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Toward More Creative Variance Analysis
As we urge every CEO and business owner to do, we compare actual results with the projections the client made at the beginning of the year, whether it’s a formal budget with staff accountability or not, and we ensure a discussion with management follows. Even without staff accountability, there is value in management learning what differed from what they had estimated only a few months ago, and looking beyond the basics for answers that will drive better results. Here’s a short example of that interaction with a current client, a product distribution and service company.
The monthly results were published. Revenue fell short but the bottom line beat the profit projection. Then we compared key elements as a percentage of total revenues, and that revealed that Gross Profit Margin (GPM) was 51% vs. the projection of 44%, each measured against their respective revenue projections. That was the lion’s share of the profit improvement, and it turned a mediocre projection into a solid gain. We saw that a dollar of sales cost them less than they thought it would. Let’s go further.
We next calculated the percentage of revenue of each element of Cost of Goods Sold (again, against their respective revenue numbers, so that the anticipated relationships are preserved).
Their labor provided to customers is their most profitable offering, and it’s an essential part of every sale, so we looked there first. The percent of revenue projected was 12%. Actual percent of revenue achieved 12%. Clearly not the contributor we were looking for.
Next, parts and components that are typically part of every sale came in 2% under the projection. No one recalled any comparison between vendor invoiced costs and the client’s price list to see if a price increase differential was the reason, so some homework to be done there.
Then we got to equipment – the largest dollar category but the least flexible in price due to supplier controls. Turns out their equipment sales cost 5% less as a percentage of sales than forecasted. That’s a big number. Why did that happen? Product mix? Price list revisions? Missed budget (always a possibility)? More homework to check that out, but we felt pretty good that the resulting research would give us information that would enable us to do a couple things better:
- Compare our price lists with vendor invoice costs to see if we are keeping up with passing cost increase through to our customers, or over-compensating,
- Help our marketing and sales teams drive their efforts in optimally profitable versions of the sales plan, with new information, and
- If needed, help to improve our forecasting accuracy with more real data.
This is more analytical than the traditional budget variance analysis, that looks at dollar differences by line item and stops there. A bit more homework. But it’s also more useful in driving management actions than analysis based on dollar variances alone. Better data, better analysis, better results. Perhaps you should consider it. Why do we say that? Because…
We are Your CFO for Rent.
Cash Management According to ChatGPT
“Cash management is a critical function for any business, involving managing cash flow to meet financial obligations, invest in growth, and succeed in the long-term. Effective cash management is vital to maintaining financial stability and avoiding cash flow problems that can negatively impact the business. It also enables businesses to free up cash for investment and growth, which can help them stay competitive and increase profitability.
Cash management can also help businesses manage financial risk and avoid taking on too much debt, as well as build stronger relationships with suppliers and other stakeholders. By paying suppliers and creditors on time, businesses can build trust and credibility, leading to more favorable pricing and better access to credit and financing.
Finally, by setting clear financial objectives and developing a cash management plan, businesses can stay focused and on track towards achieving their long-term financial goals. Effective cash management is crucial for any business, regardless of size or industry, to position themselves for success, even in challenging economic conditions.”
For those not yet familiar with this new tool of AI (Artificial Intelligence) I downloaded the free (for now) ChatGPT app and gave it a simple task: Write 300 words on the importance of cash management to business owners. While ChatGPT apparently can’t count very well – the result was 166 words long, not 300 – it got the logic of the question accurately and pretty well defined the key reasons why cash management is important to business owners. In several tests run by an associate during a group meeting earlier this week, it responded to several requests to write marketing letters or legal opinions, and responded in less than a minute to each request. In every case, as in my example, the logic was sound, the opinions well stated, and the conclusions reasonable. And at no time did a human being touch the requested response before it was delivered.
Think about that for a moment. A computer algorithm using its access to the internet to create a plausible chunk of text that looks like it was written by a financial consultant. What if it were represented as actually being written by someone you know? What if it came with instructions to send money, or pay the bill, or vote for a make-believe candidate? How will you know that it wasn’t written by your accountant, your banker, or your grandmother? How will you know if your kids earned that A or if they simply copied and pasted an AI response?
The power of evolving technology is – as we have long recognized – both a friend and a fiend. It gives us the opportunity to be much more productive, or to be duped into making a serious error in judgment. The need for awareness when we open our laptops has never been greater. Something to think about. Why do we think about these kinds of things? Because…
We are Your CFO for Rent.
Risk vs. Reward: It’s About Choices.
