Wednesday, September 23, 2009

How I Saved Almost $30,000

We (meaning my family) had a need.  We just added a sixth child to our family and our faithful minivan, with a total of seven seats, was no longer sufficient to safely hold our entire crew.  Without too many 8-seaters on the market, we started looking for a new vehicle to purchase.  We found a very nice lightly-used suburban for $30,000, and it filled our need and then some.

However, something stopped us from actually making the purchase.  Sure, all the bells and whistles of the new vehicle were nice, I just could not get comfortable with spending $30,000 for another seat.  The suburban was certainly worth $30,000, but when cast in the light of our actual need, it was quite excessive.

We received a referral to a qualified company that does seat covers and installations.  For $195 we had an additional seat retro-fitted and installed between the two captain chairs in the middle row.  We did not need a new suburban because our minivan had everything else we needed, except for an eighth seat.

So, what is my point?  Too many companies focus too much on selling their product or service rather than meeting the needs of their customers.  Most customers do not know exactly what they need – they suffer from information overload.  They want an expert to get to know them and their situation, and then recommend exactly what will best fill their needs and bring them the most value.

I failed to mention our good friend who helped us through the experience.  He wholesales cars and, as an expert, helped us find the best value to fill our need.  He earned NOTHING on this transaction, but he has earned our business for life because he took time to learn about us and then, without trying to force one of his cars or other services upon us, helped us find the best deal for us.

The marketing and sales process often fails to identify the core needs of the customer.  Whether we are selling too much or too little, our best long-term proposition is to know the needs of our customers and fill them.  Up-selling is okay as long as we do not overlook the needs of our customers.

Sunday, September 20, 2009

The Difference Between a CFO and Controller

Ben Paramore wrote a post he titled: Difference Between CFO & Controller.  He does a great job explaining some critical differences between these two vital roles, and his chart at the bottom should be the basis of expectations whereby each are judged. Here are some additional thoughts to add to his:

There are really a limited number of CFOs worthy of that title.  The reason is because it take a special breed who can master the technical elements of the accounting and finance trade, but also be visionary about how everything will work together and how the organization can best maximize its value in both the short and long term.  Many long-time CPAs get a rude awakening when, after 20 plus years in public accounting, they take their first CFO role in private industry.  Many have commented to me how it is a profession unto itself that has certain elements that can only be learned through experience.

Here is an experience I had that may help to clarify just one of the differences.  The Controller of an organization was overwhelmed by a particulalry difficult month to close.  The trial balance was all out of whack and several major balance sheet accounts were not reconciling very easily to the detail statements.  After much work on her part, she successfully balanced and closed the month.  She was so excited she rushed to the CEO's office and exclaimed: "The month is closed.  I am finally done."

After thanking her for all of her diligent efforts, the CEO asked: "So, how does the month look?  How did we do?"  The Controller's response, "I don't know, but it finally balances."

This gap in communication was not intentional, but it highlights the difference in both perspective and priority of between the CEO and the Controller.  I have found that CEOs, founders, business owners, and entrepreneurs can sometimes become very frustrated with this gap between the Controller and their perspective.

A CFO fills this gap in a very unique way.  You see, a CFO knows how to speak in the language of accounting, and a CFO also knows how to speak the language of business ownership and CEO.  We sometimes call this the language of entrepreneurship, too.  This is the reason I made the statement earlier that there are really a limited number of folks who can successfully and productively fill this role.  It is rare when someone can understand and even perform all of the technical aspects of a CFO, let alone the strategic vision and leadership to help the executive team guide the organization to success, too. The combination of these two skills makes anyone ideal for a CFO career.

We often hear that CFOs become CEOs.  I know that this is probably not as frequent as some would hope, but hopefully you can start to see why a great CFO is often a great candidate for a CEO role, and sometimes the best for that role.

Wednesday, September 16, 2009

Entrepreneurs Need to Know these Five Business Metrics

Imagine you own a successful business but become stranded on a deserted island.  The only communication you receive about your business comes once a week on a sheet of paper in a bottle (yes, a message in a bottle).  What information would you need and want on that paper?  When you remove the subjective elements of running a business and try to do it on objective data alone, how does that change your ability to make the right decisions?

For the purpose of this article, we will refer to this piece of paper as a dashboard report, although it may also be called a flash or KPI (Key Performance Indicator) report. The dashboard should be critical in assisting an entrepreneur or business owner predict sales, cash flow and profit and gain clarity on the performance and direction of the company.  In addition, it should be a critical decision-making tool used in the day-to-day operation of the firm that empowers CEOs and business owners to make the best decisions for their respective companies that will drive cash flow and profit.

