)

● Revenue growth ($ and/or %)

e.g., change in actual revenue booked from customers in the Sales person’s portfolio

● Closed deals

● Implemented deals

● Retention rates (# of customers; $ of revenue)

● New customers/relationships

● Lost business

● Penetration

e.g., the degree to which a customer’s known business needs are being met by your company’s products and services

For example, a bank may be a counterparty with a corporation’s foreign exchange (FX) trading activity. Penetration is increased if the bank becomes the settlement bank for that corporation’s FX transactions.

● Share of wallet

e.g., the amount of a customer’s known spend-for-products/services is being met by your company’s sales to them

For example, a corporation might buy all of a particular raw material from one supplier; or a bank might handle all letters of credit for a corporation

Finally, and of critical interest to the Sales people, there is the data that feeds directly into formal Sales Incentive programs to calculate performance according to the predetermined structure of the plan, and the calculation of the reward amount.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 80

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Outsourcing certain business functions

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

The way in which companies staff themselves has changed dramatically in the past couple of decades. Many of the changes have been made possible by the advent of the internet and by huge advances in technology. At one point, seems like ages ago, companies internally staffed most functions needed to produce and deliver their products and services. For example,  Ford owned Philco for more than a decade to supply radios for their automobiles.

As mentioned in “What to Do, Delegate, Outsource,” companies can take advantage of other companies whose business models focus on providing core services, especially in support and administrative areas, e.g.,:

● Payroll

● Financial bookkeeping

Outsourcing has expanded into infrastructure and operational areas:

Technology

● Customer Service

And there are what I would call hybrid-outsourcing arrangements:

● Commission-only sales

● Business process applications

e.g., car financing software packages or senior management MIS dashboards

Several areas are beyond the scope of this short article:

● The rapidly expanding SaaS (Software as a Service) market

● Equally rapidly expanding “cloud computing” applications

● A complete answer to the question: just because you can, should you?

The last question is essentially how to decide whether a company should outsource a particular function. That decision, which is not a trivial one, needs to consider two primary facets:

1. Cost/Benefit

should include both a financial quantification as well as a qualified review of impacts on your brand, quality, customer satisfaction, and long-term strategy

2. Risk

e.g., once outsourced, what could go wrong? What mitigation steps are necessary?

As with most business decisions, an “All-in” analysis, encompassing every aspect of your business that may be affected, provides the best answer.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 79

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Costing Methodologies

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

There is a continuum of costing methodologies. They range from “None” to frequently updated costing that is integrated with the daily business processes of a company. The continuum goes from “Simplest” to “Most Complex”; from “Least Detail” to “Most Detail”; from “Minimal Insight” to “Strategic & Tactical business-decisioning Insight.”

Here’s one way to view the possibilities:

Do nothing

● Do not spend time on costing work; rather, rely on intrinsic understanding of and familiarity with the business’ revenue, activities, and expenses

● This option works best when the business is simple, monolithic, and small

Use the general ledger reporting

a) As is reporting

● Use general ledger reporting as it comes off the presses: the financial reports automatically calculate net profit

● This option works best when the business consists of one, basically undifferentiated product line

b) With business-relevant normalizations

● Modify the general ledger numbers to remove financial impacts which have nothing to do with normal, ongoing core business activities

Do “Back of the Envelope” analysis

● Spend time dividing the company’s general ledger into the product and services to be costed. Use the 100% Rule to fully allocate all general ledger accounting lines.

● This option is best used when you need a quick, basic understanding of your company’s business by product, service, or other categorizations (e.g., customer segments; service tiers)

● Depending on the needs of the company, Back of the Envelope studies may be:

a) done one time

b) periodically updated

Implement a formal costing methodology

● Invest in one of the formal costing methodologies (see below for further resources) which, while requiring dedicated and skilled resources, also provides the most comprehensive, insightful, and business-decision actionable results.

● Once a costing process is in place, a company is faced with how to maintain the cost numbers. Several inputs to costing continually change:

- New products & services are created; some are retired

- Operational procedures and processing steps change

- Financial numbers change (every month)

- Volume of customer transactions change (every month)

● Here are a few ways a company could proceed:

a) Conduct a one-time costing effort

b) Periodically refresh the cost numbers (i.e., update with current expense dollars and transaction volumes)

c) Periodically re-do the costing (i.e., in addition to the dollar and volume update, re-calculate the detailed components of the costing process, including current products and services)

d) Integrate with ongoing company processes: basically, automating the process and embedding in how the company manages its business

If you are interested in delving more into costing for your company, here are some pertinent websites:

bnet: The CBS Interactive Business Network

Ezine @rticles

Accounting Coach

Wikipedia: Cost Accounting

Alternatively, contact me and we can talk about what would make the most sense for your particular business and situation.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 78

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Expense Timing

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

Accelerating the collection of revenue and postponing the paying of expenses have a positive, if temporary, impact on your cash-flow and profitability.

