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Work hard, yes. But on what?

The premise that you work hard with success to follow doesn’t address what you should work hard ON. Here’s a technique that I’ve found some success in.

I have racked my brains out looking for ideas on different businesses ideas and have set up some, ranging from successful to failures. I, being an ambivert, used to an office environment even started a busy dessert shop in an even busier shopping centre, which I eventually sold because I was unable to give consistently to the constant customer interaction. I’ve started a logistics company, which although presented a good opportunity, now take a behind the scenes role because I just don’t take enough interest in the industry and environment. After nearly seven years, I still run a few simple businesses like ticksymbol.com that generate a few pounds.

I’ve used CrunchBase to spot well-funded start-ups in other countries and using those as a basis to generate ideas or models to adapt in my country. I’ve studied emerging trends and reviewed top-performing stock and ETFs over long time horizons to understand where current and future opportunities lie.

Given all of that research and analysis, there is one constant for me: enjoyment and skill-fit are important. If I am to build something over the long term, I need to enjoy it and it should require a skill set that I have or am interesting in developing.

Aristotle gave us the following wisdom:

Using our habits as a starting point can help us figure out what we are likely to persevere with once we need to cross the chasm. Here is a simple approach that has helped me:

  1. Remove macro ambitions of “wanting to be rich” or “wanting to be famous” — they’re generally useless and of no practical value.
  2. Understand the themes of what you have been doing over a minimum time-horizon of 1–2 years. What have been the natural things that you have gravitated towards and what things have you signed up to — charity work? interning at a startup? being part of a public speaking group?
    Why not even consider what you are reading or who you subscribe to on YouTube — maybe James Frank? Matt D’Avella?

This list will be the basis of figuring out what you can do that will remain sustainable based on the things that you already do and gravitate towards naturally.

Naval, presents the wisdom that you should do things that feel like play to you but look like work to others. By understanding our “habits” and natural inclination towards certain themes or things gives us insight into what “play” is to us.

Basing success on habits and play makes things easier for us and we increase the probability of success by orders of magnitude because it is natural to us and more enjoyable for us, as opposed to running a logistics company that we know very little about, which although seems to have the seeds of success, is stressful, tiring and frankly, not sustainable.

I have an interest in frameworks; models; optimisation, systems and processes and somehow, I have landed a role in line with this. I would consider myself extremely good at my job and often find myself taking leadership roles on projects on this basis. I have worked on developing systems and processes as part of my extra-curricular work and this has often been the most successful dimension to the businesses I have started, with me wanting to work on this day and night.

I hope you’re able to use this approach to find something that is based on your habits to create something that you feel like working day and night on.

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Download: Team Generator

The problem with choosing teams with no real system is that it can sometimes result in the problems of (1) taking too long to pick teams eating into game-time and (2) the teams not being fair as a result of mismatched player ability in teams, resulting in potentially one-sided games, which is never fun, especially for the losing team.

I’ve created a calculator that enables you to create fair teams based on player ability broken down by (1) skill and (2) stamina. The tool is limited to five-a-side and seven-a-side games; please update if you need more players added, otherwise drop me a line and I would be happy to help. Once downloaded you will need to ‘Enable Macros’ when prompted.

Just use this before the game and send the teams out to all the players in the group chat prior to the game.

You may not want to make this a public document for obvious reasons.

Blank Team Generator

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Power Distance Index

The Power Distance Index (PDI) model is used largely to consider the psychological and sociological attitudes people take to hierarchy and power.
People in societies with a low PDI tend to underplay their authority or position in the hierarchy, with a view to sharing power equally and providing greater justification for their position, compared to those societies with a higher PDI, which place a greater emphasis on hierarchy and power, with individuals less inclined to providing justification apart from their apparent position in the hierarchy.

The PDI plays a significant role in social interactions. Cultures with a higher PDI will place great emphasis on their boss, teachers, parents and other people in positions of power relative to cultures with low PDIs whereby the sense of “hierarchical difference” is less and therefore not placing the need to respond to superiors from a starting position of submission, but rather equality.

Below is a table of countries with their respective PDIs with the top ten on the left and the bottom ten on the right.

The relative PDI impacts behaviour through various means that are far-ranging and applicable to most contexts. Within the workplace for example, a subordinate may be less likely to question a boss’s decision within the workplace if the PDI is high, as a result of the cultural connotations attached to the challenging of superior’s authority.
This is relative to the nature of UK politics, where society believes they can challenge authority, where politicians, who may be deemed to be in positions of power come under public and peer scrutiny, which is also extendable to judges and parents within those countries with a low PDI.

What is more interesting however is the cultural responses to the challenging of authorities within a same context. An example may be that a lecturer is teaching on business in the UK. A student from Denmark may challenge the lecturer on his knowledge, with fellow classmates seeing this as a strict demonstration of non-compliance and accordingly may see the student from Denmark in a certain way, even though it may have not really meant anything to the Lecturer as he is from the UK and the student from Denmark; countries with low PDIs.

What can be noted is the geographical locations of the countries with higher a higher PDI relative to countries with a lower PDI. Below is a geographical heat map that demonstrates these locations.

