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Who Needs a Fractional CFO?
This is a question that often comes up as we get referred to CEOs who need help but aren’t quite sure if a non-employee relationship is a good idea, especially in the sensitive area of finance. When our firm was founded over 35 years ago, that was a huge decision for CEOs to make, since the company finance chief was considered so valuable to the business that full control through employment was seen as the only safe option.
Well, we changed that, and today it’s not hard to find a part-time CFO practicing under a variety of catchy names. Even a few CPA firms promote their staff members as part-time CFOs because they know how to handle the accounting, even if they don’t have much depth in the more important roles the job requires.
Today, mid-sized and small business leaders have learned that expert guidance, loyalty and integrity can be acquired without owning the source. But from our beginning up to today, there is only one original – Your CFO for Rent®. Our firm offers a distinct set of services which can be valuable to any privately owned company, especially those run by founders, family teams, and entrepreneurs who excel at building companies but not at financially managing that growth.
In recent years our CFO for Rent service has been valuable to companies up to and over $100M in revenues, but the most predominant need has been seen in the $5-50M range, and that continues today. Some of the areas in which senior financial management expertise is critical to the success of a privately owned and operated business:
- Manufacturing cost control – do you know what each product really costs you to make?
- Customer profitability – just as important as cost control, do you know how each of your customers contributes, or detracts from, your overall profit margin after servicing costs are considered?
- Banking relationships – are you really getting the best service and lowest rates from your bank? How do you know?
- Cash forecasting and budgeting – Do you know what your cash position will look like in 6 months, a year? Are you doing profit planning?
- Administrative cost control – Are you getting your money’s worth from the team that supports you?
- Employee benefits and regulations (including COVID) – A huge area for cost management and regulatory risk.
- Accounting and financial reports – Are you getting the information you need to make the best financial decisions? Is it crafted for your understanding, rather than what pops out of most software packages?
- Business insurance – Do you have the right mix? The lowest premium from a reliable insurer? When’s the last time you checked?
Just something to think about…If you want to think about it with someone who thinks about this stuff every day, call us.
We are the original – Your CFO for Rent.
Concentration – Blessing or Curse?
We have a long-term client that manufactures precision machined products for their customers. One of those customers contributes over 80% of the company’s annual revenues, a situation that has been in place for years. We call that “concentration,” a condition that is usually seen as a serious business risk, because losing such a customer can make huge dent in revenues and thus profits, perhaps even causing the failure of the business. Add to that a condition that all those products are made to the design requirements of the customer, who also own the designs and the exclusive right to decide who can use those products.
How can you possibly look at such a business as anything but a disaster waiting to happen? How can that be a positive attribute of this company if, for example, the owner wanted to sell it and retire? Technology evolving as it is today, so much manufacturing production is now done in Asia at much lower cost, and access to alternative suppliers for most everything is easier today than ever before. Our client’s (then) CPA told them over 20 years ago that they should sell it and run, because everything was ultimately going to be made in China.
So how come they’re still around? How come they’ve experienced some of the most profitable years in the history of the company over those same 20 years? How is it that their huge customer hasn’t gone away for any of the reasons outlined above? The answer lies in managing that concentration and managing the relationship. Here’s how this company is doing it:
- Virtually all of their products require very precise quality standards, that they manage and adhere to scrupulously. Very high quality consistently delivered.
- Most of their products require a steep learning curve to manufacture correctly, something hard to duplicate (remember all those stories about manufacturing going overseas and then coming back again? This is one reason for that).
- Because their products often go into equipment with a long service life, some of their products have been made and delivered for years without changes, making the manufacturing process easier over time as familiarity lowers production costs, learning curve, etc.
- They have consistently been responsive to their customers’ shifting production needs, often shuffling scheduling to help their customer meet JIT requirements, thus lowering the customer’s need to keep large inventories on hand.
- As a result of all that, their customers’ buyers keep coming back because it’s easier to go to a supplier that you know will perform every time, than to go through the pain of finding and training another supplier and praying through their learning curve.
