Monday, February 22, 2010

The Benefits of Financial Clarity

Clarity in business has to do with three things - the past, the present, and the future.  Where we've been, where we find ourselves today, and where we are going - our final destination.  Like a three-legged stool, removing any one of these elements would damage our ability to see the whole picture of our business.  When we achieve this clarity, here are the three main benefits we receive:

Anxiety in a business is usually associated with fear, worry, and uneasiness about potentially undesirable outcomes.  For example, a business that is nine months behind with its financial statements may generate some anxiety in those who are running that business.  They might know what the balance in their bank account is today, but they have no idea if they are actually profitable and if they can sustain the business in the future.

I was recently introduced to a business experiencing financial difficulties.  It did not surprise me to learn that they had not received accurate or timely financial statements in years.  They lacked any way to measure their performance historically other than the cash in their bank account, which is often a false indicator of how the business is doing.  They lacked a way to measure their current productivity and success, and they had no clarity on where they were going and how they intended to get there.  Anxiety in this business was high.  It was not until they gained clarity in their past, present, and future that they could create a plan to turn their business around and return to profitability.  Not coincidentally, this clarity, even though it painted a very grim picture, reduced everyone’s anxiety and reinvigorated the entire company as they worked together to save the business.

We obtain clarity in the past with timely and accurate monthly financial/managerial reporting.   We obtain clarity in the present with weekly dashboard reports and other productivity and cash management tools.  Our clarity in the future comes from a combination of short-term cash flow projections, an annual budget, a 5-year plan, and an up-to-date financial model.   Knowing that tactical decisions involve the day-to-day functions in a business, here is an example from one of my clients on how we improved our ability to make tactical decisions with clarity.

In our monthly executive team meeting in which we discuss the past, present, and future of the firm, the President shared that one of our largest customers was requesting a new Request for Proposal (RFP) from all of its vendors for some of the services we provide.  Included in this request was an entirely new tier of services for which we had never had to provide unbundled pricing.  Within 30 minutes we constructed an entire financial model to determine the lowest possible prices we could offer without damaging our margins.  This information was powerful, especially when the President realized that her competitors would likely have much higher prices than our minimums.  The result – we won the business with prices that increased our margins but still came in at or below our competitors.

In addition to improving tactical decision-making, financial clarity may bring its greatest benefit in terms of driving the strategic direction of a business.  Here is just one example:

Another growing company became dissatisfied with the performance of its distribution strategy.  Sales growth had been less than stellar, to put it nicely.   They began to explore different distribution strategies, desiring to be open to all options and suggestions.  Because of the already-existing financial clarity, the process was quite simple – evaluate all of our options and find the distribution strategy that would add the most value to the shareholders.  We modeled each option and eventually chose the one with the most promise.  Although we are still in the development and implementation phases of this strategic change, we have already received several points of validation that we are moving in the best direction.

Monday, February 15, 2010

Startups Need to Know These 10 Things about Accounting and Finance

Start-Up companies do not need theoretical or impractical advice. They need tips and suggestions that they can easily and swiftly implement to improve their chances for success. In the spirit of this need, here are ten tips in the areas of accounting and finance that they should consider implementing in a hurry:

1.  Entity selection - I am asked about this a lot. It is always wise from a cost-saving perspective to run as a sole-proprietor when you first get started. However, it is not wise to remain that way for too long. Some of the potential triggers to incorporate or organize an LLC include:

  • bringing on partners or investors
  • gaining your first and subsequent customers
  • adding employees and/or contractors
  • protecting intellectual property and personal/other assets
  • planning for taxes.

One other point to make in entity selection - creating an entity is about setting up a legal structure and, in my opinion, does not mean you have created a business.  Getting customers to accept your promises and then receiving payments from those customers when you keep or deliver upon your promises constitutes a real business.  Focus on getting customers, then you should spend more time worrying about your legal entity.

2.  Record Keeping - There are plenty of software options for record-keeping, but we need to be clear about what we are after.  Why are we bothering to keep records?  Is it to be compliant with taxes, our bank, or some other entity, or is it so that we can review and use our financial performance strategically - to improve our performance and build competitive advantages?

A start-up must first focus on record keeping for compliance.  This may mean an outsourced bookkeeper or your CPA looks over and corrects your information quarterly or annually.  My recommendation is to move towards establishing your record keeping system for strategic reasons.  You may need to have someone working on this information daily.  Depending on your volume, number of transactions, and overall complexity, the most economical but highest impact structure can be designed for your business.