The heat map largely suggests two key things:

  1. Countries with higher or lower PDIs are not geographically far from one-another
  2. European and the United States have a high concentration of low PDI

There is probably a lot to be studied and to be said as to the rootings of these PDIs, however, it may be a reasonable deduction that European countries and the United States have similar PDIs as a result of their similar cultures that may stem from similar histories; relations; geographical proximity, with the same to be said with the countries with higher PDIs.

Perhaps the power distance index is one variable to be considered when managing foreign relations or more practically, when addressing individuals of different cultures.

PDI Rating Source

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Note to Self: Just Go

Note to self:
Always make your starting point one of love, compassion and kindness, however remember that this is not always everyone else’s starting point.

You’re in school. You need to go to the bathroom badly. Mr Fletcher said last week, “you cannot go to the bathroom without my permission and until you get it you need to sit in your seat and raise your hand”. You raise your hand as far as you can raising it ever more higher the more you need to go in a bid to get his attention sooner. Soon your trousers change colour and you’ve lost control. Mr Fletcher rushes over immediately in anger, shaking his head and you sadly whisper, “Mr Fletcher, I really needed to go”.

The people you are supposed to or are told to trust are sometimes wrong or don’t understand. It’s okay though; that’s part of life. What your job is to make sure you understand this and make sure that if you’re in a situation where you’re relying on someone is to understand, “does this person have my best interests at heart?” It may not be anything malicious, it may be that they just don’t understand how badly you need to go.

Just go.

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Your Big Problem

There is no room for big problems. Nobody likes them and nobody wants them. In order to keep it this way, we must be able to manage them and maintain an approach to resolving them if they do ever arise, which of course, they will at some point or another.

A simple approach is one of breaking it down to sub-problems and tackling those in a bid to resolve the bigger problem. In any event, this is always a good starting point for understanding and gaining clarity of the problem.

This review and understanding of the sub-problems should be supported by effective understanding of the following items:

  1. Key issue at hand
  2. Relevant variables involved
  3. Forces and impacting items
  4. Actors involved
  5. Tasks required to resolve
  6. Success criteria – what is success?

By understanding these items, we are able to build a picture of the smaller problems and work towards resolving them by managing the above items.

Monitoring the progress of your problems is the next step; by monitoring you’ll be able to see the progress and know exactly when the problem has been resolved. Therefore this is a critical part to the process and without this, you will have no idea when your sub-problem is resolved. Tracking your performance is critical.

This same approach can be flipped and applied to  goals too. By setting  high level goals of losing weight or getting a new job through understanding sub-tasks to be achieved such as (1) updating your CV and (2) then looking for jobs and other tasks required will work towards the goal of ‘Find New Job’ being achieved.

Without measurement you will have no idea of what success is and therefore, your goal will never be achieved, because you will not know when it has been achieved, therefore track your goals too.

Taking a bit of time to plan the resolution of your problems and goals will certainly go a long way. Remember:

1. Your problems and goals are easier to resolve and achieve when they’re broken down

2. Whatever is measured and tracked can be achieved

Problem solved.

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Why your Change Efforts are Unsuccessful

Being able to recognise, plan and implement change is a critical success factor for almost any organisation. Organisations are subject to various forces both within and outside of their control, known as ‘internal’ and ‘external’ forces. For the most part, internal forces, can, to some extent, be planned for and “controlled”, however, often, external forces can be the largest drivers for unplanned change that the organisation needs to respond to, often quite quickly; take Brexit as an example. External forces may relate to regulatory and legislative change; increased competition in the market; the unavailability of a resources and anything else that derives from outside of the organisation.

John Kotter, a Harvard Researcher, studied more than one-hundred companies, analysing their change processes, reviewing how successful/unsuccessful their change efforts were relative to initial objectives for that change.

Synthesising all that information from successful and unsuccessful projects, he came up with the following most common errors that were detrimental to effective change delivery:

  1. Allowing too much complacency: Complacency is a virus that should be rid of immediately. There is absolutely no space for an organisation to remain stagnant, nor subject to external forces without at least a little bit of control. Therefore, it is imperative organisations remain both vigilant and responsive to their environment, both internally and externally, to ensure any change can be recognised early on, managed and delivered effectively. This is to ultimately ensure maximum value can be gained in response to ‘late-in-the-day’ or retrospective implementation.
  2. Failing to build a substantial coalition: The team are the drivers for change and need to be wholly bought in to the change, its vision, deliverables and objectives. They need to maintain the necessary mindset, skills, team spirit and drive to get the job done irrespective of circumstances. The coalition may include project team members, but may also include supporters and stakeholders that may have an interest in the project. In any event, the stronger the coalition, the stronger the likelihood of success.
  3. Underestimating the need for a clear vision: The vision is critical; if the organisation doesn’t know where it’s going, how is it going to get there? Time should be spent early on in the project, to define, understand and plan the project. Naturally, the vision plays a critical role in this definition. The largest cost to projects are change requests raised during the project delivery, so if extra time is invested at the outset, understanding the vision and how to achieve it, this will save resources further down the line.
  4. Failing to communicate the vision: No brainer, right? The problem is around individuals involved not understanding the wider impact of the change. The word, ‘Vision’, itself is not a short-term idea; vision relates to the wider objectives of the project that may impact profitability, business processes, customer service, learning and growth for the organisation and more. It’s critical for the stakeholders to understand this vision, so they can see the benefit and value to be gained from it. If the coalition doesn’t understand the vision, how can they be expected to communicate it to others, so the coalition is certainly a good place to start to ensure buy-in can be gained across the board, from all stakeholders.
  5. Permitting roadblocks against the vision: Roadblocks are unacceptable and should be completely removed from the journey as quickly as possible. Naturally, if they can’t be removed, a strategy should be in place to manage them, so to prevent any potential detrimental impact on the achievement of the change. The coalition’s key objective should be to deliver the change and therefore, the review of risks that may affect that delivery should be clearly identified, managed and preferably removed. The more aggressive a team is around this, there is an increased likelihood of successful change delivery.
  6. Not planning: Again, a no brainer; we’ve all heard it: ‘if you fail to plan; you better plan to fail!’ There’s truth in that; we’ve all been in that position where we’ve not thought something out thoroughly and regretted it once we were in the thick of it. On this basis, it’s so important to plan the change to ensure successful delivery. This may include understanding risks, milestones, people involved, what we need to produce, by when, whose support we need and more. The idea of planning is to increase the level of ‘control’ we have over a project, to ensure we’re driving it in the right direction and that we’re subject to as little roadblocks, problems and issues as possible preventing us from achieving our change objectives.
  7. Getting short-term wins: Getting those short-term wins in as quickly as possible can support in the morale, momentum and team spirit of the coalition, further increasing the drive and ambition for success. Soft-skills and emotional intelligence are of course critical, but often overlooked elements to successful change delivery and this should be managed by the guiding members of the coalition, facilitating and encouraging team morale, spirit and happiness. No recognition, sense of achievement or short-term wins can often result in burn-out, drainage and a coalition not feeling motivated. The coalition members are the drivers of the change and their attitude and motivation towards the achievement of the change is, some might argue, the most important thing.

With these errors all under control and managed, you will have drastically reduced the probability of your change efforts being unsuccessful. Change is an essential part of life and business and the quicker we can learn how to best manage the wider delivery of change, the more effective, efficient and productive the change and its delivery will be.

Good luck you change experts!

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Blog Quotes

Be Brave…

“Be brave. Even if you’re not, pretend to be. No one can tell the difference.
Don’t allow the phone to interrupt important moments. It’s there for your convenience, not the callers.
Don’t be afraid to go out on a limb. That’s where the fruit is.
Don’t burn bridges. You’ll be surprised how many times you have to cross the same river.
Don’t forget, a person’s greatest emotional need is to feel appreciated.
Don’t major in minor things.
Don’t say you don’t have enough time. You have exactly the same number of hours per day that were given to Pasteur, Michelangelo, Mother Teresa, Helen Keller, Leonardo Da Vinci, Thomas Jefferson, and Albert Einstein.
Don’t spread yourself too thin. Learn to say no politely and quickly.
Don’t use time or words carelessly. Neither can be retrieved.
Don’t waste time grieving over past mistakes Learn from them and move on.
Every person needs to have their moment in the sun, when they raise their arms in victory, knowing that on this day, at his hour, they were at their very best. Get your priorities straight. No one ever said on his death bed, ‘Gee, if I’d only spent more time at the office’.
Give people a second chance, but not a third.
Judge your success by the degree that you’re enjoying peace, health and love.
Learn to listen. Opportunity sometimes knocks very softly.
Leave everything a little better than you found it.
Live your life as an exclamation, not an explanation.
Loosen up. Relax. Except for rare life and death matters, nothing is as important as it first seems.
Never cut what can be untied. Never overestimate your power to change others.
Never underestimate your power to change yourself.
Remember that overnight success usually takes about fifteen years.
Remember that winners do what losers don’t want to do.
Seek opportunity, not security.
A boat in harbour is safe, but in time its bottom will rot out.
Spend less time worrying who’s right, more time deciding what’s right.
Stop blaming others. Take responsibility for every area of your life.
Success is getting what you want. Happiness is liking what you get.
The importance of winning is not what we get from it, but what we become because of it.
When facing a difficult task, act as though it’s impossible to fail.”

— Jackson Brown Jr.

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Here’s How you Identify & Manage Stakeholders

One of the most important elements to successful project delivery is, Stakeholder Management; stakeholder management is the management of all parties that have an interest or stake in a project, ranging from, the people responsible for the project; subject matter experts; key decision makers; the do-ers, to the end users.

Effective stakeholder management can either make your job really easy or really hard; the better you are at stakeholder management and managing people’s expectations, requirements, input and perceptions, the more value you will get from your dealings and interactions with your project stakeholders.

Below I highlight effective and well-established ways of identifying; analysing and managing stakeholders.

Identifying Stakeholders

If your role includes working in ambiguous project environments, with uncertainty or you are charged with delivering a project that is at its very early stages, identifying stakeholders is a high priority task. Some of the ways in which they can be identified is by first of all consulting with the individuals responsible for the sponsorship of the project, which one would assume would hold some basic or detailed knowledge around who the individuals or teams that may be affected by the project.

Although this is certainly a good starting point, it would also be value-adding to review project documentation produced to highlight the scope, benefits and value of the project, as these documents such as the ‘Project Initiation Document’ or ‘Charter’ will highlight the direction for the project, individuals/teams impacted and much more, which will give you good indication and direction on the people/teams/departments you may want to consider.