Is this the kind of company you would try to build from the start. Not likely. But if you have one, or inherit one, perhaps there is real lemonade that can come from your lemon(s). You build on your strengths, fix your weaknesses, and tout your company as a success story whose revenue is amazingly predictable and predictably profitable.
And then again, if you are already in the precision manufacturing business and want to acquire a solid position as a supplier to that very big customer, what better way than to buy a successful company that already has that connection, and then own the profitable business that is already in place?
Want to know more? Call us. We are Your CFO for Rent.
ROI, IRR, DCF, Alphabet Soup or what?
Every well-run company that is considering making an investment in new equipment, a new facility, upgraded technology, or a new product or development project, considers at some level what return it will earn on that investment. Accountants and analysts will often calculate Return on Investment (ROI), Discounted Cash Flow (DCF), Payback Period, or Internal Rate of Return (IRR).
Oops! Wait! Most of them get that last one wrong! Often a well-intentioned analyst will calculate ROI and call it IRR, maybe because it sounds more technical or more elegant or whatever. But the calculation and the information conveyed are very different. Look at these definitions:
Return on Investment – a comparison of the total amount an investment will earn over its effective useful life compared to the total cost of that investment, expressed as a percent of that total cost. A simple enough calculation if you have the correct numbers.
Internal Rate of Return – that rate of return, stated as a percent, at which the return on the investment and the cost of capital to make the investment are equal, with both at present value. Put another way, it’s the discount rate that makes the net present value of all cash flows (in and out) from a particular project equal to zero.
Big difference, huh? ROI does not consider the cost of the capital used to make the investment, other than to include it in the calculation of the earnings from it. And, there is no comparison to the cost of the money, or the significance of the time value of money. So, some lessons you can draw from this: First, never invest in a project with a net present value less than zero or a negative IRR. Second, you can’t decide on the first until you actually do the math.
So, which one should you use in making your company’s investment decisions, when the return from the investment is a factor, for example, in choosing between competing projects when there isn’t sufficient capital to do both?
- Obviously if the project at hand is critical to your company’s growth or survival it must be done, and the only choice may be to do it at the lowest possible upfront cost. In this case both metrics are effectively irrelevant to the decision process.
- In today’s interest rate environment, the project to go ahead might be the one that can be done without borrowing additional money, or borrowing as little as possible, unless the additional capital can materially increase the return. Now we’d consider IRR the metric to use.
- If the project is an acquisition that must be consummated now or it will be lost, consider whether the sellers would value more money down the road rather than less money at closing, if the difference must be borrowed money. This may be especially valuable if your acquisition will produce more value than the sellers have been able to produce with the same assets. In this case your future returns as measured by ROI might help decide how to structure the deal, whereas an IRR calculation would help you evaluate where to tweak the deal. We’d use both.
As in every great recipe, the quality of the meal is decided by the careful selection of ingredients. In this arena, we are excellent cooks to consult with, because…
We are Your CFO for Rent.
“Working Capital” – Why Does It Matter?
Most business owners think of Working Capital as the amount of cash they have in the bank. But CPAs. financial analysts, advisors and bankers define it as the difference between current assets and current liabilities. One sounds simple and easy to understand, the other a bit esoteric. Why do they make it so complicated? The answer: because it really matters.
Cash in the bank is real and always dependable – today. But what about tomorrow? Many business owners don’t get regular forecasts of future cash balances or future cash flows, which often results in a surprise when the customers don’t pay on time or an unexpected expense suddenly arrives at the door. If cash is tight that surprise can be alarming or worse.
So let’s look a little deeper. On your balance sheet are Current Assets, those things a company owns that are either cash or will become cash in the next 12 months, largely composed of accounts receivable and inventories. Those are the assets that will convert into cash for the purpose of paying the Current Liabilities, which are due for payment in the next 12 months.