We’ve all heard about the relationship between risk and reward in business – the higher the reward, the greater the risk that inevitably follows it. Nowhere is this more true than in real estate investing. Well, maybe crypto stocks are still ahead, but in real estate you have choices that aren’t all in or all out. This was demonstrated this week in a conversation I had with another small property commercial real estate syndicator. The comparison was interesting.
His purchases have to date been smaller deals, in industrial areas with tenants whose names you wouldn’t recognize, sometimes with lease terms that necessitated a refinance early on because it wasn’t possible to get long term financing for not-so-long term tenant commitments. Sounds a bit far afield from the kinds of properties we prefer – long-term leases with built-in rent accelerators for premier tenants in inflation-proof healthcare industries.
But that’s where the choices come it – it’s not simply black or white. His properties are in pretty solid businesses – warehousing for some small but successful industrial tenant deemed likely to stay awhile, for example – and his cap rates to his investors are a full point or two higher than we typically offer. While all Absolute NNN deals (no repair obligations slipped in), they require more handholding to make them work, like early refinancing once a short term lease has been lengthened to reduce the debt service cost, or having to decide whether to negotiate higher renewal rates or sell the property sooner than might be necessary to capture the full anticipated returns. But the promised returns are very nice, in return for the higher risk.
We talked about his interest in getting into bigger deals, and our possible interest in taking on a bit more risk to improve our overall returns until the spread between cap rates and interest rates widens again. Those are the kinds of trade-offs investors need to make if they want to expand their portfolios in today’s market. We have looked outside our traditional healthcare focus at some different but equally successful business models, such as dollar stores, fast food chains and value-add residential, and have even invested some money with other folks who are willing to exert the management effort that we don’t want to take on.
All in the interest of making choices to balance off risk vs. reward, and to put capital to work in an economy that is demanding better returns but not yet offering the best opportunities to capture those returns. So far, we’re still waiting, but constantly looking. How will we know when the time is right? We know how to read the signs. That’s what we do, because…
We are Your CFO for Rent.
Safe or Easy – Pick One
- North Korea-backed hackers stole $1.7bn (£1.4bn) of crypto in 2022, says blockchain analysis firm Chainalysis. For
context, North Korea’s total exports in 2020 totaled $142m worth of goods, so it isn’t a stretch to say that cryptocurrency hacking is a sizable chunk of the nation’s economy. - The (Justice) department said it had successfully prevented victims from having to pay $130 million in ransoms to Hive, a prolific ransomware gang, before seizing two of the group’s servers on Wednesday night.
These are just two news items from a blog that I read weekly, to keep aware of trends in this problem area of cybersecurity that everyone talks about, but that too few (CEOs) are doing enough to protect themselves from. The blog is called “Cybersecurity News of the Week & Weekend Patch Report” and its author is Stan Stahl, the best-known expert on cybersecurity protection I know. The quotes I chose are not to suggest that North Korea or Hive are coming for you, but to remind everyone that hacking can hurt us all in many ways, only one of which is by picking our pockets directly.
OK, maybe they are coming for you and we just don’t know it yet, but our job – your job in your company – is to make it difficult rather than easy for them and others to succeed. And that means keeping aware and updated. And that means your software, the publishers of which issue regular updates in the form of patches for security risks that they have discovered and fixed. Besides relevant news, every issue of Stan’s blog contains a list of new updates along with the current versions of most of the popular software in use today, and if our stuff doesn’t match Stan’s list, I get busy. Even better, Stan recommends www.ninite.com, a resource that can check all your applications against current versions and automatically handle many needed updates.
So my message for you today is this: Sign up for Stan’s weekly letter. You can do that at www.securethevillage.org. How do we keep up with all this stuff? It’s our job.
We are Your CFO for Rent
Marketing Spend: Which Half is Wasted?
Those of us who have spent our careers in the financial world have been working with a quandary for many years: It’s very important to invest in marketing, but only in the marketing that works. And, as most marketing experts will tell you, “You only really know if it works after you spend the money.” A sharp CFO will then come back with “Show me how you will measure that, so we don’t just spend the money and then hope we did well.” You can see how this back-and-forth debate can go on endlessly, between the two critical support functions backing every company’s CEO.
The good news: everyone knows, including the CFO, that marketing drives sales and sales drives the company’s bottom line. As an old friend of mine was fond of saying: Nothing happens until you sell something. Actually, one thing happens before you sell something: you create prospective buyers.