3.  Banking - Yes, please set-up a separate bank account from the first day of the business, even if you are a sole-proprietor.  This makes record-keeping much easier and it helps you initially manage your business cash flow better.  I recommend a bank that has a high-level of online banking features to keep you or your staff from going to the bank very often.  Once you set-up the bank account, you may not need to ever return.  With remote deposits, online bill-pay, and so many other services available, your time can be focused on more important things, like getting your start-up going.

In addition, have a separate credit card for your business purchases.  This simplifies tracking your expenses.  You may also get a credit card in the name of your business, but it will based on your personal, not business, credit score and you will have to personally guarantee it.

4.  Billing & Collections - Be very careful to whom and under which terms you extend credit to your customers.  Resist the temptation to extend your customers an extra 30 days to pay at their request.  You are running a business and your cash flow is your life-blood.

Establish your invoicing practices under the premise of receiving payments from your customers as early as possible, even before you deliver your products or services, if possible.  Why do you think so many monthly subscription companies are willing to discount their subcription fees if you pay for an entire year in advance?  Because they know that cash flow is the life-blood of their business and 10 months of subscription cash in their hands today is worth more than receiving small monthly subscriptions over the next 12 months.

If your customers are delinquent, cut them off from your product or services.  This is hard to do, especially if they are a large and/or very profitable customer.  However, the risk of not getting paid is potentially far more damaging than trying to keep that customer happy.  Stick to your guns.  If they still don't pay, then charge them late fees and send them to collections.  Yes, collection agencies are expensive, but they will report the delinquency to the credit bureaus as well as give you your best chance of getting paid.

All of this implies having a policy and procedure for invoicing and collections.  For more information on establishing these, you can refer to a prior blog post I wrote Collections - The Pleasant Nuisance Theory.

5.  Payroll - Do you have employees or independent contractors?  If you answered yes to the independent contractor part, then you need to know about a potential liability you have.  Are they really independent contractors?  I will not go into detail here, but I have seen companies assessed penalties in excess of $200,000 for improperly classifying their contractors.

Payroll compliance is complex and, in many instances, it makes sense to outsource it.  First, you need to be aware of it.  I know several companies that, when they started, were unfamiliar with the payroll tax laws and codes.  It did not take long before they got in trouble and one of them went out of business because they could not cash flow the back-payments, penalties, and interest.  The IRS is the worst and most expensive potential creditor for your business. Second, there are many on and off-line companies capable of the task for reasonable fees.  If you run payroll in your company, I recommend you seriously consider outsourcing this task.

6.  Taxes - Most start-up companies have losses initially.  While a start-up experiences losses for tax purposes, it is beneficial to have those losses off-set income from the highest tax bracket possible.  This may be beneficial to you, or it may be able to benefit someone else, like a close relative, even more.  There are some strategies worth exploring in the early days of your start-up.

Once the business becomes profitable, a few issues arise.  First, how you and the other owners are paid.  You can be paid through payroll, profit-taking (aka distributions, dividends, draws), and reimbursements.  There are critical tax consequences to each, and they should be explored to keep as much cash in the business as possible.  Second, the entity type will become crucial to taxation.  And third, business deductions and credits should be maximized that might include: home-business deductions, section 179 for equipment purchases, R&D credits, hiring credits (thanks to President Obama), and many others.

7.  Staff - I have written in detail before on staffing accounting and finance for start-up to medium-sized companies.  Outsourcing usually makes sense at first, and then every start-up reaches a point in growth, volume, and complexity that merits bringing the function in-house and building it into a core strategic competency.  Every business has to deal with this, and when it is handled correctly, it can be a tremendous competitive advantage.

8.  Professionals - You will need a good tax CPA, a business attorney, and other professionals to help you be compliant.  You will also need professionals to help you strategically grow and succeed in your firm.  One example of professional services are the CFO services we offer to our clients.  I recommend three things for you to consider as you engage and work with professionals in your business.  First, interview at least two or three to find the right fit for your business.  Do they have experience in your industry?  Do they have contacts or other connections that could help your business?  Do you get along with them?  Do they listen well and help you understand things in a way with which you are comfortable?  Interview and find the one you like.

Second, remember that you are their boss, and not the other way around.  They work for you and you pay their bill.  You need to question their recommendations and, ultimately, the buck will stop with you even if something bad happens because you followed their advice.

Third, you want to work with professionals who have the right blend of hunger, experience, empathy, energy, initiative, and honesty.  This is tough to find, but they are out there.