There are three main steps to consider in building an effective dashboard.  First, we should know the averages and benchmarks for our industry.  Second, we should know what our historical performance on these same averages and benchmarks.  And third, we have to develop what many call a balanced scorecard that comprehensively examines the whole company, not just one or two parts.

The answer is not to initially buy a business metric or dashboard software program.  These tools are valuable, but every business needs to initially determine what metrics it should track.  In fact, it is always best to use Excel or even a pen and paper to initially track several different metrics. It is nearly impossible to know which metrics will be the most effective until we get some experience with it.  We can save money on the software for now and focus on finding the best metrics for our business.  Once we know the metrics that are the most effective for our business, then we can consider investing in a dashboard tool.

Marketing, sales, operations, and financial are the four main categories every business needs to include if we want the dashboard to adequately inform us on our deserted island.  We will briefly discuss each of these areas below:

This is where it all begins.  We need leads if we ever hope of acquiring customers.  Our dashboard should include the top two to four metrics for measuring our lead generation.  These may include number of visits to our website and percentage of those visitors that become qualified leads.  The key here is to focus on the processes you are currently employing to market and generate leads and measure on your dashboard the efficacy of these efforts.  The cost of acquiring a lead should be included if it is measurable (and it almost always is).

Obviously a lead is still useless to our business if we cannot convert the lead into a paying customer.  Conversion of leads to customers is a critical element of most dashboards.  In addition, total sales should be included so we know how our volume is doing on at least a weekly basis.  Sales should be communicated in terms of dollars, number of sellable units, and average pricing.

Since sales is responsible to turn the leads into a paying customers, we desire to satisfy and retain the customer as long possible as effectively and efficiently as possible.   The point here is to structure our business model so that we deliver everything we promise for as little cost as possible.  Let’s review a couple of examples.

If I am a professional service firm that is mainly selling time in exchange for services, then I am concerned about my average cost of paying staff per hour as it relates to my average revenue per hour.  I will also be very concerned with ratios like revenue per employee and sales-to-wages.

If I manufacture products, then I will want to understand the efficiency of all of my inputs, including materials (and scrap), labor, contractors, and other direct costs.  In essence, we need to look at the major determinants of our gross margin.

We should consider three additional metrics on our dashboard that deal with operations.  First, an indicator of our current utilization of our total available capacity.  Second, customer satisfaction and retention metrics are a valuable barometer for ongoing sales.  And, third, a measure of product or service quality levels.

We should know what is happening with all of our major current assets, which usually includes cash, accounts receivable (AR), and inventory.  We should quantify the performance of our AR in terms of total % over 60 days past due as well as the Days Sales Outstanding (DSO).  We should understand if our inventory levels are at efficient levels.

We may want to include some of major current liabilities, like accounts payable and line of credit balances.  This information leads to the tracking of the firm’s current ratio on a weekly basis and other versions of the current ratio that traditionally predict cash flow with some accuracy.

If we received a weekly dashboard report with all of the information above (tailored to our industry and business model), how well do we think we could manage our business from a deserted island?  Now, we should imagine having all of that information every week along with being in our business every day.  Not only will we feel empowered to make the right decisions to improve cash, profits, and financial health, but we will see our level of anxiety (which comes from a lack of this information) drop significantly.  Even if the dashboard reports bad news, knowing about it will still reduce our anxiety because we will at least have the opportunity to do something about it before it becomes worse.

Wednesday, September 9, 2009

Key Terms of an Asset-Based Line of Credit

Short term working capital financing is most commonly facilitated with an asset-based line of credit. As its name suggests, the loan is secured by an asset in the business – usually accounts receivable. If you ever consider using this type of a vehicle in your business, here are the 5 most critical terms you should understand and know how to negotiate.

What is the asset that will be securing the line? These loans are normally tied to current assets like accounts receivable and inventory, but they can also be secured by equipment and even intangible assets like intellectual property and goodwill.

If we default on our payment of the obligation, the lender will have the right to seize ownership of the asset. Banks and lenders do not want to have to do this and they will be the first to admit that they are not structured or equipped to effectively liquidate such assets. These assets are usually very valuable to the business which makes payments on the line of credit a top priority for most businesses.

Assuming the asset is the accounts receivable of the business, the lender usually sets limits and conditions on the amount of the receivables that can be included in the borrowing base. The two most commonly used limitations are past due accounts and customer over-concentration.