The bad news: everyone knows, including the CMO, that companies fail every year by spending themselves into the ground trying to create a new market or grow an existing market, and going at it the wrong way, with the wrong product or to the wrong market, which is discovered after the wrong way ends in the collapse of the company.
There has to be a better way. And today, happily, there is, thanks to the advances of technology and the prolific use of online marketing techniques to drive virtually every company’s marketing strategy. Today we have options that didn’t exist when we launched Your CFO for Rent 35 years ago, thanks to the increasing capability of companies to capture data in a timeframe that enables informed decision making, including redirecting test marketing efforts, reinforcing successful initiatives on the fly, and cutting programs midstream if they are proving fruitless. The trick is picking and using the most effective KPIs to capture, measure and review the most relevant data.
The job of the executive management team is to ensure that the right tools are put in place to do that, avoiding the strategies of the past in which everyone hoped the CMO’s plan was a good one, and waited anxiously for the results at the end of the day. Here are a few proven KPIs for your consideration:
- Website traffic growth from period to period – whether supporting brand awareness, outreach, or product recognition, this metric is the most basic strategy for scaling a business, creating new opportunities to convert visitors into customers.
- Traffic-to-Lead conversion rate – how much website traffic converts to leads that express interest in buying something, best tracked as a percentage of website traffic visits. This measures your ability to build trust between you and your visitors, so they become prospects when they’re ready to go shopping. Call it your Marketing Qualified Leads metric, or MQL.
- Marketing Qualified Leads to Sales Qualified Leads, or SQL – this percentage captures the transition from aware and curious (MQL) to significant interest in your product offering (SQL), even if they’re not yet ready to commit. These are the leads that get passed to your sales team, who will try to convert them into sales.
- SQL to committed sales – this one doesn’t need a label, only a number, the percentage of SQLs that become closed sales. And finally…
- Marketing cost per sales dollar – the KPI that measures how much money you spent to get a new customer, calculated by all the costs of the first 4 steps, divided by the number of new customers captured. Ultimately translated into the marketing cost per dollar of monthly sales.
I wish we’d had the ability to track this kind of information without the painful manual data collection 35 years ago. The concept was there but the implementation wasn’t easy to sell or carry out. But we have it today, and we know that because, as you know…
We are Your CFO for Rent.
Read Between the Lines
As I sort through our daily barrage of emails, I see more than a few offering webinars or workshops or white papers promising to help business owners learn how to read their financial statements. All very nice and certainly addressing a need we frequently see when we take on new clients. But none of them talk about the real secret in financial statements – the stuff between the lines – or between the numbers – that provide critical information for managing the business. Call it financial analysis or reading the tea leaves, most CEOs don’t see it in time.
Brings to mind a client of ours, a company with owners looking to plan their exit and considering the sale of their business as an exit strategy.
Only one problem. After years of profitable operation, today they’re not making any money. Inflation has added to their costs, too many fixed price contracts have prevented them from passing (most of) those costs through to their customers, and the barely recovering economy hasn’t boosted sales enough to cover the increases in overhead costs once considered fixed. To top that off, customers are paying more slowly, and our client has tapped out their credit line to pay their own bills because their customers aren’t paying on time. Finally, their biggest customer – the one with most of the fixed price requirements – wants to extend their contract into the future, ideally retaining as many of those fixed prices as possible.
Hard to see a bright future with that as a starting point. What can they do now?
Here are some ideas we suggested to try to make lemonade out of lemons:
- Start now to educate their big customer that future anticipated price increases will have to be built into any new agreements, and do the research to be able to defend the pricing they want to get.
- Help their big customer understand that competitors are facing the same cost pressures and will not be ready to bid at pre-inflation pricing just to buy the business.
- Put more effort into identifying those costs that have increased in areas that can be passed on to customers, and get that into their billing system to ease the pain a bit.
- Be more assertive in getting customers to pay on time to ease the pressure on the company’s credit line, and get it paid off or reduced as much as possible.
- Try to capture more profitable business by learning what areas of their market have the best future prospects, and go after that business aggressively.
- In the end, be prepared to stick around a couple more years so that profitability is either recovered or clearly on an uptrend, so that a buyer can expect a positive ROI rather than buying a turnaround opportunity.
How did we get all that from interpreting their basic financial statements? By reading between the lines, because that’s what we do.
We are Your CFO for Rent.