9.  Financing - The very best way to finance your business is to bootstrap it and use your internally-generated cash.  Besides watching expenses, you can improve cash flow through vendor credit/trade terms, customer pre-payments, and other strategies.  If you do not have enough cash and you are sustaining operating losses, you will need to finance those losses with personal credit cards and signature loans/HECLs or equity.  When the business needs to make capital expenditures, these can be financed with leases and loans secured by the equipment.  If the company needs capital to fund an aggressive growth trajectory, then some debt and most equity instruments will do the trick.  Remember that most forms of debt require a personal guarantee from the owner(s).

10.  Benchmarking - In my recent blog post 5 Ways Entrepreneurs Improve Cash Flow with Benchmarking, I identify that benchmarking is usually free but few business owners utilize this powerful concept.  Compare your performance to yourself, your industry, and to other businesses as well.  The accounting/finance function usually facilitates this, but in a start-up it is usually the owner that initiates and follows-through on benchmarking.  Your benchmarking should include both quantitative and qualitative data.  Make this a regular part of your business, and you will quickly find competitive advantages to improve your cash flow and profitability.

11.  Payment Priorities - BONUS TIP!  I recently spoke with a man who started his business 26 years ago.  He has been through many cash flow "valleys" wherein he did not have enough cash to meet the financial demands of payroll, vendors, etc.  He taught me his payment priorities when such emergencies come.  First, he pays his employees.  Second, he pays the government.  Third, he pays the landlords of all of his locations.  And finally, he pays all other loan payments, vendors, suppliers, and others - including himself.  This is not a bad way to prioritize.

Thursday, February 11, 2010

Lessons Learned from Ponzi's Scheme

I just finished a biography on Charles Ponzi by Mitchell Zuckoff titled Ponzi's Scheme. This was a very interesting understanding of the psychology and motivations of a man whose name has far outlasted the name of many men more respectable than him. His legendary rise and fall, and his manipulation of financial instruments in the process, have made him legendary, in a very bad way.

Lesson 1 - While the press and mainstream media are often polarizing,  their effect is always attention and fame - for better or worse. Ponzi was on the front cover of the most relevant newspaper of his time two days in a row, one story praising him and another offering a much more skeptical perspective.  Believe it or not, both articles pushed his fame to even greater heights and, as a result, his company (called the Securities Exchange Company, interestingly) continued to grow in the short-term.  Many referred to him as the "wizard of finance" even though the second article gave many reasons to doubt.  The lesson - take what you read and hear about others with a grain of salt and help your business use the powerful tool of exposure through the media to improve your business.

Lesson 2 - Don't let greed, pride, and ego drive how you run your business. Ponzi was very motivated by his greed, pride, and ego.  He had a great idea to arbitrage off of currency and postal reply coupon mechanisms, but he was never allowed to actually use those mechanisms in his business.  He got some investors promising a 50% return in 90 days, then tried to use the mechanisms but was not able to.  He kept getting more investors as his fame grew, but he was never able to actually invest in these mechanisms and make the 200%+ profit he hypothetically could earn to pay his investors a 50% return on their money and still make a significant profit.  Although his profits were hypothetical, his spending habits were quite literal.  It was more important to him to gain fame and prominence by over-spending than to actually run a viable business and live within his means.  If he could have checked his pride, ego, and greed at the door, he would have put a stop to it all right in the beginning.  But he couldn't, and now he's a legend who ultimately died broke and alone.  The lesson - we all need to stay grounded and humble.  Whatever you need in your life to remind you to be that way, then get it into your life and keep it there. When convicted to five years in prison, Ponzi penned (translated to english) "Thus passes worldy glory."

Lesson 3 - Put your money where your mouth is. Ponzi's first verbal critic of any influence was Clarence Walker Barron, one of the most respected financial journalists and authorities of his time.  Ponzi had taken a great deal of money out of his growing company and invested it into bank stocks, bonds, and real estate.  He spent a great deal on fancy cars, big houses, and every luxury imaginable.  Barron took issue with Ponzi on several fronts, but the most important was this - why was Ponzi investing in so many low return, relatively speaking, investment opportunities that were far from offering a 50% return in 90 days.  If Ponzi really believed in what he was doing, why would he be so heavily diversified into such discouraging alternatives.  The lesson - if the person selling you something isn't using it, then that is your first sign you should not buy.

Lesson 4 - Success fosters lawsuits, whether merited or or not. In the beginning of his scheme, Ponzi owed a furniture dealer some money and paid him off with one of his investment securities.  The man, assuming Ponzi used his money as the seed capital to fund his new firm, saw the company begin to succeed (at least it appeared to be succeeding) and sued Ponzi for 50% of the company.  Even in the 1920s success bred pointless legal battles.  The lesson - make sure to reserve adequate funds to defend and protect yourself and your business.

