Thursday, December 18, 2008

1 Way to Reduce the Anxiety You Feel Toward Your Business

Every entrepreneur and business owner I have ever met feels anxiety towards his/her business.  In these difficult economic times, anxiety levels usually rise. What is the source of the anxiety? How can you start to get rid of it? Please allow me to try and answer: the greatest anxiety usually comes from the unknown.  Here is an example.  Let's assume your largest customer represents 25% of your business.& Your customer tells you that she is having significant financial problems and she may need to reduce or altogether eliminate her business with you in the next 6 months. Enter Stage Left - ANXIETY.

How can you survive that? What will you do? As these and other questions arise in your mind and remain unanswered, your anxiety towards your business will most likely increase.

Here is the way to begin to alleviate your anxiety - we will continue with the example above.

First, we need to create a projection, pro forma, or budget of our operations for the next 12 to 24 months without the loss of the customer included in the projections. This needs to include both the income statement and the balance sheet so we can understand both the profitability and the cash flow of the business during the specified time.

Second, we need to understand all of the elements of our relationship with this customer that we might lose. The easy part is saying we need to reduce sales by 25%. But what about this customer's impact on gross margin? Do we earn a higher or lower gross margin with them than our company average? Are there elements of our fixed cost structure that might go away if the customer goes away? Does this customer pay faster or slower than our customers? These questions begin to derive the true impact of the loss of this customer on our overall profitability and cash flow.

Third, we need to make adjustments to our projections to account for the loss of this customer. This can be a bit tricky, but is certainly possible.

Fourth, we need to objectively analyze the results. What impact would the loss of this customer really have? Sure we have had to make a few assumptions, but we will be pretty close to knowing the answer to this question. With real answers, the anxiety will begin to subside. Even if you don't like the outcome, knowing the outcome immediately removes a big part of the anxiety. This information will empower you to handle this or any other issue that arises in your business.

Saturday, November 1, 2008

Five Year-End Task to Financial Strength

If you do not take control of your business, it will take control of you. With that thought in mind, we recommend the following five tasks to help you take control of your business, finish the year strong, and make sure you are positioned for a healthy 2009: Plan for Tax, Plan for 2009, Collect Your Receivables, Fortify Your Banking Relationships, and Improve Your Web Presence.

Business Owners have the most complex tax issues, but they also have the most tax-saving opportunities available. Every business owner should meet with their tax CPA BEFORE the year is over. Our experience shows that although this may cost a little bit of money, it usually comes back at least ten-fold in the form of tax-savings. We find that if these meetings are run properly, our clients usually save thousands if not tens of thousands of dollars in tax.

Here is how you make the meeting efficient and profitable. Schedule the time with your tax CPA at least 1-week in advance. At least three days before the meeting, send your tax CPA all the information they will need to estimate where you will be at the end of the year. This includes financial statements from the business through October or November (cash or accrual based on how you file) and a description of anything major that has changed during 2008. We also recommend you include an agenda of all of the items you would like to discuss as well as strategies you have heard about that you might like to explore. During the meeting, follow the agenda and document the decisions you make; then implement everything before the year is over.

If you are a business owner who escapes planning for each new year with an excuse like: “I don’t know what will happen next year, so there is no need to plan for it,” then we offer you a different perspective. If you diligently plan for each new, then perhaps you can pick up something to improve your current process.

You need to start by reviewing your 2008 budget, if you had one, and how you performed relative to that budget. Which assumptions remain valid, and which need to be revised? Plug your old, new, and revised assumptions into your income statement and balance sheet projections for 2009. What sales do you expect and how do they need to be adjusted for season trends in your industry? Are your variable costs increasing or decreasing from you own price reductions or increased labor, material, and other costs? What fixed costs will remain the same in 2008, and which will change? Why? How will your current, debt-to-equity, days sales outstanding, working capital, and other key rations change throughout the year?

Once all of this is put on paper, two things will occur. First, you will clearly see if you like or do not like how 2009 is shaping up and you can make changes to your operations to enhance or make more realistic the results. Second, monthly budget versus actual reporting with a focus on the gross variances (more than 5-10%) will allow you to make adjustments during the year more quickly and effectively.

Most businesses struggle to collect between Thanksgiving and New Year’s Day. This does not have to be you. Review your list of receivables every few days between now and the end of the year. Your customers’ accounting staffs will take time off. Find out when that is and make sure they pay you before they leave on vacation. Track the promises they make and politely and professionally hold them accountable to those commitments.

