Blog

Don’t wait! You have to be ready EARLY!

OK, not a very descriptive title – and in fact the word “EARLY” is actually wrong. It’s just that far too many owner/CEOs wait until the last minute – actually well into the last minute – before they start preparing for the sale of the company they’ve been building for years. So EARLY really means when they should be preparing for that sale compared to when they actually start preparing. Put another way, EARLY likely means TIMELY.

Examples from our client files:

  1. A family-owned company that’s been operated successfully for over 30 years, and now the aging owner/operators want to sell it and settle back. But the inventory accounting and resulting profit reporting has for years been designed to save tax dollars rather than present the correct valuation (and the bigger net income to pay taxes on). Reaction from the investment bankers after their review: “we can’t get a fair price now. get it right and demonstrate some consistency in getting it right and we’ll try again.” Settling back is deferred, perhaps for a year or more.
  2. An entrepreneur built his company from scratch, made it successful, but got burned out in the process and now wants to sell it “tomorrow.” There was virtually no accounting department to keep track of the numbers, and the financial history shows it, with major misstatements of inventories, operating costs and owner compensation. We can’t yet construct a financial statement that is credible to present to the eager investment bankers sitting outside the front door.

We tell clients, and anyone else who will listen, that when a company owner want to exit their company, they should start getting ready 2 years before their desired exit time IF, and only IF, they think everything is in great shape, because a well executed sale transaction will take a year to complete most of the time. And if everything isn’t in great shape – think of the above examples and lots more that aren’t quite that far off – they should start the planning 3 to 5 years ahead of that desired walk-away date, because change takes time. If ever there was a need for a strategic plan, exit should be at the top of the list.

Now admittedly they could shorten the timeframe if they are prepared to accept an earnout (deferred and contingent payments) and are willing to stay on with the company for a couple years to ensure the earnout is actually earned and paid. But that usually doesn’t figure into the owner’s retirement plans. Yet by one investment banker estimate 80% of transactions these days involve some sort of earnout.

So, if you are the owner/operator of a company that you don’t want to be running five years from now, PLEASE start thinking further ahead. Get an outsider’s assessment of the condition of your business, your financial reporting history, the quality of earnings history, the real growth trends that will define its value into the future, and all the other factors that ultimately establish the value of the business today. If you think this is way too early, it may be just the right time.

We can help. We are Your CFO for Rent.

If you make it, how do you price it?

Many of our clients over the years have been manufacturers, makers of the products they sell – cosmetics, automobile parts, aerospace components, etc. Some of those manufacturers, notably in the aerospace field, make products to meet the design specs of their customer, generally on a negotiated cost-plus-markup basis.

One of the biggest challenges they encounter in making someone else’s product is knowing what price to charge for a component, perhaps one they’ve never made before. Given enough details they can determine the process of making it, and if they add the direct labor cost, materials used, subcontractor add-ons, and a decent markup, they make a profit when they deliver. If they do it well and deliver on time, they become a trusted supplier and might make that same component for their customer for years.

A corollary to that scenario might be a re-order of a product that was made in the past, trying to determine what price to charge for a re-order in today’s world of rising costs, supply shortages and all the rest. Charge the same price for the same product while their costs continue to rise? Not a great idea.

The answer in both situations is in having a firm grasp on today’s costs, and being able to translate them into a formula that captures them and is easily updated as circumstances change. The best manufacturers have learned that the best practices method of doing that is to maintain a current Labor Shop Rate, the amount they will charge a customer for each hour of direct labor that goes into making the product. Keeping that one metric current, bidding with it, and sticking to it in contract negotiations is key to the profitability of countless manufacturers, from small machine shops to major aerospace giants.