A quick look at a company’s balance sheet will usually show that Current Assets are more than Current Liabilities – a good thing since that’s where the resources to pay the bills will come from. If the reverse is true, it may already be too late, but you should call us today 310.645.1091.
But wait a minute. What if the assets are only slightly larger than the liabilities? And what if the receivables contain some slow paying customers? And what if the inventories include some stock that is slow moving – meaning we hope it’s not dead yet? Now those assets are going to turn into cash more slowly, and some of them might not make the turn at all. Oops! It’s not likely you can call your creditors and tell them you’ve got to write down some of your assets so you’ll have to write down some of your liabilities too, to keep things in balance. Wouldn’t that make it easier?
So what’s the takeaway from this little financial management tidbit? Here are a few:
- The spread between current assets and current liabilities, if it’s consistently too narrow, may mean your margins are too thin, and that’s a whole different set of problems. If you want to better understand the causes, call the number above. (Call to action #2)
- Strive to have $2 of current assets for every $1 of current liabilities, just to provide a robust cushion against the issues noted above, so you can focus on running the business and not managing the bank account.
- If you manage your current assets carefully, your current liabilities will almost manage themselves. That means collect your receivables and pay attention to your inventory turnover. The fresher both are, the safer is your company’s bottom line.
If you manage your Working Capital effectively, you’ll always have cash in the bank, and that’s a good thing. We know, because we help our clients get that positive result – every day. After all…
We are Your CFO for Rent.
Shopping for a Business Loan?
Unless you’re running a tech company or an Amazon warehouse, the past couple years are likely to have put some stress on your cash flow and your balance sheet. If you were foresighted enough to arrange a fixed rate loan a couple years ago, you are probably just fine. If not, offsetting today’s increased costs of doing business with your customers’ willingness to absorb higher prices may make getting fresh financing a necessity, as it is for a couple of our clients.
So if you’re shopping or considering going shopping, and the interest rates aren’t sufficiently off putting, here are our thoughts on the things you will have to keep in mind, and deal with, as you approach lenders – even your current bank.
- Big bank vs. not-so-big bank: It’s easy to be swayed by the perceived prestige of saying you bank with one of those huge institutions whose name is on TV daily, with branches in every neighborhood, including yours. But unless your company delivers profitable revenues upwards of $100 million a year, you are frankly small potatoes to the majors, and unlikely to get any special consideration from the loan committee. We suggest you choose a bank more in line with your size – all the way from a local community bank to a mid-sized regional bank in your city. You will mean more to them and in return they will work harder to keep you satisfied. A win-win opportunity.
- Your perceived credibility as a lender who will pay the loan back without fail – this is about your numbers as well as your mission:
- Financial performance for the lasts 2-3 years that will demonstrate you know how to manage in challenging times by how well you did in the recent past. Revenue steady or rising gets high marks. Profitability holding up is the gold standard. If your recent track record isn’t so good, at least you should be able to show that it’s coming back from the coronavirus days and is now back in good stead with reasonably stable cash flow, never mind the existing debt load you’re managing. Growth of both top line and bottom line is great.
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- Going forward, what can your lender expect? Is the trend demonstrated by your past couple years being projected forward in this year’s performance? Do your forecasts for the next year or two continue that trend? And does your planning – strategic plans and budgets – demonstrate how you will sustain that trend? Remember, that’s the timeframe your lender is interested in learning about, because that’s when they’ll be expecting timely repayment, conformity with covenants, and all that bank stuff.
- What type of financing do you really need?
- A term loan to get you through the next couple years or to capture a great opportunity,
- A credit line for some immediate relief, to use/repay/use as needed,
- New equipment financing to get your factory technologically current, or
- A long-term SBA loan to infuse semi-permanent capital into the company?
If your current bank doesn’t fit the model your company needs – typically demonstrated after you’ve had your first financing discussion with your bank rep – it’s likely time to go shopping for a new loan AND a new bank. One of our clients is making that move as I write this. They will succeed because we’ve helped them get ready after considering all the issues raised above.