Your banker has had a tough year. You might want to consider taking your banker to lunch before the year is over to renew your relationship and find out how you can better become one of the bank’s favorite customers. If the bank has lent you money, make sure you are compliant with all of the loan covenants. With the credit markets still quite a ways away from stabilizing, your bank may become one of your most critical assets, if it isn’t already.

It does not matter the industry in which you operate. It is irrelevant if your customers buy your products or services online. Here is what does matter – our society will rapidly continue its trend towards online existence. Regardless of where you are at with your online presence, you can do more. Do you have a blog? Are you using social networking to its maximum potential for your business? Does your website generate marketing and sales results? Can your website improve the experience your customers enjoy? The right investments into your web presence can improve your cash, profit, and time.

By completing these five tasks, you will empower you and your business to finish the year strong and prosper in 2009. With economic turmoil on the horizon for most if not all of next year, those who focus on these and other critical tasks will be in the best position to survive the tough times ahead and thrive when our economic outlook turns more positive.

Monday, September 1, 2008

Five Actions to Take in Times of Tightening Credit Markets

Whether we agree with it or not, small and medium-sized business owners are entering into unprecedented turmoil in the financial markets (USA Today Article). No matter how good your product or service is, the survival of your business depends on your careful and thoughtful navigation through these potentially dangerous times. We've organized a list of five important ways to make sure your company is on the best possible course.

These are and will continue to be tough times for most banking and financial institutions. They have federal and other regulators and auditors that they must regularly appease. It is imperative that you do everything in your power to help them continue to feel comfortable loaning you money. Keep them updated with your income statement and balance sheet projections for a minimum of the next twelve months. Diligently fulfill all of your monthly, quarterly, and annual loan covenants to which you have committed. Make sure they have your most recent tax return(s) and interim financial statements. Keep your deposit relationship with them and show your commitment to them. You may even want to call your banker and ask them what you can do for them.

You may have already had customers ask for extended payment terms while they work through difficult financial times. Certainly this deserves your empathetic attention, but you must be very careful with this request. The cash flow of your business is often a complex organism that, with a slight tweak, could significantly impede your cash flow. Perhaps an example will help illustrate this point.

Imagine you manufacture widgets for many companies. All of your customers pay you 50% of their orders up-front and the rest upon delivery. One customer approaches you with a very large and profitable order, but asks for net 30 terms. You hesitantly agree, grateful that the order will keep your equipment and labor operating at capacity for the next couple of months. About one month into the production process, after you have purchased the materials, your customer calls and asks to put the order on hold indefinitely due to slowing demand for their products. You now have labor to pay, material suppliers to pay, and no cash coming anytime soon.

While this example may not perfectly apply to your situation, the underlying principles do. Avoid the temptation to extend your customers' payment terms.

One of the most common sources of capital for small to medium-sized businesses is the owner's home equity line of credit (HELOC). The business owner draws against their HELOC and then loans the money to their company. With the rapid decrease in real estate values across the nation, mortgage lenders are uncomfortable with their equity position, or lack thereof, in a secondary or tertiary position against an asset that is losing value. As such, many are sending letters notifying their customers that as their line is paid down their limit will decrease proportionally. If you are looking to pay-down outstanding debt, you may want to consider keeping this line of credit maximally extended (and continue to gain from the tax benefit that most HELOC-users reap) and pay-down other obligations.

We know that in this real estate market many are walking away from mortgage obligations and either short-selling or allowing the banks to foreclose on their homes and properties. Credit card, car loan, student loan, and other payments are being missed for a number of reasons. All of these things will hurt your personal credit. What does this have to do with your business finances? The answer is almost everything. Most banks and lending institutions will run a credit check on each owner of 20% or more of a business. We have seen many circumstances where a bank refuses to lend money in an otherwise "bankable" deal because the credit score of one or more of the owners is too low. If at all possible, seek remedies to any personal credit problems that will protect or improve your credit score.

The day you started your business is the day you signed up to be an expert on cash flow. When you are running low on cash, do you know why? When you have a surplus of cash, do you know why? Forecasting will help you better you understand the answers to these questions, which will empower you to improve your strategic decisions as well as the tactical implementation of your strategies. We work with a company that during the last two years has completely changed its cash flow dynamic for the better with the help of forecasting, good advice, and diligent execution.

We are not suggesting that banks and traditional lending institutions are the only medium to finance your business. Historically, these sources have been the most affordable and sometimes the most accessible. For the foreseeable future, these resources are going to become less accessible and more expensive. By following these five steps and continuing to profitably operate your business, you will improve your chances to obtain and/or maintain your sources of credit.

