At the beginning of this series, we introduced a sweeping definition of losses in a way to include both technical and non-technical losses. Today, we will conclude on the two and introduce the general principles of loss prevention and management.
Specific technical losses: In addition to the broad generalisations of technical losses discussed last week, specific operating/current assets can also attract losses for us in several ways. For instance, when we make credit sales, chances are that some percentage of the sales might not be paid back over time. On one hand, we will need to have ways of being able to pre-identify likely defaulters and avoid making credit sales to them whilst on the other hand we need to charge such losses to our income statement appropriately. If we are able to subsequently make recovery of the amounts, or parts thereof, that we considered lost in the past, we can always recognise them as income again. Similarly, stock of raw materials, WIP and finished products can deteriorate due to storage or lost to pilferage. We should put measures in place, on one hand, to avoid such losses in the first instance. Yet again, on the other hand, we have to give them the right accounting treatment if we suffer the losses nevertheless. There are also operational costs that we incur but which do not give us any benefit. These costs can add up and either reduce our level of profitability or lead to outright losses. We should always strive to vet all activities and actions to ensure that we avoid incurring costs that do not bring us worthy benefits.
Capital losses: As we mentioned earlier, there can be capital losses that might arise because the price at which we can sell our capital assets in a willing-buyer-willing-seller scenario has dropped below the book value of the asset. If, for instance, we need to replace a lathe machine in our production workshop, and the purchase price we are being offered is lower than the net book value, then we may end up with a loss. Now, as long as the value we have derived from the machine over its life in our workshop has been substantial, we can ‘swallow’ such losses and move on. If, however, we have not derived much value that ‘justifies’ the loss, then we need to learn from our mistake and strive to do better in the future by reviewing our capital decision process and/or through improving our procurement methods to ensure that we get the right assets and at the right price. Even at that though, the loss should be taken without waste of time and emotions.
Regardless, I think treating capital losses is a little easier than handling operating losses. First, we may have made so much money overall from the asset than its net book value can reveal. For instance, if the company has been consistently profitable for all the life of the capital asset, with depreciation fairly and fully charged over the years, the fact that we are selling the asset at a price below the net book value might be declared as a transactional loss, but in the larger scheme of events, the machine had actually contributed to our overall profitability as mentioned above. Absorbing such losses and moving on with a new machine to continue to boost your production will be prudent and realistic, and the entrepreneur should not lose sleep on such a ‘loss’. Where capital losses might be trickier is if beyond the transactional loss, they may also cause overall operational loss to the business. This means you are so far, say profitable to the tune of N10 million but the sale of the equipment below its book value will hit you with a transactional loss of N15 million resulting in net loss of N5 million. In this situation you have to think deeply. Can you sell the asset at a better price by delaying the sale?
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Non-technical losses: As we mentioned, non-technical losses are those losses that may arise because of the occurrence of some event. The event might not have necessarily happened, in which case no loss is actually suffered. But the actual impact of the loss might also not be specifically measurable. We have mentioned the loss of a high-flying salesperson as one such event. If any ‘keyman’ leaves, the organisation might suffer financially in ways that may not be exactly measurable. Similarly, the occurrence of flood in farmland might cause substantial loss to the business. But the flood might have not been predicted even with the best meteorological services.
Identifying likely events that can cause financial losses even if they occur, and developing contingent solutions to them is a responsibility the entrepreneur should take seriously. We have covered such issues under risk management and in business continuity management.
Principles of loss prevention and management: Generally speaking, we need to have loss management principles to guide our thought and action. Loss management principles will aim to prepare you for potential loss identification, loss-prevention and loss-mitigation. These include:
- Understand your cost structure and how they affect your operations: Understanding cost composition and structure is necessary to help you appreciate how they interact with each other and how they affect your product delivery and profitability.
- Potential loss identification: A critical component of our sweeping definition is in capturing potential losses. We need to be able to understand how the occurrence of certain events can trigger the likelihood of our suffering immediate or delayed losses. We should understand such events and be alert to them as well as have contingent plans against their occurrence.
- Take timely actions: Losses can build up both slowly and rapidly. We should be willing and able to take appropriate actions timely if we are to be able to avoid some losses and minimise others.
- Keep our books clean: We need to keep a very realistic financial position of our business. If we cannot collect certain debts because of whatever legitimate and not-so-legitimate reasons, we need to write them off and learn to avoid such losses.
- Brainstorm regularly: We can avoid losses and manage those that occur better when we engage and share ideas with others within and out of our organisations.
- Insure relevant assets: Businesses can easily get hit by losses due to negligence, accidents or force of nature. If, for example, we do not insure our capital assets such as motor vehicles we may have to write-off the value of the asset if it is involved in an accident. Insuring our assets comes at some costs but which are always lower than those of losing the assets.
- Build the right emotional disposition: Losses come with the territory for entrepreneurs. The entrepreneur, therefore, should develop the right emotional disposition to detecting and handling losses. It is a balance between being alert and obsessive on one hand and realistic and almost equanimous on the other, depending on what you may have on hand.
Losses tend to occur more frequently than we may want. Hence, the entrepreneur has to have both the technical skills and emotional comportment for wisely identifying, preventing and handling losses when they occur. With this we conclude the series and will take up ‘Wise Decision-Making’ next week.
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