How about you? If you’re not sure, but you know you need to do something, guess what?
We are Your CFO for Rent.
How To Be Your Own CFO
Smaller companies often do not have the resources to hire a CFO, even a fractional one, yet those intent on succeeding, growing, and profitably exiting have financial issues to address that are often more critical to their survival than they would be in a larger company. If you are the owner of such a company, you probably take responsibility for these areas, because it’s your company. The diagram here may give you some helpful ideas about the functions you need to watch over.
For those of you blessed with a trusted bookkeeping department, perhaps even a young controller, it also shows those areas you can assign to someone, and those you had best not delegate unless you can closely follow their progress. Don’t be put off by the size of the list because many of the functions shown probably don’t yet apply to your company. If you don’t expect your company to grow much from current levels, the job gets easier.
At the top of the triangle are the things you may have to do personally, those which require the most financial expertise and business experience. They should also be much less time-consuming than the responsibilities at the bottom of the triangle, unless of course every decision requires a learning experience first. As you go down the triangle, the amount of time that the function requires increases, while also lessening the amount of senior management expertise that is needed to produce acceptable results. Thus, the further down the activity appears in the triangle, the more likely you can assign responsibility to an employee whose time is comparatively less costly, including in some cases part-time and temporary employees.
As with any supervising situation, the prerequisite is having a competent office staff to back you up. Then you will also need clear and unambiguous instructions, which usually means some form of written job descriptions and operating procedures. Your challenge, then, is knowing when to take responsibility for the activity yourself, and when to assign it. And when you assign it, knowing how much oversight is necessary to prevent mistakes. In the final analysis, your ultimate challenge is knowing when you, too, need help to make the right decisions. And then of course knowing where you can go to get the help. That’s where we come in. If we don’t have the answer, we guarantee we know who does, and how to reach them. More often than not, we’ve helped someone in a similar situation and they will tell you we get excellent results in a professional, high integrity, no nonsense way – even if you only need a fraction of our time.
We are Your CFO for Rent.
They Settled. You Shouldn’t.
Last year we worked with a client in the furniture distribution business, a successful, rapidly growing company with retail customers across the country and suppliers across the globe. They asked us to help them integrate the financial systems of a company they had just acquired, and we stepped up and did that. They were happy with the result and decided to move on.
But the support they needed was considerably greater than the support they asked for and got from us. They didn’t sense anything else was broken, as the phrase goes, so didn’t see the need to fix anything. We saw it differently, not just because we like to sell more services (and of course we do) but because they needed systems and process changes to support that strong growth that they didn’t want to deal with. In effect they were content to stay where they were unless something broke in plain view. They ignored the risk that when systems and processes break down during periods of rapid growth, usually ignored or minimized because there’s no time to deal with them, the result is usually a more costly and painful fix when it’s no longer possible to ignore the impact.
Some of the changes they needed but were unwilling to take action on:
- Banking relationships of the owners (not part of management) and those of the company were commingled, so that the company couldn’t make banking decisions independent of the owners’ needs and constraints, not to mention the potential legal conflicts that could arise. That is a no-no unless your business is that of a sole proprietor in which the two really are one and the same.
- The company’s financial reporting lacked the enhancements that make out-of-the-box reports more understandable and usable by non-financial users, such as the owners – non-technical labels, KPIs for all key operational and financial metrics that are key to the business, explanatory narratives accompanying the numbers. If the principals gloss over everything but the income statement because they don’t fully understand them, that’s a problem that should need no explaining.
- Having just made an acquisition, they were not able to separately track and report the performance of their now integrated business, to see if it was truly meeting the goals that had driven the acquisition decision to begin with. That makes it easier to assume those goals are being met, rather than measure them separately and risk visible evidence that they are not. Maybe a conscious agenda by the champions of the deal, maybe not.