So what to keep in mind as you develop a labor shop rate that will reasonably assure you a profit – if you can make the product in the number of hours you estimate? Here’s our recommendation:

  1. Have a proven calculation process that captures the actual cost of direct labor

This is a really important piece of arithmetic. Using the direct labor hours that go into making each product, lay out a template to make sure you recalculate your labor shop rate the same way every time. That way you will know you’ve covered everything that should be included. Then re-calculate often – we suggest at least quarterly. Then compare your newest calculation with the prior ones for variances that may indicate a boost in costs that could hurt your margins or the need to exercise better cost control. Tip: if you’re not closely tracking labor costs for each product you produce, the result will be largely meaningless.

  1. Don’t forget your non-manufacturing costs, and your markup

When you use your labor shop rate for bidding, the rate you base your bid on has to cover everything. So your calculation process should include your cost of doing business. That means not only direct costs of manufacturing, but also overhead, marketing, selling, general and administrative expenses. AND your markup! Think of it this way: your labor shop rate is the price tag on your products, and your customer is going to pay what’s on the price tag. No add-ons or extras. If you don’t build a profit into your price tag, you’re subsidizing your customer’s profits instead of yours.

  1. Labor Shop Rate X the number of direct labor hours per piece X the number of pieces in the order

That’s your bid. Now quote your customer with confidence, knowing you can deliver what they want and make a fair profit doing it.

We are Your CFO for Rent.

Why not just tax basis accounting?

A former client has had to make a change in the head accountant position at their company, and the new accountant asked: “Why are you keeping your books on the accrual basis, when you file tax returns on the cash basis?” I was asked for my opinion.

Without commenting on the questionable credentials of the new accountant, let me acknowledge that many small businesses face this same question, and far too often opt for cash basis accounting because it’s seen as simpler and it makes their CPA’s life easier when income tax filing time comes around. So, in the interest of any of our readers for whom that’s a valid question, let me provide some insight.

Cash basis accounting is just what it sounds like – you record receipts when the money arrives in your door, and you record expenses when you sign the checks (or in the case of one client who previously only recorded those checks when they showed up on their bank statement). Then your accounting software produces the standard reports – income statement, balance sheet, etc. whenever you ask for them.

A couple of small problems:

  • If you sell your products and services to customers to whom you have extended credit (assuming you’re not the corner candy store that only deals in cash) your customers owe you money. But your financial reports don’t tell you how much money they owe you. You’ll have to run a separate report to get that, or keep a record somewhere else. Oops, just got a little less simple.
  • If you buy the products you sell on credit, you typically get 30-day terms to pay those bills. But knowing how much you owe and to who, so you can make sure cash is in the bank when it’s time to pay them, sorry, you’ll have to run a separate report, or keep a spreadsheet or some other record – perhaps a stack of unpaid bills on the corner of your desk. Oops, just got even less simple.
  • Your company will often buy things that last longer than the time period between financial reports – inventory that you’ll sell over the next X months, insurance premiums and property taxes that provide value for a year, etc. If you want your financial report to show a real gross profit on your sales, you have to separate the goods you bought and sold from the goods you bought and haven’t sold. Holy Moley, we’re way past simple now. We’re in a quagmire of disinformation.
  • And to top it all off, your bank won’t lend your company money until they know the answers to those questions as well. You can send them all those separate reports and assure them they’re accurate even though they can’t reconcile them to anything, and they’ll trust you. Or maybe not.

My list of problems is only limited by the intended length of this post. So if you need to hire an accountant for your company, and the interview process brings up the question of accounting practices – as it should – you might ask them how they would feel about keeping your books on the cash basis, “to make income tax reporting simpler.” The listen carefully to their answer.

We are Your CFO for Rent.

Why a Board of Directors?

This post is written with the specific goal of reaching out to the owners of privately owned companies and their advisors. It’s even more important that owners read this if:

  • those owners are not closely involved with their companies, as in many family office settings or when there are non-owners running the company, or
  • when the company is contemplating a transition of management from a founding generation to a younger generation who may not yet have the depth of experience needed for that transition.