How much can your company affect the timing of expenses?

● Lagging payments

Pay as late as possible without incurring any fees or penalties

● Cash-discounts

When suppliers counter the first tactic above, consider taking advantage of discounts if you pay early; e.g., some jurisdictions offer discounts on property taxes; while some insurance companies tack on a 12% annual interest rate if you choose to pay via installments

● Payment terms

If you can, negotiate payment terms that let you pay bills within 30 (or more) days with no additional fees or finance charges

● Credit card statement cut-off dates

Know the cut-off or close date of your credit cards and, if possible, use the card just after that date and avoid using it during the days just prior to it. Depending on the terms of the card, doing so will give you an extra 30 days or so.

● Tax planning

Usually these provide temporary, one-time benefits. For example, the year I paid my whole property tax before December 31, I had more itemized deductions and, therefore, a lower tax liability. Of course, it was only a one-time timing benefit. Consult your tax accountant on any ideas in this area.

Bottomline:

Expense timing events are only temporary and one-off

Expenses that produce high returns are clearly a much better focus of management attention

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 77

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Pricing approaches

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

Here are a few methodologies used to price products and services:

● Cost-plus

Definition:       using your expenses as the basis of your price

How to do:       add up all your costs and tack on a profit margin

Pro:                 all products and services will be profitable (assuming they sell)

Con:                 neither sales nor profits will be maximized. If the resulting price is too high, sales will not happen. If too low, your profit will be lower than it could have been.

● Competition-related

Definition:       using information from your competition as the basis of your price (e.g., their prices, pricing, product & service offerings)

How to do:       gather competitor information and mimic their prices

Pro:                 prices will be competitive

Con:                 your products and services will not be able to reap the benefit of any differentiating advantages or counter adverse impacts of any differentiating disadvantage

● What the market will bear

Definition:       using the current “realized-prices” in the market as the basis of your price

How to do:       keep raising prices until sales stop

Pro:                 prices will be maximized

Con:                 sales and profits will probably not be maximized; customer loyalty may be damaged

● Marketing-based

Definition:       using your marketing objectives as the basis of your price

How to do:       within the context of your marketing goals, ensure that every price supports them (e.g., growing market share might mean lower prices; protecting a premium brand might mean higher prices)

Pro:                 strong and consistent branding

Con:                 may ignore financial realities

● Strategy-based

Definition:       using your company’s strategy as the basis of your price

How to do:       within the context of your strategic goals, ensure that every price supports them (e.g., sun-setting an older product might mean milking prices for as long as possible; use prices to differentiate between two products or features so that consumers naturally tend to purchase the one most strategically aligned)

Pro:                 coherent and integrated pricing will help meeting strategic objectives

Con:                 short-term opportunities may be forsaken

● Combination of all above

Definition:       using a combination of all the above methodologies to decide your price

How to do:       integrate information and approaches from all methodologies

Pro:                 tends to result in the best short- and long-term profitability results

Con:                 resource intensive

Assuming you have the time and the skills, having a pricing methodology that directly supports all business aspects (e.g., costs, competition, marketing, branding) to the maximization of the company’s long-term profitability is best.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 76

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

Revenue recognition

Small Business Finance & Profitability

By William Stong

Copyright © 2010 Integrated Profitability TM

Revenue recognition is an accounting discipline. The observations below are not from an accountant and should not be relied upon as such. Rather, they are higher-level thoughts on how one can think about revenue and its drivers and challenges.

Monetary-based

How are prices paid by customers?

● Cash

● Credit Card

● Check

● Terms (account receivables)

Obligation-based

Revenue is recognized when an obligation to pay is created. Actual payments may be based on different event-triggers:

● Signing of contract

● Work in Progress

● Delivery of goods/completion of service

Cash basis vs. Accrual basis

Businesses need to consistently use one or the other basis for their financial books:

Cash: revenue is recognized when you have the cash: without any possibility of it being reversed.

Accrual: revenue is recognized the moment someone has a legally-enforceable obligation to pay you

Business conditions

The following are related to pricing and/or revenue:

Discounts: a lowering of price prior to a sale. As such, the discounted portion cannot be revenue since the customer never had an obligation to pay that amount.

Rebates: a return of part of the price collected. As such, rebates are negative revenue. To be accurate, the concept of  “realized price” must be the amount after the rebate.

Refunds: a return of an item purchased that results in a partial or full refund of the amount collected. In this case, price is unaffected; the refund is negative revenue.

Non-payment: when the customer does not pay the price. On an accrual basis, the original sale price is booked as revenue, and the ultimate realization that the price will not be collected will cause an entry of negative revenue. On a cash basis, you never had anything to book.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 75

Telephone: 925-202-6244

Copyright © 2010 Integrated Profitability TM

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