IRS provides 1031 Exchange Relief
Relief from the impact of weather is not something we expect from the Internal Revenue Service; hearing from them is more often than not receiving a disturbing letter in the mail. But sometimes we get surprised. Politicians wanting to defund the IRS for collecting taxes will be even more surprised.
In this case the surprise is an announcement that impacts real estate investors who started a 1031 exchange just as severe storms and flooding descended on the areas where their businesses are located, impacting their ability to initiate or complete transactions that involve selling one property and buying another, deferring the gain on the property sold until the replacement property is sold.
In each case the IRS has granted additional time to complete exchanges that were initiated but could not be completed in time, avoiding the potential pain of tax benefit losses because transactions could not close in the time required by IRS regulations. Interestingly, the extensions are based on the principal place of business of the investor, not the location of the exchanged property or the relinquished property. I guess the rationale is if you couldn’t go there because you were canoeing to your local supermarket, you likely couldn’t complete the deal on a timely basis.
The states that were named in the extensions and the time periods triggered by the extensions are:
- Illinois, between July 25 and 28, 2022
- Florida, beginning November 7, 2022
- New York, beginning November 18, 2022, and again beginning December 23, 2022, and
- California, beginning January 8, 2023.
The extension announcements specify counties within each state that are included in the extension authorization, but it’s too detailed to list them here. If you have initiated an exchange that got snagged or delayed in any of those states due to weather, reach out to your tax professional or your exchange accommodator – we use First American Exchange Company – for details and the process for taking advantage of the extensions.
And if you were not impacted by the weather in a real estate transaction, but are thinking about it, be sure to read my November 23, 2022 post on the real estate investing climate at https://www.cfoforrent.com/blog/. How do we keep up with this stuff?
We are Your CFO for Rent.
Entrepreneurs beware!
I had a meeting this week with an entrepreneur/founder who had been advised to engage a fractional CFO to help him manage his company. The business is actually in its 7th year and has been singlehandedly managed by the founder, growing to a few million dollars in revenue last year with the market opportunity to grow to $10 million in short order. During the conversation I learned that the founder:
- has no financial background to guide his financial decisions,
- doesn’t quite know whether he’s currently operating at a profit or loss,
- has SBA loans with accruing interest that has never been calculated or recorded,
- has a single person CPA who responds to questions but doesn’t offer advice, and
- has never gotten a monthly financial statement from his outsourced “bookkeeper.”
Really? This is a dangerously under-served business owner who could be in crisis and not even know it until it’s too late. And yet in this era of smart professionals choosing to start their own businesses rather than return to an unsatisfying job, I believe this is far more common than we’d like to believe. This blog will hopefully find its way into the hands of others in a similar situation. If you know someone who is starting a business, has recently started one, or even – as in this case – been operating for some time by figuring it out as they go along, and assuming the light at the end of every tunnel is a green light to proceed as before, please share this with them. Every business, small or large, new or old, needs basic financial information to survive. That includes this very minimal list:
- a monthly financial report that includes an income statement, balance sheet, cash flow, and comments from the preparer about anything that isn’t self-explanatory,
- a reliable list of who is owed money, how much, and when it’s due (including SBA loans),
- a reliable list of all customers, what they bought, how much they owe, when it’s due to be paid,
- a reliable list of all assets owned by the company, their cost and estimated service life.
- if the company carries inventory, a reliable method of keeping track of that inventory – what they have, how much of it, its original cost, and any diminished value that has occurred.
And that’s just for starters. And you don’t get that kind of information by keeping your record in your checkbook or in your head. You get it by asking people who understand how to capture, track and report that information.
An entrepreneur launching a new venture may believe hiring a good sales person is more important than hiring a good bookkeeper or accountant. But they’d be wrong. They’re equally important, because the business cannot succeed without both skills in the mix. And even if the first accounting hire is an outsourced bookkeeper because the founder can’t afford a fulltime employee yet, they need to make sure that person is skilled at what they need. And if they don’t honestly know what they need, they should ask someone with skills in that area to assist them. Maybe a good CPA and maybe something more. Like what, for example?
We are Your CFO for Rent.
Cybersecurity from a Board perspective
“A $2 million punch. The average cybersecurity incident at a small- or medium-sized company leads to $2 million of business interruption losses, according to the most recent Ponemon Institute. Yet only 30% of the companies surveyed believe they are adequately prepared for the evolving nature of cyber threats.”