The project may be closely interlinked with other already established business processes, which may be owned by related stakeholders who would be a good source for information on interested parties.

You may want to reach out to core departments such as ‘Legal’; ‘Risk’; ‘Compliance’; ‘Customer Experience’ and other related teams if available to simply ask if they would need to have an input on the project; you may need to send them project documentation; it will typically be common knowledge however if you need to get certain teams involved.

Stakeholder Analysis

Based on the above activities, it may be that you’ve now generated a list of thirty stakeholders that need to be considered as part of your project. Sometimes stakeholder lists, depending on the size of organisation you’re working with can grow to be quite big, so it is imperative that we employ a sustainable system that (1) enables the project team to understand stakeholder input/requirements/involvement etc, as expecting the project team to remember who’s-who in their head is of course unsustainable; (2) allows us to individually mark who requires what level of updates and involvement, as they are two important items, that are independent of each other.

Interest/Influence Analysis

The first part is to understand from your list, which stakeholders wield high levels of ‘Influence’ and high levels of ‘Interest’. Lucky for us, there’s a simple matrix that’s typically employed to understand where people on your stakeholder sit as follows:

The matrix below brings to your attention four quadrants that should all be managed accordingly:

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‘High Power; Low Interest’: Little level of updates/input required, if any. The people in this group are considered to be passive, but may become more actively involved depending on interest and move in appropriate quadrant.
‘High Power; High Interest’: Should be kept informed throughout, as typically decision makers or high impact influencers.
‘Low Power; Low Interest’: Need little monitoring, as stakeholders are not interested, however may benefit from the odd periodical update.
‘Low Power; High Interest’: Should be kept informed of project activity, as may be able to influence powerful stakeholders.

With this information and your better understanding on the impact of individual stakeholders, it’s important to set up a Stakeholder Register/List and classify each stakeholder based on the results from (1) your influence/interest matrix and (2) knowledge on the level of input the stakeholders will have. I’ll talk about the register further.

RACI Classification

RACI classification is system used to understand the what involvement, responsibility and/or accountability stakeholders have for project tasks/deliverables/updates etc. The RACI system is broken down as follows:

  • Responsible (for): The “do-er” who is responsible for delivering the item in question.
  • Accountable: This is the person who “owns” the project/task/activity who the buck ends with, who has responsibility for the activity/project/task at hand. This can also be stakeholders with decision-making abilities.
  • Consult (with): This is a person who will have an input on the project, which could include a Subject Matter Expert; end-user or decision maker
  • Inform: These are individuals who you are to keep informed of project/task/activity progress, who may be impacted by the project, mainly end-users or low power; high interest stakeholders.

A stakeholder can belong to more than one classification, however, be warned, this can get a little messy if you’re filtering with Excel, which we’ll talk about later. May be easier if you’re using a software package.

Nonetheless, this approach to classification will make it easy for the project team to identify individuals who need to be updated according to the stakeholder management strategy.

Stakeholder Management

Here’s where you set the tools up to effectively manage your stakeholders. There are two key elements to effective management; they include (1) a coherent and useful Stakeholder Register and (2) Stakeholder Management Strategy.

Stakeholder Register

This is the register that will list all of your stakeholders with respective RACI classification, along with any further information or insight in to that particular stakeholder. This typically works best as an Excel spreadsheet, with filtering capabilities. The spreadsheet may have the following headings for columns:

  • Name
  • Department
  • Title
  • Role on Project
  • Expectations
  • Level of Interest
  • Level of Influence
  • Involvement (Level of)
  • RACI Classification
  • Date Added
  • Sign-off Required
  • [Deliverable #1] Signed-off (if required)
  • [Deliverable #2] Signed-off (if required)
  • [Deliverable #[…]] Signed-off (if required)

You can download a template I’ve put together for you here.

Stakeholder Strategy

The stakeholder strategy will inform the project team on the level of detail of updates; frequency; who will be responsible for updates; detail of any walk-throughs to be delivered; when they will be delivered e.g. before sign-off requests; what to do if stakeholders are non-responsive, which will happen! And any other detail around the complete process of managing stakeholders.

Naturally, keeping all of this information in a centralised location and incorporating updates, deliverable releases etc in to your project calendar would be useful, as related tasks like this will ensure the correct stakeholders receive the correct information at the right time. It is also equally as important to maintain strict professional, based on a friendly, courteous and respectful approach, ultimately resulting in sustained relationships over the long-term that goes beyond the project. Remember, you may be working with the same stakeholder in the future and it is extremely important to maintain credibility, a quality reputation and good relationships for subsequent projects.

Not forgetting soft skills as part of your stakeholder management, the book, ‘How to Win Friends and Influence People‘ is certainly a must read. It drives the idea of emotional intelligence and has great techniques in how to get more value out of your relationships. Soft skills are an essential skill to a good stakeholder manager and developing these soft skills, by reading such books, or further learning, will certainly add value to your project delivery skills.

Good luck with managing your stakeholders.

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The Sunk Cost Fallacy

It’s irrational to consider a sunk cost in any part of any decision. 