The lender will often only allow current receivables in the borrowing base. This is often set as all receivables less than 60 days old or only receivables less than 60 days past due. Lenders will often limit the percentage of the total receivables that one customer can hold. This is usually set at no more than 20% of the total eligible borrowing base.  For example, if we have total receivables of $1,000,000 and they are all current (very unlikely in this economy), no single customer can account for more than $200,000 of the total receivables. If they do, then all amounts over $200,000 are excluded from the borrowing base.

Once the total borrowing base is established, the lender will then often only allow a certain percentage of those assets as the final base.  On accounts receivable, this percentage usually ranges from 60-80%.  As an additional note, borrowers are usually required to report on the status of the borrowing base on a monthly or more frequent basis.

So, how does all of this work.  Here is a basic example:  let's assume the lender allows us to borrow a maximum of $100,000 against 75% of our eligible receivables.  The lender excludes all receivables over 90 days old and has no limit on customer concentration.  Our total accounts receivable is $150,000, but $50,000 is over 90 days past due and we are about to write it off as bad debt.  This means our eligible AR is $100,000, which means our borrowing base is actually only $75,000 ($100k AR times 75% of eligible AR).

This is very simply the maximum amount the lender is willing to lend on the line of credit, regardless of the value of your borrowing base. Most lenders set this amount by looking at their secondary sources of repayment, which are usually the financial strength of the owner(s) and/or the equity in un-related assets (like their home). These are often secured with a personal guarantee.

Each bank structures its fees a little differently, and it is important to understand these so that we can make an “apples-to-apples” comparison on costs. Most lenders assess an origination fee of between .5-1.5%. In addition, they will often charge document and other fees. We have also seen banks require borrowers to pay an independent third-party to verify and validate the assets in to be secured. We recommend receiving proposals from more than one bank and then comparing the total cost proposal from each potential lender to understand which may present the best deal for you.

When you establish your borrowing base and you draw on the line, interest will begin to accrue. Most banks are setting the interest rate on these lines at prime plus 1.5-2.0%. Prime is currently at 3.25%, so that would equate to an interest rate of 4.75-5.25%. Because these rates have dropped so low, most banks have instituted a floor, or a rate below which they will not drop. Interestingly, those floors are being set at 6.5-7.0% in this market.

Asset-based lines of credit are an affordable and effective way to finance the peaks and valley in working capital. As a word of caution, most require a personal guarantee from all owners of 20% or more of the business. We recommend you seek legal counsel before agreeing to personally guarantee the debt, especially if the guarantee is unlimited – which means each partner can be held responsible for 100% of the obligation personally.

Wednesday, September 2, 2009

Social Media ROI

If you want to open up a can of worms, ask a group of internet marketers and CMO's how to measure the ROI on social media investment and participation.  There is and will continue to be a heated debate on this topic until we all realize one thing: Social Media is about branding, not advertising.

Traditional advertising defines a specific spend and generally has measurable results. A return on investment is easy to calculate.  Building a brand requires a significant investment, but does not generate track-able results.  The reason a person at the grocery store chooses Pepsi over Coke is a summation of a lifetime of branding messages (sometimes in overwhelming quantity).  How do you measure that?  It is very difficult, although there are many options for understanding the overall value of branding (referred to as goodwill for the accountant types).

We have the same problem with social media.  Social media is about building a brand, with the cumulative efforts assisting to generate sales.  But branding is less directly involved with the final transaction as traditional, measurable mediums.  How much did the direct mail piece I receive influence my decision to call the home security company in comparison to the branding I have been exposed to for the last five years at sporting events, parades, etc?  Hard to say, and even more difficult to quantify.

In its truest form, social media is a venue to add value to the the market in general in the form of free advice, expertise, networking, and communication.  All of this leads to relationship building with a more targeted market that gravitates towards your content and brand.  I am all for measuring ROI, but I also think there is often a lot more at play than a simple ROI calculation will capture.

Social media is here to stay (just watch this video), and businesses need to get involved.  A great example of this is the professional services industry.  The most effective methods for marketing in professional services have long been referrals and networking, but these survey results indicate that more of the networking efforts in the next 6-18 months will concentrate on social media (LinkedIn, FaceBook, etc.).

So, are you still itching to track the ROI of your social media?  Consider a change of perspective from ROI to the overall value of your brand. Then you'll be getting closer to overall value generation than transactionally-based (and often incorrect) attempts to attach an ROI to social media, or branding, activities.

The brand of a firm should have legitimate and palatable value, and that is what I care about.  Ultimately, the value of the brand becomes a long-term and often sustainable competitive advantage that commands premium pricing, better margins, and maximal cash flow!