Every corporation is required by law to have a Board of Directors, the purpose of which is to oversee and advise management in the effective operation of the company, and to truly help the company attain the goals and realize the vision of the owners. Despite the proven soundness of this structural model, the Boards of many privately owned companies often consist of inactive family members or company officers that function on the Board pretty much to support whatever the CEO decides. The key obligations of oversight and advice are relegated to the annual minutes created by the company’s law firm to maintain the corporation’s good standing, without actually getting the value that a Board can and should provide.

Why don’t all privately owned companies have Boards in place? Several reasons come to mind:

  • They don’t believe anyone can look out for their interests better than they themselves can.
  • They don’t trust any outsiders to make decisions that will benefit the owners.
  • They don’t want to surrender any significant authority to people they can’t control.

And the problem with that thinking, while it’s easy to understand and even appreciate, it misses the point that is the foundation for Board existence, that experienced business leaders can often be more effective at getting to the right decision than the management team, at least in part because – when chosen carefully –

  • they bring expertise honed over many years of often highly specialized experience, such as finance, risk management, marketing, R&D, etc., that are beyond the expertise the company itself can attract, utilize or afford full time;
  • they’ve been there and done that, and seen how to best do it without making painful and costly mistakes; and
  • they can often see the forest despite the presence of trees, helping drive the creation and implementation of strategy that is key to reaching those long-term goals the owners yearn for.

“Noses in, fingers out.” The value of a Board is NOT to tell the CEO what to do, or to interfere with the way it’s being done, or to tell the CEO’s employees what they should do. It is to advise the CEO based on their experience, to oversee and monitor how well the CEO does the job in accordance with the approved strategies, policies and processes that are in place, and to evaluate the CEO’s performance over time, all in accordance with the intended vision and goals of the owners.

All of that falls into the broad heading of Corporate Governance. To make the company the best it can be.

We are Your CFO for Rent.

Cybersecurity Anyone?

We’re all reading about the increasingly common risk of cybersecurity exposure, the bad actors launching attacks from all over the world, and the embarrassing press announcements by companies that have been victims of these attacks. What doesn’t make the news is what company management teams should know to protect themselves from such attacks, or to recover from them if the protection wasn’t adequate (and when DoD gets hit with an attack, you know your defense will NEVER be adequate if you get in the crosshairs of a really skilled bad guy).

So what constitutes “protection”? There are a growing number of laws, state, federal and international, that dictate actions we must take to protect our data and the data of the people we do business with. They’re all different – not surprising since there’s no foolproof set of rules to follow – and it’s not possible, even if it were financially affordable, to comply with them all. Now what?

Since your protection can’t be perfect, you can be sued by regulators or those whose data you compromised. Dollar cost and a huge hit to your reputation. The makings of a perfect storm if you’re the target. A panel held earlier today by SecureTheVillage.org, a nonprofit dedicated to educating us about this challenge, raised some challenging questions and offered some potentially helpful answers. For example:

  • What makes a lot of sense as a starting point is to get a thorough cybersecurity risk assessment by someone other than your IT department or your contract provider. Try to understand why you might be a target, because that will tell you something about where to start to develop a defensible policy. Given your business, what laws are you subject to? What might “defensible” mean if you are challenged under those laws?
  • If you’re hauled into court, your defense could be that your protective policies were in compliance or were reasonable in the circumstances. Short of compliance with all the disparate rules that exist, saying your control practices were reasonable can be pretty hard to define and perhaps even harder to defend. A more effective approach might be to develop controls that are defensible in the circumstances, meaning they would hold up in a courtroom. Again, what that means in practice is not a slam dunk, but it’s a strategy to guide your processes that could help you avoid a successful attack in court on top of the attack on your data.
  • Insurance is nearly impossible to get today, or to keep, for cyber risks unless you know exactly what your insurer requires you to have in place, and then you implement and maintain exactly that. Do they require compliance? And what does that term mean to their claim adjusters? If you have insurance today, checking this out could avoid a nasty surprise: a non-renewal decision or a claim made but denied by your insurer, again trying to avoid the double hit to your bank account and reputation.
  • Given all that information, how much risk are you willing to accept? Can you put an estimated dollar amount on that, and can you accept that as a cost of doing business?