Tuesday, July 8, 2008

Capitalism Fosters Happiness

Money by itself cannot generate happiness. A lot of research has been done on this topic, and the results are unwavering - money does not and can not buy happiness. In fact, happiness is not for sale. It must be earned.
According to the article above capitalism can be responsible for fostering happiness. The basic premise - if people are allowed the freedom to succeed on their own merits, then they are in the best potential environment to find, or earn, happiness. Therefore, capitalism is a critical element to the overall happiness of our society.
Please take a look at this article when you get a chance. It provides a fascinating perspective.

Tuesday, July 1, 2008

Make the Promise, Keep the Promise, Track the Promise

As business complexity and economic turmoil increase, we will visit some of the basic principles that drive our ability to build, sustain, and improve our businesses.  We call it: "Make the promise.  Keep the Promise.  Track the Promise."  Each in its role as an integral contributor to the whole, these interdependent elements of the business cycle are equally critical to the performance of your business.

Regardless of the product or service you provide, your customers must decide if you will keep the promise of benefits and value you propose to deliver.  Ultimately, customers buy because they believe they will receive more value from your product or service than they spend to access it.  Value may not always be quantifiable in dollars since value can be achieved, or at least perceived, through time and quality of life.  McDonalds has long since given up selling food - it focuses on the value of improving its customers' quality of life with the slogan: "I'm lovin' it."

First we need to find potential customers to whom we can make our promises.  This is called marketing, which exits for one reason - to generate qualified leads.  The strategies and techniques for accomplishing this differ by industry.  Some companies combine the sales, marketing, and operations into the same department.  An example is professional service firms - they rely on their professionals to market, sell, and serve clients.  This can work so long as each discipline is separately accountable and receives an adequate amount of focus.  Ultimately, every organization needs qualified leads.

Once you have the qualified leads, it's time to make the promises.  We live in an information-rich society where our sales success is dependent on our ability to tailor our promises to the needs of our prospective customers.  If you sell computers, the needs of each of your customers will vary significantly.  Some need a computer to communicate with their tech-savvy grandchildren.  Others have a home-based business to run on the computer.  While others want to play games and watch streaming videos all day.  The point is this - first discover the needs of your customers, then make them promises if you can fill their needs.

The "keep the promise" department is often called operations, client service, or customer service.  They must keep the promises made by the sales team.  Has your operations staff ever complained that sales over-promised on what should be delivered?  If you answered yes, you are not alone.  The silos of sales and operations can often feel worlds apart.  When I was part of a company that grew to over $100 million in sales in just four years, this divide was often overwhelming.  The main issue was that each silo tended to slip back into a mode of self-interest.  We solved the problem each time by rallying the silos around the one thing they had in common - a desire to help our customers enjoy the most value possible from our services.

Bridging the customer from the hope that their needs will be met to the actual fulfillment of their needs is never enough - you want to build highly satisfied customers who become loyal to your brand.  Not only is it cheaper to keep an existing customer than find a new one, but research also says that employee retention and productivity are correlated to a firm's ability to keep its promises (

The philosophy that measurement improves performance is true.  When we suspected a lack of productivity in a firm which our part-time CFO,/a>'s were hired to help, we began measuring performance.  The department's productivity improved several fold within days!  The disciplines required to track the promise include accounting, finance, IT, HR, and other administrative functions.

How much does your product or service really cost to deliver?  What productivity levels need to exist in operations to be profitable?  How long is your sales cycle?  Does your marketing department produce enough leads?  The better you can answer these and other questions, the better chance you have for business success.  We have helped many businesses track their promises, and, consequently, increase competitiveness, profitability, and, most importantly, cash flow.

If you do not make, keep, and track the promise, you will fail.  When you whittle down a successful business to its core, you will find it has a balanced commitment to making, keeping, and tracking its promises.  Successful executive teams have members who represent each discipline to balance the strategic direction of the firm.  Whether you are a company of one or one thousand, focus on improving these three areas and you'll find yourself on the path to success.

Thursday, May 1, 2008

Should Your Company Have Debt

A lot of business owners have a hard time differentiating between their personal and company finances, yet they need to be regarded as completely and wholly separate. Many business owners who subscribe to a debt-free philosophy for their family (except for a home mortgage) want to impose the same philosophy on their business. Experience shows that not only is this not prudent, but it actually will cost them money in the long-term. Allow me to explain:

Every company has a cost of capital, or in other words, a cost associated with the money it either borrows or receives as equity contributions. The cost of debt is typically much lower than the cost of equity, but this is what confuses business owners - they do not associate a cost with the equity they either have or are going to invest or retain in their company. We know that traditional debt is costing most businesses 8-9% per year right now (not including the tax benefits associated with debt), but how much does equity cost?