You’ll know a sunk cost is something that you’ve spent or invested, where there is little to no chance of you getting your initial investment back – it’s gone – It’s sunk. This becomes a problem when you’re using a sunk cost to base a future decision on; this is because this results in BAD decision-making.

Imagine this; You’ve just picked up a book and you realise that 97 pages in, you don’t like the book and you feel like putting the book down and starting a new one. The book could be an Amazon top seller or whatever, but you feel like putting it down and just starting a new book. The subsequent thought that goes on in your head is that, “Well, I’ve read 97 pages now; if I put the book down now, those 97 pages will have gone to waste.”

By reading however many pages that are left is no way going to release you from that state of feeling unhappy with the book irrespective of the 97 pages you’ve already read. No one is going to gain or get any additional value from you finishing the book and at the same time you will be wasting your time on something you’re not enjoying.

Being sentimental about your resources that you’ve invested will usually lead to further resources being wasted.

We all fall victim to what some call the ‘Sunk Cost Fallacy’, simply based on the fact that, by the time the decision comes to leave or stop something, we’ve invested some kind of resource like money, time, energy etc, which naturally, sometimes, makes the job harder for most people to quit or stop something.

The problem however really lies with not knowing what’s going on during the decision-making process in your head. The ways in which to really understand and get better in understanding what’s going on while your making a decision is to simply do the following:

  1. Simply educate yourself about what a sunk cost is
  2. Be self-aware of your own decision-making process
  3. When in the decision-making process, consciously take a step back and consider your outcome with the knowledge of the sunk cost fallacy
  4. Review your decision and change if necessary

Next time you start that film, where you’ve invested thirty minutes of your time in to, don’t be afraid to just get up and walk away. Spending another hour watching that film will not give you any additional value, so go and do something else you’d maybe enjoy by ignoring the sunk cost of the thirty minutes.

Don’t waste any more resources than necessary.

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It’s Time to Quit

Controversial, I know. The only thing you hear nowadays is if you quit, you lose; winners never quit and quitters never win and so on, but ignore the people who tell you that; let me tell you why.

Evidently, no one has ever told these people about sunk costs and opportunity costs; the two most significant variables that should be taken in to consideration when making a decision or thinking about quitting. Let me explain:

1. Sunk cost:

“A cost that has already been incurred and thus cannot be recovered. Sunk costs are independent of any event that may occur in the future.”Investopedia

A sunk cost, in simple terms, is a cost that has already been incurred from a previous opportunity or decision that’s been made. This could include a financial investment made to start a part-time hair and beauty course or a gym membership subscription.

2. Opportunity Cost:

“The benefits you could have received by taking an alternative action.”Investopedia

An opportunity cost is essentially the cost of an opportunity or the missing of a benefit that may come from an alternative opportunity e.g. missing the benefit you may make if you started playing badminton instead of going to the gym or changing your course from a hair and beauty course to an accounting course.

The difference between these two variables is that, a sunk cost is backwards looking and the opportunity cost is  forwards looking. Secondly, a sunk cost is unavoidable, where an opportunity cost is avoidable.

In order to make a decision on if whether to quit or not, what you have to do, as the decision maker here, is to quantify, in some way, the difference between these two variables by understanding, which will offer the most benefit to you – either to keep on paying for something that you want to quit and not gaining maximum benefit from, or to gather benefit from another opportunity and quit whatever you’re doing now. You may have to be a little creative when quantifying benefits, as mostly, these won’t come in simple number or money terms; they could even be happiness, peace of mind or time saved.

Decision Maker: If the benefit from another opportunity outweighs the benefit from whatever you’re doing currently, then you should quit immediately.

I hope you will agree with me when I say, It’s not worth wasting precious resources like time, money, energy, your mental health on things that aren’t giving you the benefits you want.

Let me give you an example: You’ve just joined the gym and are paying £50 a month. The problem is that you hardly go because you’re so busy with work and commute long distances. The next thing is that, when you do go, which is once a week, you hate being there and find it a chore. You’ve now been paying £50 for three months and are thinking of quitting, but have some friends who say, the gym is good for your health and that you should keep going and only losers quit and so on.
You’ve been presented with an opportunity, where your neighbour has asked if you would like to join their badminton class for £50. You used to play badminton a couple of years ago and would enjoy the company and would find it less of a chore.
The costs and benefits between these two situations is as follows:

  1. You feel you would enjoy badminton more, as you used to play it before;*
  2. You would prefer the company, where in the gym it’s just yourself;*
  3. You may find yourself going more than once a week because you will probably enjoy badminton;*
  4. Both propositions cost the same (£50);*
  5. You can go to the gym on your own, whenever you feel like it;
  6. You find the gym a chore;*
  7. You hate going on your own* and
  8. You’ve paid £150 through you’re gym membership subscription already.

You’ll note that there’s no difference in cost and that you’ve already spent £150 on your gym membership, but that’s money gone and you can’t do anything about that – it’s a sunk cost.
Now, the logical, rational decision here should be to quit the gym. There are clearly more benefits achievable with badminton compared to the gym (which I’ve marked with asterisks above) and as a result, you will be achieving more value from your £50 investment. Sure, you’ve lost £150, but do you really feel like losing another £50 and so on by going to the gym because you’ve already invested £150? Common sense says, you should be a quitter and join your neighbour to play badminton.