No one knows the perfect answers to those questions. But you have to ask. Or be prepared for whatever comes down the road. Do you feel lucky?

We are Your CFO for Rent.

Another year, another budget? Not this year…

If you are a member of the management team of a calendar year company, and you’ve not started your budget development for 2022, you’re already late. Remember how last year went? Getting ready for the new year at this point isn’t going to be easy, but it’s going to be even more important that you do it. I can think of no industry whose prospects haven’t been altered by the pandemic, for better or worse. In my view you ignore that reality at your peril.

Here are 4 steps to help you catch up and get it right.

  1. Review your company’s Strategic Plan to see if it is still relevant in view of the events of the past couple years. With disruptions in supply chains, consumer habits, industries thriving and others struggling to survive, nothing is the way it was before the pandemic. Make sure your long-range thinking is still relevant, even if you think it will now take you longer to get there.
  2. Review – or develop if you don’t have one – your Operating Plan for 2022. Remember, the operating plan is the narrative description of what you plan to do in the next year to further the goals and objectives spelled out in your strategic plan – one year at a time. And you can’t really begin to develop a budget until you know what you actually plan to do that will need resources. Key: Remember the real purpose of a budget is to define the most efficient allocation of your limited resources. Spending those resources – money and people – in ways that do not further the intentions of the company is a waste of those resources, the sole exception being the unforeseen emergency that requires instant action because you didn’t plan for it.
  3. Now you’re ready to perform an up-to-date SWOT analysis, identifying those internal strengths and weaknesses, and the external opportunities and threats, that indicate the need to modify your plans before you start allocating resources to them. If hiring is being hampered by the aftereffects of the pandemic, you may not be able to open that office in Austin when you planned. If your product requires materials that are now in very short supply, maybe you won’t launch that new product when you said you would. Best to own that reality up front, and the SWOT analysis is designed to give you a today-focused view of the world in which you do business. Don’t miss this step in your process.
  4. NOW, you’re ready to begin building your Budget. Once you’ve assigned responsibly down to the cost center level, laid out the timetable to get it done by early December, and defined the top-line issues that you’ve decide must be included in the budget – all in writing – you’re ready to get started on the actual budget. For a thorough description of the process, take an hour or so to review my budget development course on Illumeo.com. Or call me directly.

We are Your CFO for Rent.

You’re fed up! You want out NOW!

For young entrepreneurs who launched their companies in the past 5-10 years, grew them through intense energy and hard work, and then rode them out through a punishing pandemic, more than a few of them will be saying today “I don’t ever want to go through that again! I want to sell my company and begin living my life again!”

And if they didn’t need help before, they certainly need it now. We met someone recently who said essentially that. “Let’s sell this company before the year’s out, so I can really celebrate the holidays.” The only problem, well problems plural, that will likely dampen the holiday spirit, are these, among others:

  1. They have a list of past due creditors among their key suppliers who could virtually shut the company down if they stopped shipping and were willing to forego the possibility of future orders that they’d actually get paid for.
  2. A key corporate insurance policy has been cancelled for non-payment of the premium, and due to a bad history of claims against the policy. Even an ethical insurance company would have trouble with this one. But the owner thinks they can save money by finding a different insurer. Their broker says “Good luck.”
  3. As for many B2C companies, their busy season is approaching and cash to buy inventory is in short supply. They could miss the whole season unless everything falls into place soon.
  4. There is no financial department in the company, and accounting data are pretty much handled by whoever drew the short straw. They haven’t had a credible financial statement in months.

So, do you want to buy this company? I bet you could get it for a bargain price. And time would tell if it was a bargain or a train wreck. But, if you were still looking to buy this company, you should require:

  • A credible financial statement with some verification of all significant assets and liabilities,
  • The personal guarantee of the seller for any surprises, backed up by an escrowed share of the purchase price, and
  • An earnout for as much of the purchase price as you can negotiate.