Using a basic analysis, let's assume that a large, well-established, multi-national corporation returns 10% per year to its shareholders (in the form of dividends and growth in stock price). This 10% return represents the firm's cost of equity, or the return with which the shareholders are satisfactorily compensated for their risk. Your company's cost of equity is most likely higher because your business represents much more risk. Perhaps you are not very geographically diverse, or perhaps you have one customer that accounts for more than 50% of your business. Maybe your industry is traditionally volatile and/or cyclical, or maybe your product or service is not yet proven. And don't forget that emerging and medium-sized businesses are viewed as more risky than larger companies.

There are many ways to quantify this risk, and it is called a risk premium. In other words, how much more than the 10% would someone expect to earn from investing in your firm. Assuming your risk premium is 6%, then your cost of equity is 16% (average market return of 10% plus your risk premium of 6% equals 16%).

So, how does this apply to you? Let's use an example that assumes your cost of debt is 8% and your cost of equity is 16%. First of all, since interest is tax deductible and equity is not, we need to reduce your cost of debt to truly understand your overall cost of capital. Assuming you are in a 35% tax bracket (federal and state marginal brackets combined), your cost of debt drops to just 5.2% (one minus 35% equals 65%, then multiply 65% by 8% to arrive at 5.2%).

Now, let's assume you need $100,000 to grow your business to the next level. You could draw against your company's line of credit at 8% or sell enough of your company to raise the $100,000 required. The debt will cost you $5,200 in interest the first year, but your investor will be looking for a return of at least $16,000 in the first year (sometimes they are willing to wait longer than a year to realize their return, but they eventually will want at least a 16% annualized return). Obviously, the debt solution is the most prudent for the current shareholders.

Even if you want to put the capital into the business yourself, your ownership won't change (if you already own 100% of the company). So, you would be risking $100,000 for no additional stake in the business and its future profits. Sure, you would benefit from the growth your $100,000 facilitated, but you could still benefit by using the bank's money. In essence, you give away $5,200 per year to the bank until you can pay back the line of credit in return for keeping all of the profits and value generated from the capital. No matter how you slice it, you would be much better served to use the bank's money than your own capital. The best case scenario is you generate a return far in excess of 16%. The worst case scenario is $5,200 per year, not your entire $100,000.

You should, for all intents and purposes, diversify yourself personally with your $100,000. Most of your net worth and your salary probably come from your business. It is your role as a shareholder to diversify yourself. And, although this may seem counter-intuitive, investors and outside professionals do not normally favor or assess any additional value to a firm that operates debt-free. According to an article in the USA TODAY on April 17, 2008, the 164 companies (including Microsoft and Google) in the S&P 1500 that are currently debt-free have experienced worse returns during this credit crisis than those with debt ("Lack of Debt Doesn't Boost Firms' Stock"). A Financial model can help you keep to the goals you have with your business.

The proper structure and utilization of debt is one of the most beneficial financial strategies a business can have and execute. In fact, research and experience have shown over and over that the right use of debt in your business will increase the value of your business.

Wednesday, April 23, 2008

Human Capital

An article I recently read in Fortune magazine discussed the global competition for human capital. In essence, economic growth and success will be mostly driven by an economy's commitment to build and retain its human capital. From the perspective of the 6,000,000 businesses in this country with fewer than 500 employees (which happen to employ the majority of America's human capital), here is an idea of what this means.

The first or second largest expense category in almost every business is LABOR. Of all of the assets used and things input into a business, studies show that 60-75% of a company's general and administrative costs, or overhead, are consumed by labor. By adding all of this up, this means that the largest expense in almost every business is people.

Now, imagine if your labor, or human capital, could be just 5% more productive every day. Obviously, this would have an enormously positive impact on your bottom-line. So, the question of the day is: How can you improve your human capital?

On a global level, things like education and opportunity are major parts of how large countries are trying to improve their human capital to improve their economies. These strategies take a long time to implement, and even longer to measure the results. I have seen a lot of business owners think that by giving a raise or a bonus or even a stake in the company their human capital would become more productive. Generally, this does not work. Those things become entitlements and do not create sustained productivity, unfortunately. The best long-term strategy to maximize a firm's human capital is a holistic human resources strategy that has a healthy budget for training.