That’s a quote from a white paper written a few months ago by the Private Directors Association’s Cybersecurity Committee. This reminds me of the old fable about the ostrich that buries its head in the sand to hide from threats it’s afraid of. While that fable has long ago been disproven, this one proves itself true on a regular basis. Companies have read – and correctly so, by the way – that it’s impossible to protect themselves from all cyber threats, because the bad guys are smarter at getting in and avoiding getting caught than the good guys are at stopping or catching them. The short-sighted rationale seems to be: we can’t be foolproof so why do anything beyond the basics? And the answer is: because the bad guys will go after the easiest marks first, those that have the least protection, so the more protection you have, the less the odds you’ll be tapping your insurance company for help to save your company.
So not just for the big guys. And for those companies wise enough to have a Board of Directors in place, here are some foundational guidelines for directors to follow in respecting their role of caring for the company they serve when it comes to cyber governance, compliments of PDA, and rephrased to avoid some of the stuffy phrasing:
- Define the most critical assets and functions that are so critical to the company’s success that they rise to the importance of Board governance oversight.
- If there are relevant Board committees in place, clearly state in committee charters their role, including knowledge sharing, cross-committee membership, and update frequency.
- Have access to someone with the specific expertise to advise the Board, either on the Board or relevant committee, or available as a consultant, to effectively evaluate the risks.
- That person should report regularly and directly to the CEO and/or the Board, rather than a senior leader in the IT department.
- Often sited as the most critical risks to protect include intellectual property, reputation of the family or company name, ability to operate, and uninsurable financial losses.
- Be ruthless in protecting those assets considered most valuable. Set the policy and be unwavering in enforcing it.
- You are not protected by outside regulations or compliance requirements. Those are minimum protections that are constantly being overwhelmed by creative hackers.
- Do not let routine business decisions create detrimental consequences for cybersecurity; that includes those of employees, vendors, and business partners. This IS business.
- Have a clear incident response plan. Who should be notified? How frequently to revisit the plan? Is the plan tabletop-tested? Is management prepared for the alternative options they may face?
- Even if your company is small, that does not necessarily mean your cyber risk is small. You need outside assistance to identify the risks that are most critical to your company.
We are NOT experts when it comes to cybersecurity. We ARE experts in knowing when to ask for help. We do know WHO to go to when that help is needed. How do we know that?
We are Your CFO for Rent.
You’ve Finished Your Budget! Now What?
HAPPY NEW YEAR! We hope for you and yours a healthy, happy and prosperous new year.
That said, let’s talk about how to help create the prosperous part of that. Specifically, let’s focus on the financial plan/budget that you’ve finished just in time to start the new year. How do you and your team use that plan to optimize the probability of reaching the goals at the top and bottom lines of your income statement? Here are the tools we’ve found most useful to that end.
First, you have a line-by-line budget for income and expenses, ideally by department, so that each department head can understand and be accountable for the results generated by their department. With that as a starting point, here is our recommendation for the most effective process for achieving that accountability:
- Develop a new page for your monthly financial reporting (assuming you don’t already have one) that is your Budget Variance Report. It will detail each line of accounting data that you track for income and expenses, typically mirroring your chart of accounts, and these are the headings for this report:
Current Month Year to Date Actual Budget Variance % Actual Budget Variance % - Identify those variances that are off by more than 10-20% (you pick) or more than $XXXX (you pick here too, based on the size of your business, with the intent of eliminating minor variances).
- Ask these 4 questions of the team member responsible for that department/line item, and remember this process applies to both positive and negative variances:
- What caused this variance to occur? What was the event/activity involved?
- What will need to happen in the following periods to either prevent the negative variance from occurring again, or to preserve the benefit of the positive variance?
- What help do you need from senior management to make those results become reality?
- What are we learning from the answers to the first two questions that will make our next budget an even better tool for profit management?
- Make it clear to the responsible team member that the responses to these questions are not only to keep you aware of the progress of the plan but are also an action plan that they will carry out to achieve the results noted in question 2.
- Next step, for the CEOs who have also created KPIs beyond or in support of their income statement, e.g., lead generation and follow up, social marketing outreach, sales quota achievement, insurance coverage review, etc., those too can be built into your monthly variance review, although the format will obviously vary based on the type of KPI assigned.
The key here is to keep everyone focused on the goal, rather than being preoccupied by the day-to-day distractions that occur in every organization. That’s how you stay ahead of your competition and ensure a smashing 2023.
Make the plan, follow the plan, get the results promised by the plan. It’s that simple. How do we know that? We’ve proven it with real clients over our 35-year history.
We are Your CFO for Rent