But if you’re the seller, you should as a minimum fix a couple things before you go looking for a buyer, despite your desire to celebrate the new year on your own south pacific island:

  • Fix your accounting, at least for the assets that constitute the majority of the value of your company, not based on your books, but in the eyes of any knowledgeable buyer (this may mean actually hiring an accountant or two to get things on track and keep them there), at least for 6-12 months,
  • Settle your insurance situation and ensure that no claims were filed or are anticipated during any period that you were not covered, and buy a “tail” to protect you personally after the sale, and
  • Negotiate paydown agreements with all your key past due creditors, so they’re not a club your buyer can use to pound down the price, even if it means committing a chunk of your purchase price or getting an SBA loan that a buyer would be able to assume. OR you could assume those obligations personally, but that would tie you to the company that you want to get away from.

No easy answer for either side of this deal. As the Farmers Insurance pitch man says: “We know a thing or two, because we’ve seen a thing or two.” Just ask us.

We are Your CFO for Rent.

Support for Building America, or SBA for short

I don’t really think our folks in Congress had those words in mind when they authorized the Small Business Administration back in 1953. But it’s pretty clear that was the essence of their mission. Since then the SBA has done amazing things to help small businesses in this country, and they continue to be a valuable resource for the segment of America’s economy that produces the most jobs, the most innovation, and the most economic growth of any nation on the planet (perhaps except for China the past decade or two).

Those of us in the advisory business know that a company that is launched by financially strong founders doesn’t need an SBA in the mix, and typically companies founded by previously successful business leaders don’t need it either. But most of the rest will struggle to adequately capitalize their companies to support infrastructure, product development, acquisition, and growth. One of our new clients, not well capitalized, just got a $2 million loan for their young business: low interest rate, no payments for 2 years, and 28 years to repay it. By contrast, another new client who were also undercapitalized – but felt trapped – opted for a hard money loan that will cost them about 40% in interest by the time it’s paid off.

What’s the point? New and emerging business owners who have not launched businesses or run businesses before don’t usually realize how much capital it takes to get the company generating enough cash to be able to finance its needs independently. That means a substantial amount of time is spent chasing dollars, making late payments to suppliers they need to survive, begging for a loan at a bank that isn’t interested in the gamble, or in many cases just folding their tent and chalking it up to a life experience.

It doesn’t have to be that way.

I’m not saying every new business should immediately head to the SBA. That wouldn’t work, and since most loans are made through a member bank, even the SBA would not fund unproven ideas. But given some reasonable preparedness this is an opportunity to get it right. A short action list of things to do before you apply:

  • Have someone on your team who can speak credibly about the numbers and knows how to help you manage to them. Ideally that’s the founder, but frequently not. When a founder tries to get by without that knowledge, they usually stumble. You don’t want to stumble at the SBA’s front door.
  • Get your historical accounting done right. Without it, you don’t know your business and neither will the bank. And even the SBA isn’t that soft.
  • Build a credible forecast of what your business will do going forward. As little as a year of forward thinking will give you a wealth of good information and show you have done the homework. The bank and the SBA will appreciate that, and you can actually use the result to make your business better. No downside there.

That was not a commercial. But it could have been.

We are Your CFO for Rent.

When Your Accounting is Broken

Business charts and graphs

One of the things that small businesses – and often mid-sized ones too – don’t do well is bookkeeping, the source of all their financial reports. When money to (1) expand the sales and marketing team, or (2) add new products, or (3) pay bonuses to the owners, have to compete for dollars with an adequate accounting system and competent staffing, accounting sometimes loses out. After all, accounting doesn’t make money for the company (or so I’ve heard), and often getting it right means paying more income taxes than the owners want, which means even less money for those favored projects.