Just giving a training budget could be a mistake unless specific results are measured. I recently heard an employee say that the company's training was horribly boring and as soon as they went to a training class they could not wait for it to be over. Just as with any other investment you make in your business, you should measure the return on your training dollars. Sometimes this is a little hard to do, but it can be done. Part of this budget could be used for tuition reimbursement or on other incentives that encourage the staff to improve themselves.

In total, many are concerned with the United States' human capital strategy because, according to some standards, the US is falling behind relative to other large countries in terms of the education of its people. Without delving into the political realm of this subject, as business owners we can possibly learn something from this. The future of the US and the global economy rests squarely upon our human capital. The future of our businesses rests squarely on your human capital. Your ability to attract it, improve it, and retain it will have everything to do with your long-term growth and success.

Wednesday, April 16, 2008

Workforce Productivity and Expectations

Entrepreneurs and business owners are easily frustrated with their employees over a number of issues. The most common is that entrepreneurs and business owners expect their employees to care about the business as much as they do. This is an unrealistic expectation, and learning this lesson can often be very costly. The internal controls of your business are crucial in preparing a business for success.

A picture in the USA TODAY on 4 April 2008 stirred the thoughts for this blog post. Although its focus is on the effect chronic illnesses can have on an employee's absenteeism, it underlines a broader point - employees add a stressful and often frustrating facet to a business. But, when it is managed correctly, employees will be the biggest reason why you can grow and succeed. In some ways, they become one of your most important customers. Every employee has a different set of objectives as well as current and future needs that they will look to the company to meet. Hopefully the company can continue to meet the objectives and needs of its employees, but sometimes this does not happen.

Let me share an example: Several years ago I hired a talented recent college graduate as a staff accountant in a large company. He had a bright future ahead of him, and we felt we could offer him the CFO career track and opportunity he desired. Within months he was asking for a raise and a promotion. I had clearly defined his compensation and career progression when he started with the firm, and his requests were far ahead of the agreed upon schedule. We could not afford to grant his requests because of the overall disruption they would have caused in our long-term plan. We had to part ways, and I believe both parties were better off as a result - he found a quicker career path, and we found a new person that was delighted with what we had to offer.

So, here is the take-away for business owners and entrepreneurs: set expectations up front and resist the temptation to grant concessions that will hurt the long-term plan of your business. As a company, you exist, in some degree, to help your employees accomplish their goals and objectives. When the company and the employee's goals and objectives fall irreconcilably out of alignment, then it is best for every one to part ways and move on.

Tuesday, April 1, 2008

The 4 C's of Getting a Bank Loan

I think it would be worthwhile to cover the four C's of credit from the perspective of the start-up, emerging, and medium-sized company perspectives. Particularly, understanding the four C's from this perspective should help these businesses better understand the banker's perspective when trying to determine the credit worthiness of the company to which they may extend a loan.

The four C's are: character, capacity, capital, and conditions.

Business owners sometimes struggle with this the most. The reason - we feel like the loan should be based on the character of the business ALONE. The reality - unless it is for a small amount, banks do not offer loans or lending based solely on the assets or free cash flow generated by the business. They always look to a secondary source of repayment, primarily in the form of a personal guarantee from anyone who owns at least 20% of the business. This means that banks will be looking at the character of the business as well as the character of the owners of the business in underwriting lending opportunities.

On the personal side, this means they will want to see your most recent three years of tax returns, including all K-1s you received and reported on those returns. This underlines a very important reason to get your taxes done on-time every year with a competent tax CPA. Bankers will become uncomfortable if you tell them you are behind on your returns for a couple of years, and they will become leery if they see blatant mistakes on your returns. Also, they will require a personal financial statement, which includes all of your sources of income and your current balance sheet (Assets = Liabilities + Net Worth). They will not begin the underwriting process without this information, so you should give it to them before they even have to ask for it. Nurturing the banking relationship in this way is often overlooked by business owners, so you can become one of the banks favorite customers, and receive better treatment and their best offer.

On the business side, be prepared to provide the company's most recent three years of tax returns and financial statements (along with the most recent interim financial statements) as well as a formal business plan and pro formas, or projections, of the plans for the business. Again, the tax returns should be correct and current for the reasons listed above. Also, the financial statements should match the tax returns. If they don't, then the bankers begin to worry about what is going on and they become less comfortable with putting a deal together. Your projections and business plan should include a pro forma income statement, balance sheet, and statement of cash flows. These projections should justify the use of the funds requested and clearly identify the firm's ability to repay the loan well within the timeline requested.

