Overhead! – Every CEO’s First Response to Subpar Performance Results


Profit DropOf course, it would be obnoxious to generalize my observations to include the entire class of business owners and chief executives (maybe they are not all the same), but every single CEO, with whom I've ever dealt, displayed the same behavioral pattern at the first sound of "bad news."

It's one of the most unpleasant experiences many financial professionals go through from time to time. The fiscal period (month, quarter, year) is closed and you look at the bottom line that is way below the company's target, or worse – the numbers are in red. You cannot help feeling singly responsible, simply because you are the first person to stare in the face of this unfortunate reality.

Yet, while it's true that a holistic CFO, the rightful member of an executive team, shares the P&L responsibility with the rest of the decision-making crew, unless she uses extravagantly expensive capital resources, her direct responsibility for the poor performance is highly unlikely. In fact, she probably anticipated this outcome and was doing everything in her power to prevent it: fought for better informed procurement decisions, higher efficiency, sensible distribution methodology, more selective sales, and so on.

Nevertheless, here are the results. The gross profit is too low, eaten away by sub-par sales. Some of new products couldn't make any money at all due to the lack of marketing and distribution efforts. There is a delinquent debt write-off on an account blessed by the boss for open terms. All these operational losses that you tried so hard to thwart.

And now it's time to present the results to the CEO. Frustrated by the company's poor performance, worrying about the impact the loss may have on the cash-flow, formulating the bullshit you will have to feed to the bankers to spin the disappointing news, you go through the established reporting protocol, whatever it is in you company: KPI tables, graphic dashboards, formal financial statements. As I said, in my experience the delivery of the news causes the same reaction: "We have to reduce our OVERHEAD!!!"

Overhead? We've kept our general and administrative expenses (G&A) stable for years! While we doubled our volume (triple, quadruple – whatever is your case), we managed to do so with a mere 10% increase in non-operating expenses. It's the gross margin we should be discussing. Alas, your reasonable arguments will break against the wall of stubborn conviction that overhead is the source of all evil.

Afterwards, the useless exercise of scrutinizing every single category of G&A will commence. You will have very expensive meetings with highly paid executive staff, including yourself, devoting their valuable time to discussions of $5,000 monthly Federal Express charges and $500 spent on various subscriptions. While you do that, another transaction bound to lose $250,000 will materialize, and then another, and another…

Why does it always happen like this? The answer is simple: only a handful of people are capable of facing their own failures without flinching away. It is very difficult for chief execs , who are frequently involved in operational management, sales, and business development, to admit that they don't really handle their side of the business too well. So, instead of dissecting the real causes, they jump on something they rarely control. And it's really funny, because a significant portion of the overhead is created by them. You know – travel, dinners, drinks, limos, perks, etc.

The Trade Finance Prison


Images-1Theoretically, you can imagine an international business operating without a trade finance facility – no letters of credit, document negotiations, confirmations, etc. Your suppliers would be more than happy if you always pay in advance. On the other side of the equation, there are some desperate for product customers that you may be able to coerce into pre-payment plans, but, if you want to grow your volume, you will most likely end up extending them unsecured credit terms instead.

Let's pretend for a minute that we don't see the elephant in the room – the cost of working capital, which, under this stretched cycle of paying way before the product is received and collecting long after, turns into a painful burden on the profit margin. Let's ignore it and agree that yes, it is possible to conduct business in this way, especially if the company is cash-rich. It's possible, but dangerous and stupid for reasons too numerous to elaborate in one blog post. I'd say that the top 5 hazards of such modus operandi are as follows:

1. Risk that a foreign supplier will not deliver the product at all.

2. Risk that he doesn't comply with the terms of the purchase contract and delivers wrong goods of unacceptable quality and origin, in random quantities, too late or too early.

3. The danger of not receiving sufficient and correct set of documents that would allow you to claim the ownership.

4. Customer non-payment risk, which is always there when you give open terms, but especially if the payment is anxiously expected to come from abroad.

5. The overwhelming difficulties and costs of international litigation to recover your losses.

To mitigate these risks you need instruments that will protect you and an intermediary that will defend your trading fort. And that's when the trade finance divisions of various banks and financial institutions come into the picture with their Letters of Credits and related services. They can step in and be your guardian against the risks.