This approach to decision-making is applicable to anything in life, both from your decision about your fitness, or to a financial decision. The question you really need to be asking yourself is, “is the new thing that I’m going to do, after quitting what I’m already doing, going to give me more value?” ‘Value’ can be anything from financial, emotional value or anything else. If ‘Yes’, then the sunk cost is irrelevant because it’s gone and you can’t get it back; it’s unavoidable. What is avoidable is how much you carry on spending on it by not quitting.

It’s time to quit.

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Approaches to Valuing a Business

So in this entry, we talk about the three most used approaches to valuing a business. These approaches are typically used when someone is trying to calculate a value of the business either to attract investment, for reference or sell. Although there are a few more ways to calculate the value of a business, here are the three main approaches used by most professionals.

  1. Net Asset Value Approach
  2. Price-Equity Approach
  3. Free Cash Flow Approach

The above approaches all help us achieve the same thing i.e. the valuation of a business, but take very different approaches using different variables, that invariably result in different figures. The reliability of these figures is another key factor that has to be taken in to consideration too. Here’s a breakdown of the three approaches.

Net Asset Value (NAV) Approach
This approach to business valuation takes in to consideration the total assets and liabilities owed and gives us an indication of what the business value is after all liabilities have been paid off with assets owned by the business.
Some like to use this approach to give them an indication of the business’ intrinsic value, excluding items like brand, customer loyalty etc, which, although hard to quantify, add value in their own way.
This approach works best when business Accountants haven’t tinkered or manipulated asset or liability figures; this is one of the biggest problems with this approach – that it uses variables in the calculation that are exposed to the risk of manipulation and therefore may result in a misleading calculation e.g. Assets could be massively depreciated, or inflated and the same goes for liabilities.
As accounting measures such as assets and liabilities are documented historically, this valuation approach gives us a snapshot of a time that has gone i.e. the last financial year; this is because asset and liability figures are typically sourced from yearly accounts produced at the end of the financial year documenting the year that has just elapsed. You’ll know that this is a problem because if this approach is used to value the business for future purchase, what we’re doing is basing future decisions on information from the past, which is no indication of what the business will be valued at in the future.

Net Asset Value Calculation: (current assets + non-current assets) – (current liabilities + non-current liabilities)

Price/Equity (P/E) Ratio Approach
The approach calculates the value the market attaches to each £1 of the company’s earnings, forming the basis of a valuation if the calculated figure is multiplied by the number of shares.
By calculating the P/E ratio, we can understand that the business may be worth 7x its earnings i.e. for every £1 the company generates, it can attract investment of £7. Therefore, if a business is earning 100,000, this approach suggests that the business could ask for £700,000 as a purchase price.
Now this asking price, as with most things, is relative as we don’t know if this asking price is good or bad, until we compare it with something else. So the next step would be to understand either (a) the average P/E ratio of the industry in which the business operates or the average P/E ratio of a few company that may be similar; both would obviously be better.
As Investors, we always want the P/E to be lower than the average or comparable companies, as this tells us the company is undervalued. The business owner however would always want their P/E to either be commensurate with the average industry figures, or above. If it’s too cheap, this should raise also raise an eyebrow, as something sinister may be going on, which i’ll discuss in another post.
A problem with this approach is that it is fundamentally based on a historical accounting measure (Earnings) that is exposed to the risk of manipulation. By using an earnings figure that has been subject to manipulation, this would skew the figures and not give us a true picture. More importantly however, as we talked about in the Net Asset Value Approach, this approach offers an indication of historic performance and this of course is by no means an indication that the future performance will be as good or bad as historic performance after someone buys the business; it is a snapshot of a given time period that is based on historical data.

Price/Equity Ratio Calculation: Current Share Price / (Latest Earnings / Number of Shares)

Free Cash Flow (FCF) Approach
The FCF approach incorporates future forecasted cashflows for the business that are discounted by a rate of return or ‘discount factor’, bringing future values to today’s value i.e. final figures that are discounted, so they are net present values, after any discounts such as investor rates of return or interest etc. The calculation takes in to consideration (1) future cash flows; (2) required rate of return or a discount factor; (3) any debt outstanding and (4) any outstanding preference shares or portions of the company that are owed to somebody else e.g. Bank holding preference over percentage of some shares.
People tend to consider this approach as the most informative approach to valuing a business, as it gives the investor of the business an indication of future forecasted cashflows, taking in to consideration other important variables that should affect the valuation. Investors like this approach because as per the above definition, the value of the business is the sum of future cashflows, less debts and discount, suggesting that if the future cashflows are zero – is the business actually worth anything?

Free Cash Flow Calculation: Value of free cash flows – Value of debt – value of preference shares

Imagine This:
A company has a government contract contributing to 70% of the business’ turnover for over ten years and the owner decides to sell the business the year the contract ends. With the NAV and P/E approaches to valuation, the investor would have no idea that the contract has ended and how it affects the company’s future. Alternatively, the FCF approach would highlight to the investor that the future cash flows are considerably less, therefore should be purchased for less.