All of these items help the bank understand the character of the business and its principals. They will most likely run credit reports on the owners and the business, and they will search for liens, judgements, and any other information they can find. Both your and your company's character are paramount in a bank wanting to do business with you. A savvy business owner will set themselves up to put their best foot forward with their bank. We have found that we have been able to help businesses in this area, and our presence as the firm's part-time CFO has improved the company's ability to obtain financing. For example, we helped one of our clients increase their bank loans from under $750,000 to almost $5,000,000 in a very short period of time.

Do you know what your debt-to-equity ratio is? How about your current ratio? At what multiple is your interest coverage ratio? These and other ratios derived from your firm's financial statements help a bank determine how much money they are willing to lend you. In essence, the bank is going to assess the capacity that your company has for debt and how much they are willing to lend your business.

In the process of determining your company's borrowing capacity, the bank wants to know in what position they will be against your company's assets. If it is a small enough loan, they may be willing to offer an unsecured loan, meaning they have no claim on company or personal assets if you default. Or, the bank may want to secure, or collateralize, itself against some or all of your assets. Banks will usually file a UCC-1 lien on your business stating the assets to which they have rights should you default. Some business owners are offended that the bank would take such drastic preliminary measures. The bank has shareholders and federal regulators that they must appease - this is how their industry works.

The way a company accounts for its assets and liabilities can make a big difference in the bank's perspective of the company's capacity to borrow. It is very important that all of your loans are booked correctly, meaning the current portion (the next twelve months of payments) is separated from the long-term portion (all payments due later than 12 months) on your balance sheet. Inter-company transactions and shareholder loans need to be treated correctly or they can hurt the bank's view of your overall lending capacity.

Do you know what your debt-to-equity ratio is? How about your current ratio? At what multiple is your interest coverage ratio? These and other ratios derived from your firm's financial statements help a bank determine how much money they are willing to lend you. In essence, the bank is going to assess the capacity that your company has for debt and how much they are willing to lend your business.

In the process of determining your company's borrowing capacity, the bank wants to know in what position they will be against your company's assets. If it is a small enough loan, they may be willing to offer an unsecured loan, meaning they have no claim on company or personal assets if you default. Or, the bank may want to secure, or collateralize, itself against some or all of your assets. Banks will usually file a UCC-1 lien on your business stating the assets to which they have rights should you default. Some business owners are offended that the bank would take such drastic preliminary measures. The bank has shareholders and federal regulators that they must appease - this is how their industry works.

The way a company accounts for its assets and liabilities can make a big difference in the bank's perspective of the company's capacity to borrow. It is very important that all of your loans are booked correctly, meaning the current portion (the next twelve months of payments) is separated from the long-term portion (all payments due later than 12 months) on your balance sheet. Inter-company transactions and shareholder loans need to be treated correctly or they can hurt the bank's view of your overall lending capacity.

The bank wants validated proof that your company and the personal guarantors have the financial wherewithal to repay the loan. They will first look to the free cash flow the business has generated over each of the last three years. As a general rule of thumb, free cash flow calculates the amount of cash available for distribution to equity and debt holders. Generally, a firm's free cash flow is derived from the following formula: Net Income plus depreciation/amortization plus or minus the change in working capital minus capital expenditures.

Next, the bank will look at the equity, or net worth, in the company. First of all, they want to see a positive net worth. Second of all, they want to see that the net worth is increasing. If it is decreasing, they will jump to one of two conclusions - either the company is not profitable or the owners are taking too much money out of the company. I once sat in a meeting in which the banker accused my client of using the bank loan to distribute cash to all of the owners of the company. We were able to quickly help the banker understand what really happened, but therein lies the point - the bank has certain things for which it looks. Without the right information, the bank will make assumptions, whether the assumptions are correct or not.

A savvy borrower will understand this and head the bank off by anticipating its questions, in advance, and answering them voluntarily before the assumptions are made. The bank will next, somewhat hesitantly, look over your projections to understand if the cash flow trends may change in the next 12-24 months. Unless you have proven to them that you really understand your business and can make relatively accurate projections, they will put very little weight on the information in your projections. This is often a frustrating point for business owners - bankers loan money based on the past. Once the bank considers the capital in the business, it will next analyze the capital of the personal guarantors or collateral offered as a secondary source of repayment.

I have often seen a business receive financing based solely on the capital of the owners. I had a client once tell me that the bank was willing to loan him only as much money as he could write a check for and personally pay-off himself. While this is not entirely true, a strong personal financial statement of the owners brings a high degree of comfort to the bank.