No finger pointing – this is a ‘hypothetical discussion.’ But if that should be happening in a company that you know, there may be a couple problems, such as:

  • A company with multiple products or services, or both, may not know which products or services are making money (and how much) and which are losing money (and how much). Discontinuing a product could actually increase profits, if they knew that.
  • There is no ability to reasonably project the future results of the business, and that means limited ability to prepare for surprises (good or bad), allocate future funds for those special projects with the advance knowledge you can fund them, or develop strategies that will reduce income taxes legally.
  • Limited ability, or maybe none, to get a bank loan to take on a really exciting project, or mortgage a new building or piece of equipment – at least at reasonable interest rates. The potential for growth may never be known because the project couldn’t get off the ground.
  • Even a business in financial difficulty can often qualify for funding to help them through tight times, such as SBA loans, but if the accounting reports are clearly unreliable, that possibility goes away, absent a rare government grant program, e.g. COVID related. No bank wants to gamble their money that your company might be better than it looks on paper.
  • If you have an exit in mind in the next few years, the price you’ll likely get for your company will be a lot less than you hoped for, maybe even a lot less than it’s worth, because you can’t prove it.

Now some would say that they can fix the accounting if and when it becomes a problem. That’s nice, dear, but by then it’s too late to fix the problem from last year, and the year before that, and so on. Accounting is a historical record of your business, and nobody puts much trust on history rewritten in the moment. Except those folks who don’t understand how this works. The cost of good accounting is always less than the cost of bad accounting. We know, because we’ve seen the results of both.

We are your CFO for Rent.

About Nonprofit Boards and Fundraising

Many of us recognize our obligation to give back to our communities by assisting various nonprofit causes, and one of the best ways to do that is to volunteer to serve as a director on a nonprofit Board for a cause that you feel strongly about.

  • You get to personally use your expertise to advance the cause you believe in, such as a CFO guiding the agency’s financial staff to produce more useful reports,
  • You can get an opportunity to directly serve the population you are supporting, e.g., serving food in a soup kitchen, wrapping holiday gifts for underprivileged children, etc., and
  • You can contribute money to help the organization support itself and serve more people.

And there’s where it can get sticky.

Most well-run nonprofit organizations choose their Board candidates carefully, and vet them through interviews with agency management and other Board members, such as a nominating committee. There is, or should be, a give-or-get policy that sets a target for Board members in the money contribution department. Every Board member is asked to make an annual contribution that is meaningful to them (the “give), and to encourage others in their personal or business network to give as well (the “get”). This is a sound way to raise money, to ensure Board members feel sufficiently committed to the agency to support it with some of their cash, and for the organization to be able to say to foundations and other potential donors that their Board is 100% financially committed to the agency. All good. As long as we keep in mind that a Board of Directors is primarily about governance.

The sticky part is when a nonprofit organization feels so strongly about financial support from its Board that it populates its Board with big givers who are not interested or qualified for the governance part of the job. One seasoned Board member wrote an article in Directors & Boards magazine that said it pretty well:

“Nonprofit boards that need to be heavily involve in fundraising, i.e., ‘doing’ rather than just ‘overseeing’ do not automatically commit a cardinal sin of governance. Rather, they should just make sure that their governance does not suffer as a result, such as by automatically populating the board only with large donors who may not be qualified for or interested in governance.”

Sometimes large donors want to be honored for their financial support, and to them that often means a seat on the Board, even though they have no intention of being actively involved in governance. In some agencies the “give-or-get” is quite high, and the real message is “give-or-get-or get out.” That can often exclude from Board consideration a candidate whose expertise would greatly benefit the organization, but whose financial condition would not enable a large financial commitment. Instead, I submit, organizations should find a different way to honor those generous donors, and keep the Board focused on governance – looking, listening, asking the questions that will make agency leadership better as a result. To me that means going first for the skill set and second for the wallet. Governance in the nonprofit world should be interpreted just as it is in the for-profit world: using the director’s expertise and experience to help the organization achieve its mission.

My fellow Board members have heard this before. Nonprofits, this blog’s for you. Need a better governance policy? Give me a call.

We are Your CFO for Rent.

Subscribe to the eNewsletter

  • Sign up to receive articles, the latest blog posts, and helpful tips.
  • This field is for validation purposes and should be left unchanged.

We value your privacy and never sell or distribute email list information.