Chris Conolly-Smith

Chris Conolly-Smith:
Financial Management for Book Publishers in Developing Market Economies

For permission to reprint this publication for profit the publisher should be contacted first. E-mail: ; fax: (36 1) 327 3042 phone: (36 1) 327 3014

CONTENTS

Chapter 1: Introduction and Aims
Chapter 2: Publishing and the Economic Environment
Chapter 3: Financial and Investor Objectives and Targets
Chapter 4: Accounting Concepts – a Set of Accounts for a Book Publisher
Chapter 5: Title Investment Decision and Pricing Methods
Chapter 6: Working Capital Management
Chapter 7: The Print Run Decision
Chapter 8: Planning and Control: avoiding failure
Chapter 9: Raising Finance and Banking
Chapter 10: The Financial Management of Returns in Electronic Publishing
Chapter 11: A Postscript

APPENDICES

1) New Title Investment Decision models

a) Full cost costing
b) Profit Contribution format 1
c) Profit Contribution 2 format including marketing and distribution costs
d) Using Net Present Value

2)New title costing proposal for Electronic Publishing using NetPresent Value

3) Cashflow Forecast

a) Using Receipts and Payments method
b) Using the Balance Sheet method

4) A Simple Investment Schedule

5) A Financial Management Audit Check List

6) A Title Cost and Sales Database Forecasting and Control System

7) Case studies

Chapter 1: Introduction and Aims

This book aims to assist private and state publishers, and NGO publishers operating within young market economies, in understanding how better to handle the financial management of their organizations during a period of rapid change; to develop stronger, larger, more profitable, more valuable organizations; to grasp new opportunities rather than leave entre-preneurs outside the industry to take the initiative for developments and change.

The book will discuss the financial management techniques employed by book publishers and by other industries in developed economies. The purpose of this is to illustrate the financial management techniques that may be appropriate and necessary for publishers in the future,

and in order to contrast the financial management techniques required in young economies.

Who needs to understand financial management?

In young market economies, companies are accustomed to accepting the advice of their accountant. Financial accounts are drawn up solely in order to calculate the amount of taxation due to the government. The format is highly regulated for this reason. In developed economies published accounts are aimed not only at government regulators but also at existing and future shareholders.

In such young market economies, companies rely on the accountant for recording keeping, cash management and financial advice. It is rare that all these skills can be offered adequately by a single accountant. In many young economies the accountant is only a bookkeeper of records for tax purposes. The culture of non-accountants being involved in financial decision-making is not a familiar concept, but one that all senior staff of private or state enterprises must learn quickly. It is the prime aim of this book to teach managers in publishing companies how to manage their organisations financially, how to monitor success, how to analyse key decisions, how to reduce the risk of cashflow disasters. Any manager contracting with authors, printers, distributors, customers, the landlord, must understand basic financial management concepts.

It is not the purpose of the book to teach the details of financial accounting. Many managers also believe wrongly that by learning how to use professional accounting software programs they will become good accountants and understand how to run companies. There are,

however similarities between the skills and personal attributes needed in banking and those required in financial management.

This book does not aim to propose an ideal method of practice for all publishers. It takes concepts from different economies. Commercial realities – obtaining finance and satisfying finance providers, and controlling cash and assets to maximise returns – exist worldwide.

Publishing is a business

Publishing is definitely a business, which must compete successfully and please its customers both locally and internationally. In colleges publishing and media courses are generally contained within the arts faculty. Accounting can be taught but commercial skills are more difficult to acquire. Publishing companies need a balance between creativity, efficient financial controls and sound investment policies. In some publishing companies the power of the accountant may be excessive because the creative staff do not understand, or do not want to understand, the principles and practical skills of financial management.

Terminology

International accounting conventions will be used on the basis that they are the most appropriate to readers. In young market economies most banks now demand business plans and presentations in international accounting format. The terminology used will be American as this is most widely used. However the format of financial statements will not necessarily be in a format appropriate for published accounts. The aim is to explain financial concepts clearly to managers and shareholders, not to satisfy or emulate auditors' requirements.

It is assumed that all publishers accept that they need to operate as financial entities which are wholly or partly independent; that grants may be awarded for key projects but on a dimin-ishing basis; that the state will remain a major customer e.g. for textbooks but will award contracts on a commercial basis; that books created by publishers will have to compete in the market place; and that consumers will make the decisions on whether to buy or not.

The examples

Prices and costs will differ dramatically between countries. The numbers used in the examples are not based on exact market data in any single country but aim to illustrate the financial management principles in a simple clear way. The numbers and ratios should not be used as guides for ideal practice; rather, they aim to highlight key issues and compare the different financial management needs of different countries and different types of publishing. The commercial skills needed are of course very similar.