What are the external factors that the bank considers in its underwriting process? Normally, the bank is concerned with shielding itself from risks that may be outside of the bank and the company's control - these are referred to as Conditions. Some of these external factors include the economic conditions of the geographic market and industry in which the company operates, political and/or legislative concerns, among other items.

Here is an extreme example - a bank of one of my client's refused to allow us to increase the company's line of credit because they felt the industry in which the company operated was headed for a major downturn. With a phenomenally strong balance sheet and enough work and orders on the books to justify a healthy and profitable rate of growth, the bank still refused to consider the request for an increase in the line of credit. The point is that banks are about hedging their risks. They are trying to avoid over-concentration, and they often make decisions based on big picture trends and concerns that have nothing to do with the attractiveness of an individual loan.

In the example above, we found three other banks more than willing to compete for this wonderful customer with a perfect credit history. The result - we doubled their line of credit into seven figures and got better pricing on the deal than we previously had.

Tuesday, March 25, 2008

Who Should Do Your Taxes?

Just like every other profession, there are some CPAs and tax professionals that are very good, and there are some that are not. Unfortunately, a professional designation does not guarantee perfection. If you hire an outside professional to do your corporate and personal taxes, it is still ultimately your responsibility to look them over and ensure they represent the truth. That is why you must put the final signature on the document. No one expects you to know everything about taxes, but you should feel comfortable that all of the material items are represented. Perhaps a second opinion is not completely out of the question.

We have found that the very best way to create a successful relationship with your CPA is to become their favorite customer. You do this by getting them your information before the busy tax season. It also helps to get them accurate information so their time can be productively spent on your tax situation rather than on the day-to-day accounting taking place in your business. Also, you should never let the month of November end without at least a 1-hour meeting with your tax CPA. They are very proficient at helping you reduce your tax liability as long as there is still a little bit of time before the end of the year. They also usually enjoy this opportunity to receive an update on your situation and offer advice.

If you do your own corporate and personal taxes, then you are very brave. The tax code gets more complex every year, and it is very difficult to stay abreast of all of the relevant changes and how they impact you and your business. We recommend that a professional who is trained and stays current with the tax code be involved in the preparation of your return(s). The amount of additional savings they identify or the potential risk they remove from your filings is usually several times more than the cost associated with their services.

Some entrepreneurs ask their part-time CFO or other staff to complete the company's tax return. For the same reason mentioned above, it is often more prudent to use a tax expert who is current with the ever-changing tax code to keep the company and the owners in compliance.

Saturday, March 1, 2008

Steer Your Company Through a Recession

Headlines of "First Quarter Was a Real Downer," and "Recession is Here," highlight a major concern in our economy. Fortune 500 companies cannot avoid a shrinking economy - they will all be negatively impacted. But emerging and medium-sized companies can sometimes avoid participating in recessions. In fact, they can often grow and thrive while the "big boys" struggle.

The belief that emerging and medium-sized businesses fare poorly in economic slowdowns is: "a common misconception that is not true." Emerging and medium-sized businesses are generally nimble and can quickly adjust their strategies to maneuver through tumultuous times. They are close to their customers and are often in touch with niches and growth opportunities that are below the radar screen of bigger companies.

A recent poll of business owners of emerging and medium-sized companies estimated average revenue growth of 28% and employment growth of 24% in these recessionary times! Comparatively, Fortune 500 companies are going to struggle to repeat their 2007 performance, and most will do worse. If you are feeling the effects of the recent economic turmoil, here are a few suggestions to help you steer your ship towards deeper waters.

Cash flow is critical during tough economic times. Your working capital, current ratio, and accounts receivable will make or break your ability to cash flow through tough times. It is more important than ever to implement a three-month cash flow forecast so you are ready for both surpluses and shortages of cash.

Interestingly, the banks haven't cut back on lending to healthy and well-run companies. Interest rates have dropped significantly, which has done wonders for the cost of capital and return on equity within emerging and medium-sized businesses. Now is the time to increase your borrowing capacity with your bank while they are lending to you on your historical, non-recessionary financial statements.

Use your strong customer relationships to learn more about the needs of your customers and potential customers. A strategic brainstorm session with your team centered on your core competencies and the needs in the marketplace will usually result in the discovery of new opportunities. Innovation is often the best way to recession-proof your business.

Ultimately, you should work to diversify your customer base so no single customer accounts for more than 20% of your business. Although this may seem hard to accomplish during recessionary times, over-concentration makes you especially vulnerable to difficulties during an economic slowdown.

How will an economic slowdown affect your vendors, suppliers, and subcontractors and their competitors? Since their competitors are probably hungry for business during a slowing economy, you could easily diversify to multiple sources for each of the major and minor inputs into your business, and you will most likely reduce your pricing in the process. Be wary, because your customers may very well try the same tactic on you.