Now this scenario that demonstrates one of the points of value of the free cash flow approach, however each model has its own merits and ultimately offer different information. The NAV approach offers a companies intrinsic value that may be used as part of valuing the business and may be considered a base cost for the business. The P/E approach advises of a multiplier that the company could use to value the business. And the FCF approach advises us of the future cashflow position, taking debt and discounts in to consideration.

My point is that, I don’t think one approach is better than the other. Where I decided to calculate the value of my business, I would use all three and probably more to give me a good picture of where the business is in terms of intrinsic value; market value; future cashflows and then deduce a figure taking everything in to consideration. My opinion is that you cannot value a business using just one of the above approaches and anyone who tells you differently is not doing your business justice. Apart from the above, there are a lot more variables that need to be taken in to consideration including brand, customer loyalty and probably more when valuing a business and this is why I and most of the finance professionals will probably tell you that valuing a business is not a science, but more of an art.

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DOWNLOAD: Net Present Value Investment Appraisal

Ever find yourself in a situation where you have to make an investment decision? Either setting up a new business,  investing in a property or pondering a project within your business? The decision can, sometimes, be a tough one if we don’t have the necessary tools in our toolbox to help us make a good decision.

The Net Present Value calculation is a technique that helps us to make better decisions based on more variables that go beyond other investment appraisal techniques. It is probably one of the most widely used techniques in professional investment appraisal. It is used when you are looking to understand if a project is viable or not. It tells us the profit generated by the project and if whether it exceeds the initial investment, taking into consideration the term in which you need your money back by and any discounts you need to apply to that income such as costs, interest or required rates of return etc.

The NPV is the difference between the cash inflows and cash outflows, discounted by a rate that the future inflows will be subject to, therefore bringing all income to today’s terms or “present value”.

The tool includes the following variables, which you need to know in order complete the calculation:

  • Investment Amount
  • Project Term in Years
  • Discount Rate
  • Cash Outflow/Investment Required
  • Forecast Cash Inflows for Project Term

The way you know if whether a project is viable or not is from the output of the calculation. The NPV will calculate your result in monetary terms, that will either be more than £0 or less than £0. If it is less than £0 over the project term, then you should not progress with the project. Where however the result is a positive figure that is above £0, then the project, in theory, is positive and therefore, cashflow positive and able to pay off liabilities such as costs and return you initial investment.

I’ve created a calculator for some projects I am working on and have made it available for you to download here.

The calculator is limited to a project term of five years, as most forecasting is just guess work after that.

If you would like to level up your NPV game, you can read my blog post here about calculating your discount factor or ‘WACC’ – Weighted Average Cost of Capital.

Hope it’s useful. If you would like the calculator tailored, please email me and I’ll be happy to help.

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Tracking your Business’ Performance with Ratios

If you run a business, here are some of the most important ratios you should be looking to monitor. They range from profitability, to liquidity, to efficiency and will, if monitored on a regular, periodic basis, give you good insight in to your business’ financial performance, enabling you to improve.

Current Ratio
Current Assets / Current Liabilities (expressed as a ratio e.g. 1.5:1)
This ratio gives you an indication of the ability to pay off liabilities within the current fiscal year with the assets you have available to you within the current fiscal year, which may include cash in the bank, inventory and other items that can be sold within the period to generate cash, to pay liabilities, within the period. The ratio can be communicated as; for every £1 liability, the company has £1.50 worth of capital that can be produced within the fiscal year to pay off liabilities. A ratio of 1:1 is required at minimum.

Quick Asset Ratio or Acid Test Ratio
(Current Assets – Stock) / Current Liabilities (expressed as a ratio e.g. 1.4:1)
This ratio gives you an indication of the business’ ability to pay off immediate liabilities with cash that is immediately available to the business i.e. Cash in the bank; this is why the calculation excludes stock because it assumes that there will be a time delay with selling stock. The ratio can be communicated as; for every £1 liability payable immediately, the company has £1.40 worth of capital available. A ratio of 1:1 is required at minimum.

Return on Capital Employed
(PBIT / (Total Assets – Current Liabilities) x 100
One of the most important profitability ratios; this measure will give you an indication of how worthwhile a project is based on it’s income relative to its investment. PBIT (Profit before Interest and Tax) is used so that we can directly compare ROCE’s with different projects, businesses etc, before they employ any tax and interest strategies. Non-current liabilities are not included in the calculation, as these may be interest payments for long-term loans or similar, where the loan may be used to generate income, that go beyond the project term.

Gross Profit Margin
(Gross Profit / Sales) x 100
This is a measure of how efficiently the business uses its resources labour and materials in the production process to generate its first layer of profit (cost of goods sold). The higher this figure the better. The figure gives a good indication of the profitability of operations before any costs of overheads are applied and is widely used in the investment community to determine potential opportunity e.g. a low margin may suggest the company is using its labour and materials inefficiently and therefore could be improved, resulting in increased profitability.

Operating Profit Margin
(Operating Profit / Sales) x 100
This is a measure of the business’ profitability after fixed costs overheads are applied to the calculation and gives an indication of the profit margin before interest and tax. Operating profit is also known as PBIT (Profit before interest and tax) and is another figure that is typically used to compare projects with to understand how efficiently businesses use resources, inclusive of their overheads.