All the examples were creating using spreadsheet models. Rounding has therefore been applied. In some cases examples may not appear to add up exactly due to these roundings. I have tried to use integers to simplify the numbers.

In many countries a standard or recommended retail price is used, whereas in other countries the retailer has freedom to vary the selling price. In this book I frequently use the term ‘selling price’, which is the price that the consumer will pay. Publishers will offer retailers a discount

off the selling price according to their turnover. If the selling price is US$ 10 and the publisher offers an average discount of 25% to retailers, the net price received by the publisher will be US$ 7.50. Both retail selling price and net price are used for calculating royalty contractual payments.

Industry categories

Publishers may be categorised in the following ways:

Category / Explanation
By subject area / literature, science
By the nature of the subject / Reference books, children’s books, adult books , gift books
By type of customer e.g. / Professional and business readers, consumers, school children, university students, male or female readers, location of customers; companies
By channel of distribution / through bookshops, by direct marketing, party plan selling, bookclubs, wholesalers, Internet
By physical format / by paperback or hardback formats, cassettes and CD, on-line databases, Internet, partworks, loose-leaf; linked to this may be the price category

In developed economies the firm trend is for publishing companies to be organised by customer type and channel of distribution as the two aspects are linked. The trend has come about through competition and the need for greater market orientation. In marketing terminology, publishers has to change their selling techniques from a “push” situation to creating a “pull” situation where the customers are demanding more of their books to satisfy their needs. Publishers have to focus on the needs of specific markets e.g. secondary education textbooks. However in young economies few publishers have the confidence to rely on only one market as the market changes rapidly.

The author

The author has worked in both financial and non-financial positions in book publishing. These include directorship of a multi-national publishing company, directorships and shareholdings in private book publishers, including one as a founder shareholder / director. He has many years of experience in international consultancy work in the publishing field where has both advised and listened. He taught “Finance for non-financial managers in book publishing” for many years on industry courses. He has travelled widely in particular within the FSU, Asia. He lectures also on MBA programs at KingstonBusinessSchool in England. The MBA program is run also in Moscow.

Chapter 2: Publishing and the economic environment

Any book on financial management is incomplete without a brief study of economic principles and issues. This section will contrast the economic environment of developed and young market economies, and in particular its impact and relevance for book publishers.

It is important to note here the difficulties of contrasting developed and young economies as if there were only 2 economic models. Many developed economies have semi-controlled market economies. Certain young economies operate as “government controlled market economies”. Most economic principles are based on human nature and common sense. Any commercial enterprise must be seen in the context of the following issues relating to their economy.

Interest rates and possible investment returns
The efficiency of markets
Inflation levels
The country’s Balance of Payments; economic growth
Taxation Issues
Distribution channels; barriers to market entry; competition
Wages and employment levels
Population size; urban versus rural population

Of particular relevance to book publishing are:

The country’s education policy: whether education is regulated on what is taught in each class, or by examination success.
Availability of local pulp, paper and printing industries
Copyright and Intellectual Property Law
The use of the national language outside the country; the number of local languages

The relevance of these issues is illustrated in the table below. The table contrasts their relevance in both developed and young economies. It concentrates on book publishing issues: authorship, printing, paper, distribution, selling, book customers, and schools.

In developed countries, it takes a typical citizen the following times of work to earn each category of book: Paperback 1 - 1.5 hours; primary textbook 90 - 120 minutes; university textbook 3-4 hours; multimedia CD 4 – 10 hours

The environment in which publishers in young economies operate is thus dramatically different. The benefits of market economies take a long time to filter through. Market leaders, monopoly suppliers, will not willingly reduce prices for paper or printing unless forced to do so by lack of work or cashflow problems. Without competition, printers will demand long runs. Under open competition printers will all want the same large orders and be forced to negotiate lower prices. In time, printers will become more competitive on shorter runs and work to shorter lead times.

The culture of using multiple channels of distribution is often strange to those accustomed to having a single distributor. Monopoly suppliers have the advantage of economies of scale but in the shorter term little incentive to be competitive or to serve the needs of the customers.