- These days any growing company has to work hard to hire people, and then keep current with benefits and employment law to keep them happy and engaged. But the company had no HR department leader who could do all that – if they’d had time – and the idea of engaging a PEO or similar outsource support, and overseeing that support, is more often than not a part of the CFO’s responsibility, not the CEO’s as in our client case. As a result, no proactive effort, lots of reactive effort, more risk on a variety of fronts.
My point: They settled. You shouldn’t. Are you?
We are Your CFO for Rent.
Noses In, Fingers Out
That expression will be familiar to readers who have served on boards of directors or have had some decent board governance training. They will agree with it or not, often largely depending on their relationship with the company. Since I have served on, and chaired, a couple of mid-sized nonprofit boards and currently sit on the advisory boards of two privately-owned companies, I’ve had more than a little experience helping fellow board members understand, and adhere to, those four words.
The phrase, for those not familiar with it, refers to the level of involvement of directors as they work with CEOs of the companies on whose boards they serve. The concept of “noses in” means board members need to know their company, monitor its activities, and ask the hard questions about all those areas that impact the success or failure of their companies. The job of a director – whether in a public or private company, or even a nonprofit organization – is to try to make sure no surprises will damage the company or cause it to lose an opportunity to be better, and to strive to make the company more successful because of their participation. They do that by asking the questions, evaluating the quality of the answers, supporting the good responses and pushing back at the bad ones.
But none of that implies they should burrow into the details of company operations and try to direct management team activities, or give orders to anyone on the management team (other than for fiduciary boards in very specific circumstances, the CEO). That’s the “fingers out” part. The fiduciary board has authority over the CEO. The CEO has authority over the management team. That authority gives the board the right to hire, evaluate and fire, if necessary, the CEO. They do not have that same authority over the CEO’s management team, or the actions of those team members. And that’s where it sometimes gets messy. Board members are often corporate leaders in their own right, and accustomed to having their expectations acted upon by those under them. It’s sometimes hard for them to keep in mind that they’re not in charge when they serve as directors. But it’s critically important they do just that.
Interestingly, I’ve had more than a few opportunities to guide the thinking of directors who felt their power was broad enough to dip their fingers into the operating processes of a company. At one board meeting I had to call aside a director who had just spoken to the CFO in such harsh tones that she left the meeting in tears. His thinking may have been clear, but his words in that moment were very inappropriate. He no longer serves on that board.
On the flip side – there’s always a flip side, don’t you know – what if the answers to directors’ questions just aren’t right, or a situation has arisen that the CEO is clearly not prepared or willing to handle? If it involved outsiders – lenders, investors, regulators – the hands-off approach may expose directors to liability because of their responsibility to the company. Yet, if they were in a “fingers in” mode when the situation came up, they may even be deemed a part of the problem, and they could even find their D&O insurance less than supportive.
The best course of action for a director? Diligent review of the information you get; alert monitoring of company operations in support of approved strategic plans; share your concerns with the CEO and perhaps the other directors. In a worst case situation you may need to enlist the board to back you up if the CEO is not sufficiently responsive. But don’t try to be the backup CEO. That’s not your job.
And make sure your insurance is solid, just in case….
Yes, we do serve on company boards in selected instances, but other than that…
We are your CFO for Rent.
About Knitting and Systems Evolution
Spoiler Alert: This is not a techie post about bits and bytes or a new take on AI. It’s about making good decisions when your internal growth requires support from outside your company in an area that is not your area of expertise. And it’s from an actual case history.
A company in the chain fast food restaurant business had grown significantly over several decades, to the point where their internal HR systems would no longer support the huge hiring, management and turnover needs of their large part-time worker force, which typically experienced around 90% turnover each year. Added to their needs were the requirements of their franchisor, including mandating seamless integration with the franchisor’s HR systems. So they decided to go outside for a new system that would satisfy their data needs as well as those of their franchisor. Without an internal IT department to assist, the process was managed by their VP of HR, who had never managed such an effort before (red flag #1). Despite advice to the contrary, he declined to engage an outside IT advisor to help manage the process (red flag #2). He was clear on what he wanted to see, and the selected vendor’s sales team assured him they could provide what he wanted, a representation that was accepted though not proven in any demonstration (red flag #3). The transition was long and costly, but it was expected to increase data visibility and reduce internal HR staffing.