A Letter of Credit defines all conditions of purchase/sale, including documentary requirements; and only if these conditions are met, or when discrepancies are accepted, the money will exchange hands. So, the reality is that, you can have $100 million of free cash on your operating account, but if your business has an international exposure, you will end up engaging in Trade Finance relationships one way or another.

The trouble is that the banks know you need them and their benefits come with a price and many strings attached. Even if you only accept your customers' LC's, the cost of advising and processing services may be as high as 0.5% of the transactional value. If you buy product with LC's, then the costs could be as high as 2% (banks love this lucrative business). Yet, that's not the most strenuous part of the arrangement.

When a bank issues a Letter of Credit on your behalf, it takes an obligation to pay to the supplier even if your company goes bankrupt. Therefore, trade finance facility is essentially a credit line (most are utilized by LC's and advances alike). Obviously, to obtain any sizable credit line you must go through a grueling due diligence and you have to pay for it too: field exam, the bank's and your own attorneys' charges, closing fees – $10-12 million facility may end up costing around $150-$175K.

And even that is not the most painful part of the deal. The trade finance Credit Agreements are full of covenants and conditions that restrict your capital distribution, debt acquisition, treasury, operational management, and even dictate how the business is conducted. The banks demand collaterals and guarantees, including personal pledges from owners and their spouses. There are strict and voluminous reporting requirements.

And yet, we work very hard to get ourselves into the Trade Finance prison in order to facilitate our employers' commercial activities. The only thing we can do to ease the pain is to bitch and moan about the banks – a regular exercise of international-business CFO's around the world.

Quote of the Week


Images-1"It's only in our self-confident time of knowledge popularization, through the most powerful weapon of ignorance – mass publication, that the subject of free will could be reduced to … naturalism."

                          Leo Tolstoy

                          "War and Peace," 1869

                                                            Translated by MZ

Politics & Promotions: Gil Grissom vs. Conrad Ecklie


  Images I cannot really call myself a CSI fan.  I think in eleven years they've released over 250 episodes (!) and I watched maybe 25 or so.  It was enough to familiarize myself with the protagonists and even the first level of secondary characters.  Their dynamics piqued my interest.

After all, the Crime Lab is a workplace and many actors on the show portray co-workers.  Even though they are government employees, the operational localization makes CSI and the human conflicts within similar to a small business.

One antagonistic relationship between two characters I consider archetypal.  It is applicable to any workplace. I am talking about professional devotion  vs. careerism as represented by graveyard shift supervisor Gil Grissom on one side and Conrad Ecklie on the other side.   

It is not that Ecklie is a complete professional failure or a wicked person.  Not the sharpest pencil in the box or the most advanced scientist around, he is good enough.  He is spiteful, but not diabolically evil. He puts all animosity aside when Nick Stokes is in trouble (in the episode conceived and directed by Quentin Tarantino).  Still, his priorities are clear and they have nothing to do with being the best at what he does.  His ambitions are all about getting ahead in the organizational structure, and he will do whatever it takes to achieve that.

On the other hand, Grissom is a brilliant scholar whose life's purpose is to never stop learning.  The puzzle of crime investigation is his passion.  His rise to the shift supervisor position had occurred without his doing anything but the best job he could. 

In one of the episodes I've seen, this exchange between the two took place:

Ecklie:        "You kept the sheriff out of the loop, that's a career killer."

Grissom:    "That's your problem, Eckley, you view it as a career."

And that says it all.  So, what happens?

Ecklie consistently rises from dayshift supervisor, to Assistant Director to the Undersheriff of LVPD.   Grissom, even though a PhD and a star in his field, holds the same title leading his team until he retires and goes to Paris to teach in Sorbonne.

Obviously, I feel very strongly about this issue – I despise self-promoting careerists who climb up the ranks not because they are the best at what they do, but because they don't step on anyone's toes and know which ass to kiss at the right moment.  You, with all your knowledge, intellect and diligence have no chance against them.  If promotions and bigger salaries are rewards and it's the mediocre Ecklies who succeed, it means that the merit based system fails.

Whatever was the real reason for William Petersen's departure from the show, the viewers are to believe that Grissom is happier now.  But he did leave the job, to which he devoted a big chunk of his life.  And so did I – at one point in my career I left a job I liked because someone else undeservedly got ahead of me.  It wasn't easy.