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19
Jul
2009
Need of strong sensitivity analysis

Budgeting is the most critical task in today’s environment of CONTINGENCY MATURING TO REALITIES. Professionals are talking about zero based budgeting, just in time budgeting, scenario planning etc. Cost cutting is gaining emphasis and opportunities to turn risks in revenues are just been ignore as no one like to take risk at this moment of time.

Today I got news that the net profits of renowned toy manufacturer MATTEL Inc. (manufacturers of Barbie Dolls) increased by 80% over a year. Don’t think in this time of crises people start playing with dolls. The profit increase is there despite of decrease (15% down) in total revenues. It simply suggests that they have done massive & effective cost control. Their net profit stands at US$ 21.5 mln against US$ 11.8 mln last year. The total revenue stands at US$ 898.2 mln against US$ 1100 mln last year. Even if you analyze some other financial results of companies in U.S. and other parts of the world, so they have posted some good results (some times increase in profits and some times more than anticipated), it is mainly because of cost control. (In our term INSAN KAY BACHAY BAAN GAYAY HAINE)

Mattel’s chief Robert Eckert still emphasizing on managing company’s cost structure and need to be watchful as coming time is challenging. His tone is not confident as increase or stability in sale is a serious concern.

Mattel is one of many examples in the world. I am surprised why they didn’t minimize their cost when there were no crises. Just assume if the sales would be all fine, how much it would worth to the company. The reality that is visible today is simple that companies never see their cost structure’s irregularities when they are having good cash inflows. It is in my view, “Financial Psychology” that a financial planner who sees handsome cash flow of the project or company, some times ignore the proper cost management. If you see the project causes inflows of 100 million and the total out flows are 15 million, your natural reaction would be non serious towards minimization of cost (& its analysis). In my view the approach is really dangerous and non-professional. If working out minimum cost is possible so you have to go for it regardless of how much you are earning. This laziness or ignorance is financially sinful.

In my view there must be a separate cost control team with in a company’s Management Account Department. They need to work apart of understandings of inflows or revenues. They need to be rewarded proportionally of the cost they cut (their performance). Their tasks must be highlighting the areas that are working in extra cost and how they can reduce their cost structure or increase their efficiency. If you have to cut your cost in the time of crises so why not now to have some more funds for crises or contingency management? The money from cost cutting in good time can be utilized as the reserve for contingency or reinvested cyclically to get more funds.

Many times I have been seen people making financial models for projects and companies. They use to be focus on forecasting financial statement on calculated growth rates, ratios etc. They are more focused towards calculation of cost of capital rate, IRR, MIRR etc. The real disciplines that work more than any thing in projects or company are the elements of its CASH FLOWS. It is the health of cash flows that determine the success or worth of the project or company. You can come out with the dynamic looking spread sheet for a financial model (real time sheets) but if your analysis for cash flow’s instincts is not up to the mark so it is mere a calculation that a software can do also. It is not your graduation examination hall where you have to calculate NPV, IRR, MIRR, WACC, Ke, Kd etc. Here you have to engineer things to the extent of efficiency and effectiveness. Your role is not to accept (calculate) the cash flows but you have to develop them with the help of financial and non financial measures.

Sensitivity analysis is the back bone of financial planning whereby you will have to assess the probability of variables that are the components of your grand financial plan. You need to come up to the number or figure that is highly probable. The highest probability never means that you don’t have to cover it with a suitable contingency plan for sensitive variables (with the highest probability). If I say 90% probable, anyways it is probable but not a surety. Financial plan has to be like a decision tree that will have some other plans embedded that will work when the dynamics of the plan starts disturbing, generally a courtesy to an external environments.

Your grip on operational sensitivities has to be sharp enough that will reflect in your presentation files. It is not a matter of shame to sit with different strategists of different disciplines to understand the cost & revenue structure of different cost & revenue centers. Don’t create technical (financial) issues in your minds. Don’t focuses so much on IAS, IFRS, Regulatory implementations. These things come after your superb operational studies. Try to focus more in understanding business operations and its financial impact. Then you will have more time at your home to think about accounting standards, auditing techniques, regulations etc. I generally (ideally) like recording companies to develop CDs and Audio cassettes for financial tools (IAS, IFRS, Prudential Regulations etc) that they can listen while driving in the car and once they will be on seat in the company or project desk, so they have to understand how they can have cash flows and time them. You need to distinct your role as a finance professional from an accountant or even a charted accountant.

My today’s writing is simply in response of financial results of METTAL Inc. that tells me; the stuff they are carrying today is the same that they could have done far before. The lacking is simple they have never seen it as a serious issue but in serious time a lesser serious aspect is the most serious demand. If it is all serious so we have to seriously care about it.


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Mr. Omer

Mr. Omer [1982 born] started  his professional career as a commercial / investment banker after achieving Gold Medal in Finance at master level from University of Karachi in 2006.

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