Well, they couldn’t and it didn’t. After struggling to make it work for over two years the company decided to scrap that relationship and find a different vendor. This time they engaged a skilled outside IT consultant to advise them and help evaluate prospective vendors. Several vendors appeared well qualified in the eyes of their advisor, but now the cost of a transition was even larger than the first time around. The company balked at the realization that they were going to incur another high transition cost in addition to the inevitable strain on staff time already stretched by compensating for the shortcomings of the vendor they had. Caught between the proverbial rock and a hard place, they opted to stay where they were.
No happy ending here, we’d have to admit. But perhaps a lesson for others facing a similar set of choices. We frequently read advice to companies to “stick to their knitting” – do what they’re really good at, and get someone else to do the rest. That is really good advice. And with the light speed at which technology is evolving today, few companies can afford to keep current with only their internal staff as a resource. This applies to many areas of support that companies rely upon outside their normal core competency: human resources, finance and accounting, supply chain management, and of course technology.
In other words, companies should outsource those essential functions they can’t do well rather than drain valuable resources trying to do them badly.
And so, the moral of the story: Stick to Your Knitting!
We are your CFO for Rent®
Handling conflict or avoiding it – a choice
As an enthusiastic member of the Private Directors Association, I read with interest the solicitations of candidates for director positions across the country and in a wide variety of industries. Often written by search firms who are anxious to diligently reflect their client’s concerns and desires, sometimes the announcements that come out reflect such a strong need to avoid conflict at Board meetings that they may err on the side of missing a primary reason Boards exist – to protect the organization from making costly mistakes in its business. When organizations search for new director candidates, we often see phrases in the section called Candidate Requirements that look like this:
- Must be able to work well with fellow directors.
- Must be able to discuss sensitive issues without causing disruption at meetings.
- Must be a team player.
And, in reality, all those phrases are valid for an effective director. But so are these:
- Must understand the company’s strategy, its strengths and weaknesses.
- Must be able to firmly raise issues that are not being adequately addressed by the Board.
- Must be able to work collaboratively with directors who hold different views without abdicating their sense of responsibility.
- Must have the integrity to hold firmly to an unresolved issue when it’s in the best interest of the company’s stakeholders.
As you can see, the first list of requirements speaks to candidates who will be cooperative Board members, an admittedly important trait, but it doesn’t temper those traits with the kind of toughness that may become necessary when issues arise that management may not be effectively dealing with. This often results in Boards where the majority of directors routinely support the CEO’s view regardless of their belief in its effectiveness. This is where the team player must also remember that loyalty extends to all the stakeholders in the company, and be able to make that transition in a way that moves the Board to resolution without causing chaos at meetings. That is the true meaning of an effective director.
Some months ago, as an Advisory Board member of a mid-sized privately owned company, I raised the issue of cybersecurity protection at a quarterly Board meeting. Actually I raised the issue at a couple meetings before it made it to the agenda. After a brief discussion the president assured everyone that the company was well protected and had no need to consider either an independent assessment or stronger insurance coverage. The decision was accepted by everyone at the meeting, myself included.
Fast forward five months and 29 days, one day before a quarterly meeting, and Board members got an email from the company president announcing that the Board meeting had to be cancelled due to a cybersecurity event the week before, and from which they were still attempting to recover. To date, no serious damage was done to the company’s operations due to effective backup processes, although they had to advise thousands of customers about the potential loss of their personal information and offer free credit monitoring to them, a common and costly aftermath of such events. The issue of better protection is now firmly back on the company’s agenda, hopefully with a different answer this time.
Since this is an Advisory Board and not a fiduciary Board, we could only advise, not require. I think we did that. Perhaps we should have been firmer in our advice. What do you think? As always…
We are Your CFO for Rent.