Concept / Developed economies / Young market economies
Supply and demand / Wide choice of authors, designers, printers, paper mills skilled staff, distributors, bookshops and direct marketing companies. / Lack of choice in these areas
Price elasticity / Different types of books have varying “perceived values” / The concept of volume is worshipped regardless of demand. In FSU countries, people were accustomed to cheap books and free textbooks
Efficient Markets, competition and Information / Vast amounts of data available through book trade organizations. The book trade however is still very inefficient when compared with financial markets and most other industries. Legal protection against monopoly powers / Those who possess important commercial information will act on it privately through cartels until blocked by foreign competition. The need for market research and selling outside urban areas is not fully understood
Distribution Channels / Books are sold directly to bookshops or by direct marketing to the customer (e.g. to professionals or via bookclubs), through specialist wholesalers and distributors, through supermarkets, through publisher sales forces. / Publishers concern themselves more with production rather than with distribution issues. Distributors operate in cartels. Bookshops choose to sell more profitable products. Pavement bookshops emerge and thrive.
Taxation / A sales tax (VAT) is charged on books in many countries although in some others a zero or lower rate is charged in order to protect “culture” / Young market economies will usually charge the same sales tax on books as for other goods.
Banking / Wide choice except for equity investment in small firms / Lower levels of competition ; Lack of confidence in banks
Inflation and interest rates / Most developed economies have inflation rates of below 5% and interest rates between 2 – 10%. / High and volatile inflation and interest rates
Balance of Payments / Most countries will have competitive printing industries but few will have pulp industries. Strong currencies make imported paper and printing cheaper / Import quota as well as taxes may be levied on paper and printing plates and equipment. Many countries rely on a single major export
Legal framework / Actions can be brought quickly through the courts against companies breaching contracts or not paying. Copyright Law is strictly enforced by courts and by publishers. Intellectual copyright is valued and protected. Companies who break or bend the law may suffer from reduced business confidence of their customers and suppliers / It is more difficult to enforce breaches in the law quickly. Copyright infringements within the country are difficult to enforce. Foreign countries are unwilling to license books to such countries and will not offer printing manufacturing contracts to these countries because of the risk of copyright infringement. Without a strong legal system to protect and confirm ownership of assets, Balance Sheets have less credibility and value

As young economies develop, overseas investment is attracted; local people have slightly more money to spend as wages rise. Entrepreneurs are attracted to new areas of investment to supply the new “needs” of the population. Competition in the supplies of basics will have reduced the profitability of such industries. Book publishing as an industry starts to become more attractive to investors and banks, and more profitable. The parity of the locally currency may rise making overseas printing or paper relatively cheaper.

However, research shows that small businesses in young market economies face similar problems and priorities to those in developed economies. In developed economies small firms complain about lack of government support, uncooperative banks, bureaucracy, payment problems, pressure from large companies.

For example, in the UK, 1 in 5 of all small companies collapse because of poor financial management. One in approximately 3 businesses is no longer in existence after 3 years. Most reasons for financial collapse are financial and include the following:

a rise in interest charges
a large increase in rental payment
slow payment by customers
a very large order where the customer seeks to re-negotiate or reject or delay payment
the financial collapse of a customer

While these are all financial reasons, they ignore the quality of decision-making that led up to the decisions being made, but also the quality of the product and the organisation’s marketing. According to other research, the chance of survival increases if the company has prepared a business plan prior to starting business.

The evolution of enterprises

Many industries evolve from being departments under state control, into state enterprises, into part public or public ownership. Some for strategic or political reasons stay under state control. The de-centralisation of power and budgets to local regions will often accelerate this trend.

In financial terms these stages may be expressed as follows

Stage / Change / Explanation
1 / State control as part of ministry / The business negotiates a cash budget for wages and capital expenditure. The money must be used in full during the budget period and cannot be exceeded except by agreement with the minister. All strategic control is with the ministry
2 / Translation into a state enterprise or parastatals / The business becomes a separate legal entity under the legislation, has powers to open and operate bank accounts, and may negotiate loans. It operates using a Balance Sheet and can carry forward profits and other balance sheet items e.g. it can owe money to suppliers at the end of each year. Businesses become responsible for sales and marketing.
3 / Translation of state enterprises (in part or whole) either into privatised enterprises; or managers break away to compete after purchasing certain assets of the state enterprise / Businesses become partly or fully independent and have to survive using their own resources and contacts. Private companies now compete with state and former state enterprises. Customers have a choice of suppliers. Companies seek to raise risk (shares) and loan finance. State-owned enterprises have to use ministry funds more efficiently and rely more on loan finance but rely on supplier and banks contacts
4 / Enterprises grow or collapse; specialisms occur; new enterprises enter the market / Former state monopolies have the opportunity to re-earn their market leadership, wane or collapse. Over a long period, key staff leaves enterprises to start new enterprises. Competition grows among customers and suppliers. Publishers specialise for marketing reasons and because of scarce funds.
Enterprises often become more involved in market distribution and less in printing.
5 / Companies obtain stock exchange listings / Publicly owned companies have to provide more information both legal and financial to shareholders and to the stock exchange on which the shares are listed. The performance of the company has to match that of other shares on the stock exchange or the share price of the company will fall.

In financial and investor terms these stages may be expressed as follows