How to hang on to your profits in tough times

Rahul Guha uses his experience as an accountant to provide a few tips on how to manage profit in uncertain times.

The dark cloud looming over the financial services industry continues its ominous shadow. Businesses are struggling through these volatile market conditions with ongoing economic and regulatory concerns.

Is there any end in sight?

How can one sustain or grow profit in the current economic environment?

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Many years back when I was still training to be a chartered accountant, I attended a meeting with a senior partner of my then firm for a discussion and analysis of the year-end results with a client whose company profits had fallen in that year.

I was excited, anticipating to learn the secrets of business, but the client’s response was a bit of an anti-climax: profit is down because the revenue has fallen and costs have gone up!

I have no doubt that every CFO and CEO would love to increase their revenue to grow profit.

Unfortunately, this is not always in our control but more often than not, market driven – especially for the financial services industry.

That leaves us with the other variables in the profit equation: costs.

What is the right level of costs? One of the key measures used in the industry for expenses is cost to income (CTI) ratio.

That is, how much of a dollar (net of selling costs) we earn is incurred in expenses. At the risk of generalisation, I will call the standard ~60 per cent as CTI.

If your business is operating at a higher level, a serious look at opportunities for efficiencies is critical.

On the other hand, if you have a lower percentage, you are more likely to have a competitive advantage.

How do we come up with market neutral initiatives to manage costs?

Given 50 per cent of costs in the financial services industry are largely staff costs, it is hard to ignore potentials in reducing such costs through offshoring or reducing staff in non-core areas that do not impact the service level or quality for clients.

But then I ask myself, what about the social consequences?

If all of us are so concerned about the bottom-line and start sending our jobs offshore for a cheaper labour cost or simply cut staff, what happens to the fair dinkum Aussies?

Let’s look at this issue a little bit deeper.

Recently I read an article in which the head of a large institution was lamenting that their return on investment had currently dropped from 22 per cent to 16 per cent. It is a return of 16 per cent when the share market in general has fallen over 25 per cent since the global financial crisis.

The underlying truth is that if a business cannot generate the returns expected by the shareholders, smart money will move somewhere else; the business will suffer and need to fold in extreme cases.

The choices that a responsible business leader has is either to continue running the operations for the short-term at an unsustainable level (which will lead to its demise in the current economic conditions) or make the hard decisions and thus still be able to provide employment to the remainder of staff in the longer term.

However, it’s not an easy decision for anyone due to the inherent social cost.

But is offshoring for everyone and what can we offshore?

While larger organisations have embraced this practice, our industry at large has not been able to tap into as yet the huge potential that can be obtained by offshoring for second tier, boutique companies and small-to-medium enterprises.

This is largely for a couple of reasons: first, there are very few quality service providers catering to the individualised needs of this sector and secondly, due to perceived lack of scale in the individual businesses we often tend to overlook the benefits and miss the opportunities to redirect resources to core competencies.

Any activities that are non-core, routine/repetitive and low-risk are ideal candidates for offshoring.

As an example, some of the audit firms have offshored the ‘ticking and bashing’ aspects of the audit while retaining the review and analytic functions onshore.

Similarly, the big banks may have looked at payroll process (amongst others) for offshoring but being non-core to its business.

While offshore and staff reductions dominate the headlines, we can put expense management initiatives broadly in three buckets – tactical, strategic and deferral.

There are several tactical easy-wins to tide over the difficult times which do not require a huge amount of time or resources - reducing annual leave balances/compulsory leave, salary freeze, reducing discretionary incentives, span of control review, working part-time to reflect reduced business activities, etc.

Strategic initiatives includes centralisation/consolidation of business functions, outsourcing non-core activities (similarly, insourcing core activities), move to online communications, straight through self-service processing for simple tasks, moving non-client facing roles to non-CBD locations, shift work where possible to better utilise rent space, etc.

Remember, the on-cost such as rent, amenities and insurance for each staff can run up to 20-30 per cent of the salary costs, so any structural change could bring in years of benefits to the cost structure.

Finally, projects, conferences and events, and marketing programs can be deferred to a later time as the affordability increases. The list goes on. 

When the market does well, everybody gets a share of that by default. In many ways, organisations risk becoming complacent just because they can afford to.

Inefficiencies tend to build with growing revenue and it becomes an expensive business to run.

When the market turns down it presents an excellent opportunity to look deep and hard within the expense base to separate the wheat from the chaff.

Not all companies will survive this period, but the ones who do will come out much stronger and efficient. It is really the difficult times that separate an outstanding CEO or an organisation from the rest of the flock.

Rahul Guha is the financial controller at Fiducian Portfolio Services.