By definition, fixed costs should not change. However, some fixed costs were added to the corporate cost structure when the company was less worried about an economic slowdown. You could start by taking a hard look at these fixed cost categories: salaries, wages, automobile expenses, insurance, repairs, maintenance, travel, entertainment, advertising, and marketing. Avoid doing anything that will hinder your top-line. If your marketing campaign is responsible for generating most of your revenue, then be very careful changing that fixed cost.

Hopefully, you are not going to participate in this recession. If, however, you do, then start with these suggestions and you'll be on the path to building a more sound and successful business not only to weather this storm, but also to competitively position yourself for long-term success.

Thursday, February 28, 2008

Layoffs after a Buyout

In the world of privately-held companies, when one company buys another, the buyer will almost always try to reassure the seller that no one will lose their job. The seller often has close relationships with the employees, and some of them are probably immediate or closely-related family members. Although this assurance from the buyer is meant to comfort the seller, it is almost always NOT true.

Comparing the number of layoffs in PE purchased firms to a control group, the first and second years after the PE purchase show dramatic increases in layoffs relative to the control group. During year three the difference narrows. Interestingly, years four and five actually see less layoffs in PE purchased firms than the the control group. Several things may be assumed from this study. Logically, when a buyer purchases a controlling interest in the company, often changes occur. A new culture starts to form, disrupting the old way of doing things, and often people feel like they don't in the company anymore. Turnover and layoffs increase for a few years, but then the culture stabilizes and everyone that is left fits into the new firm.
I have personally been involved in PE purchases.

I have heard the PE firm promise that the existing team of the purchased company would not be changed. Inevitably, it does. New systems, procedures, and reporting relationships are introduced. After all, the PE firm wants to help the business run more efficiently and effectively. They bought the company for some set of inherent and intrinsic reasons, usually centered on ways to help the company ultimately become more profitable. There is nothing wrong with selling your business to a Private Equity firm. In fact, it can be a very lucrative exit strategy for a business owner, not to mention the legacy opportunity that comes from a new owner with deep pockets and additional resources to help the company grow and progress. Regardless of what the buyer says, the seller needs to accept the fact that within a couple of years things will change drastically within the company. Some of the faces they have grown to love and appreciate will disappear. The buyer and the seller should consider and even plan for these layoffs to occur as they discuss this transaction.

Tuesday, January 1, 2008

A Financial Model that Drives Your Success

"Creating a solid financial model and using it to run your business is one of the fundamental actions required to build a successful business." Assembling the dynamic and fixed parts of the financial structure of a business creates a powerful tool - a financial model. However, failing to use it to run and improve your business renders it powerless. We hope to briefly discuss some of the benefits that may come if you discipline yourself to participate in and regularly revisit this exercise.

Here are the words of a budding entrepreneur: "I had a mentor who sat me down and built a financial model for me. He asked me, 'How many days does it take to do this? How many people does it take to do that?' Building on the answers to those and many other questions, he was able to predict the company's future several years down the line, a big plus in meeting with venture capitalists" ("Speaking From Experience,", 11 Jan 2008). Your model can help you see years into the future and help you appropriately capitalize your business.

I know a lot of business owners who see no value in trying to understand the future because, as they might say, "I don't know what's going to happen in the future." While their statement is probably true, it fails to consider that forecasting the future empowers them to make the best decisions as the future becomes the present.

For example, I serve as the part-time CFOof a company that saw a decrease in its sales in 2007 of 21%. The firm's financial model helped the owners maneuver through its unforeseen internal and external challenges, tweak part of their revenue and cost structure, and still have a very profitable year. More importantly, the firm will, as a result of its corrections in 2007, increase sales in 2008 by at least 44% and reach an entirely new level of profitability. Without their financial model as a guide, they would have lost money in 2007 and would be struggling to return to a break-even status in 2008.

You will struggle to receive debt and/or equity financing if you do not have a firm grasp of your financial model. Lenders, angel investors, venture capitalists, and often friends and family want to see the financial model and understand how it works. They will ask questions about your assumptions and may want to look at your historical performance to validate your claims. Your model will also clarify the amount of external money required, your intended use of the funds, and the repayment period or return on investment your financier can expect.

There should always be one thing constant in every deal - a sound financial model built on realistic assumptions. Regardless of if you need to raise money to take your firm to where you want it to go, having a financial model will help you run and improve your business. If you use it correctly, your model will be a driving force in your success.