Net Profit Margin
(Net Profit / Sales) x 100
This measure gives an indication to the margin the company achieves after variable costs, fixed costs, interest and tax. It is also another profitability measure that can be used to compare with other projects and businesses, but should be taken with a pinch of salt, as different companies can sometimes employ very different interest and tax strategies, convoluting the points of comparison; that’s why the PBIT/Operating Profit is the favoured ratio used when comparing projects and businesses.

Gearing or Leverage
(Long Term Liabilities / Capital Employed) x 100
The gearing ratio gives us an indication of the debt-to-equity structure of the business i.e. the proportion of finance that is provided by debt relative to the finance provided by equity (or shareholders). The business is considered to be more speculative if the gearing ratio is high, as it suggests that a larger amount of the business’ capital structure is based on debt and therefore subject to external forces that are not under its control. The higher the gearing, the more speculative or risky the company is to be perceived. This ratio also gives indication of the long-term financial stability of the business.

Debtor Days Collection Period
(Average Debtor Days / Credit Sales) x 365 (expressed as x number of days)
The Debtor days ratio gives us an indication of how long, on average, it takes for us to collect monies from our customers who have purchased on credit. The amount of debtor days usually under the control of the business and the lower the ratio this is, the better, as it facilitates good cashflow management.

Creditor Days Payment Period
(Average Creditors / Purchases) x 365 (expressed as x number of days)
This ratio gives us an indication of the average number of days the business is required to pay off liabilities owed to creditors, which could be suppliers, professional services etc. The higher this figure the better, as the longer we have to pay back liabilities, the better it is for us, as we are able to cash in money from our debtors to pay our creditors. This figure is usually under the control of creditors, but can sometimes, depending on the relationship, be negotiated.

There are a couple more, however these are some of the most important and widely used. I will write another post on other ratios including:

  • Return on Equity Employed
  • Stock Holding Period
  • Interest Cover
  • Earnings Per Share
  • Dividend Yield

Enjoy.

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Getting the Record Straight about Opportunity Costs

So I met somebody the other day; let’s call him Ryan, who said something along the lines of, “I didn’t do it. I was suffering an opportunity cost, it would have taken up my time, so I got someone else do it; I outsourced it.” I said, “Oh okay, cool. So what did you do instead?” He responded with, “I went to the pub instead.” We then laughed together – it would have been rude if I didn’t, right?

Now the problem with ‘Opportunity Cost’ is that it’s a term banded about so much that the idea is sometimes misunderstood and therefore some may not use the idea properly as part of their decision making. I wasn’t even sure if Ryan properly understood what an opportunity cost was. Here’s a definition:

“A benefit, profit, or value of something that must be given up to acquire or achieve something else. Since every resource (land, money, time, etc.) can be put to alternative uses, every action, choice, or decision has an associated opportunity cost.

Opportunity costs are fundamental costs in economics, and are used in computing cost benefit analysis of a project. Such costs, however, are not recorded in the account books but are recognized in decision making by computing the cash outlays and their resulting profit or loss.” Source

So, according to the above definition, every action, choice or decision has an associated alternative and therefore, opportunity cost if it’s not taken. To further expand in my own words, an opportunity cost is the cost of something that was not accessible or doable, due to the resource that could capitalise on that opportunity being tied up elsewhere doing something else, therefore you are losing an opportunity and incurring a cost.

Back to our mate Ryan who paid to outsource a task to someone else for him to do because he suffered an ‘opportunity cost’ – the opportunity being, going to the pub.
What’s important to note is that, no matter what Ryan did, he would have always incurred an opportunity cost, as based on the above definition, there is always an alternative and therefore, there will always be a cost. The next most important decision criteria that can be used to prioritise opportunities however is understanding, which, out of those opportunities is the most value-adding.
Now if Ryan valued the opportunity of going pub more than the result of the task he outsourced more value-adding, then he certainly made the right decision and you should stop judging him here ;-).
Where however he used the opportunity cost as an excuse to outsource a task and not take up another opportunity that was equally or more value-adding than the one he outsourced, then he made the WRONG decision and suffered an opportunity cost.

It is an assumed objective that every resource should be appropriated and utilised to undertake the most value-adding activity he/she/it can. Where it isn’t, it is a waste of resource and therefore an opportunity cost is incurred because the resource could be capitalising on another more value-adding opportunity.

My opinion is that Ryan did suffer an opportunity cost, as I don’t see going to the pub as being that value-adding relative to what seemed like a business related task; he may think differently however.

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DOWNLOAD: Mortgage Calculator

If you’re buying a house to live in or a buy-to-let and need to understand monthly mortgage costs, you can download my mortgage calculator below.

The calculator offers you insight in to your ‘Interest Only’ and ‘Repayment’ monthly payments, taking in to consideration loan-to-value rate, arrangement fee rate, interest rate and term, which are all customisable.

Hopefully this will give you better insight in to how much your mortgage will cost you and/or how changing interest rates, term, arrangement fee and LTV will affect your mortgage payments.

The calculator is completely customisable and I’ve made it easy to know where to change what by highlighting changeable cells to green.

There are various websites that help you to calculate mortgage costs on a month-to-month basis, however I didn’t find them very flexible in terms of including arrangement fees, changing loan-to-value proportions and changing interest rate levels. I also really wanted to compare and do a bit of analysis around changing rates, which this calculator helps me to understand.

Download here.