There are certainly more lessons to be learned, but those were the most poignant to me as I experienced the amazing rise and fall of such an interesting character in the financial history of the United States.

Monday, February 1, 2010

Improve Cash Flow with Benchmarking: 5 To-Dos

Imagine swimming from one end of the pool to another in 30 seconds.  Is that good or bad?  How do we determine how we are doing, what is going well, and what we should try and improve?  It primarily has to do with comparing our performance to ourselves and others.

Staying with the swimming analogy, what if 5 other people swam from one end of the pool to the other at the same time as you?  In the context of the others, you can measure your performance.  What if you made the exact same swim 100 times before, and you knew each of your times?  Now you could understand your performance in the context of your past.  What if swimmers all over the world made the same swim every day and you could compare your time to theirs?  Again, this gives you another perspective on how you are doing.

In sports we seem to track every number and every statistic feverishly.  It seems like every night some individual or team is breaking an obscure record of which I have never heard.  Maybe tomorrow a college basketball team will break the winning streak for a team's consecutive wins in January when there is a full moon :-)

In business, we sometimes forget to use our numbers and stats to measure our performance.  That's where benchmarking comes in, and, generally speaking, entrepreneurs tend to under-utilize this tool.  With this in mind, I am writing on some of the ways that entrepreneurs have and will continue to use benchmarking to improve their businesses and, ultimately, their cash flow.

First, here is a sample report that can be used in benchmarking.
Request a Free Industry & Data Report

How can we gather this and other information, both quantitative and qualitative, to make a difference in our businesses?  When approached with an attitude of humility and genuine desire to improve, here are five suggestions to use benchmarking to help you take your business to the next level:

1.      Refine Key Performance Indicators (KPIs) - Some companies aren't sure what they should be tracking and benchmarking.  As a general rule of thumb, there are main categories of data that need to be addressed.  I wrote about these at length in my blog post: The Key Business Metrics every Entrepreneur should know.  As we research industry data and talk to others in our industry, we typically find new numbers and/or ratios that make sense to track.  For example, after doing some benchmarking at a trade-show with companies from around the world, one CEO learned that these other companies were tracking some operational efficiencies down to the level of daily employee activity.  This CEO quickly implemented this KPI into his dashboard and now feels he has a much better handle on productivity, which is a major driver of both cash flow and profit in his company.

2.     Enhance the Business Model -  Benchmarking means we mine through a lot of data and information, find what is relevant, and then try to use it in some way to make us better.  This process inherently leads to insights into improving the business model a company currently employs.  For example, one company that uses our CFO services learned through benchmarking that it was taking much longer than others in its industry to collect on its receivables.  With a little more information and the discovery of some "best practices" it has overlooked, the company accelerated its collections, which had a significant impact on cash flow.

3.     Emphasize Internal Benchmarking - When we discuss benchmarking, we traditionally think about comparing ourselves to others.  Sometimes some of our most helpful information actually comes when we compare ourselves to ourselves.  As sales grew in one company, the CEO failed to keep an eye on her inventory relative to the growth.  Once analyzed against the company's historical data, the CEO learned that inventory crept way too high relative to sales.  Empowered with this information, the company quickly addressed the issues causing the problem, inventory returned to regular levels in context to the history of the company, and cash flow increased.

4.     Mobilize & Harmonize Improvement Initiatives - This is often the trickiest part of benchmarking - actually implementing positive change.  We have found that when managers and key employees are included in the benchmarking process they tend to take more ownership of the ideas for improvement that arise from such efforts.  They work together to bring about positive change, which means it gets done more quickly and effectively than if everyone continued to work in their relative "silos."  While with a Fortune 500 company with over 300 branch locations throughout the world, benchmarking between branches was encouraged.  The branches that benefited the most from benchmarking were those that involved more than just their General Manager in the process.  Not surprisingly, those same branches were also consistently among the best-performing business units in the entire company.

5.     Make it an Ongoing Part of Your Business - Benchmarking is not unlike anything else that requires consistent attention to makes its biggest impact.  Benchmarking once and trying to implement a few new ideas will create minimal, if any, sustainable results.  By making benchmarking a part of monthly, quarterly, and annual conversations and meetings, it will become more and more meaningful and helpful.

Whether you are a swimmer, entrepreneur, or into something else, numbers tell a story about our performance and they help us know what we need to do to improve.  Benchmarking is a critical ingredient to a well-run business.  Chances are your cash flow will benefit if you do it.