Change and how to deal with it

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I CONCLUDED my 2010 review of the Top 100 SMEs by predicting that 2011 would be another year of uncertainty and change. It was of course hardly the boldest of prophecies, but nevertheless, the 2011 survey demonstrates that there has indeed been substantial change in the make-up of the region’s most profitable SMEs.

Overall, there are 49 new entrants to this year’s Top 100. The highest new entry is property developer Elmsdale Estates (2) which benefited from a substantial legal settlement of some £3.5 million in its most recent accounts. Other notable new entries include vehicle component distributor Thos. Winnard & Sons (10), glazing manufacturer YWC (13) and engineering group Tinsley Bridge (20). At the top of the table is specialist giftware wholesaler History & Heraldry which posted a very impressive performance, driven in part by expansion into Spain and Portugal.

So what are the key reasons behind such wholesale change? Whilst corporate reorganisations and disposals resulted in a number of companies no longer having headquarters in the region, the bulk of the change in the make-up of the Top 100 arises from volatility in earnings. In broad terms, approximately two thirds of 2010 leavers failed to make the 2011 survey due to a fall in profitability.

This volatility is even more pronounced if we look at the performance of the 2011 Top 100. Of the 97 companies that have reported two years’ earnings, aggregate profitability has increased from £64m in 2010 to £101m in 2011, a rise of over 57 per cent. Moreover, eight of 2011’s Top 100 were loss making in 2010.

Whether earnings are rising or falling, large swings in profitability bring a number of challenges, not least of which is the ability to plan and forecast. There are, however, a number of steps that businesses can take to mitigate the impact of volatile trading conditions

Such steps might include:

Reviewing the cost base for opportunities to move fixed costs into variable or semi-variable costs that can flex more easily with activity levels. The use of agency labour and the outsourcing of non-core functions are both common examples of “operational de-leveraging”.

Ensuring that the financing structure is appropriate. For example, avoid using working capital facilities to fund long-term capital investment. When growth comes it is vital that a business has access to working capital to support increased trading levels.

Considering the appropriateness of hedging variable costs that are outside of the business’s control. The usual candidate is foreign currency but other opportunities exist where commodities, such as fuel, form a significant part of the total cost input.

Leaving enough “wool on the back” to survive a downturn. In good years the natural temptation is for shareholders to extract significant funds. Unsurprisingly, however, insolvency statistics indicate that aggressive extraction of profits is a common factor in business failure.

Looking forward to 2012, events in Greece and elsewhere point towards a further period of volatility. Whilst this might be good news for hedge funds, it will be much less welcome for our region’s SMEs. However, whilst we cannot influence the macro issues, there is still much that can be done to mitigate uncertainty and risk in our own businesses.