It has been my experience that business owners seem a little confused between a CFO and a CPA. When they ask what I do and I tell them I am in a partnership that provides part-time CFO services for business owners, they often respond that they already have a CPA.
So what’s the difference between a CPA and a CFO? Perhaps the best explanation I have heard is that CPAs (and bookkeepers) look through the rear view mirror. They look where the organization has been. What were the sales? What were the expenses? What did the business sell? What did the business buy? They prepare taxes, perform audits, maybe perform bookkeeping services or prepare payroll. Their focus is on the past.
CFOs on the other hand look through the windshield. They come along side the business owner to translate the vision, goals and objectives into a financial game plan and then work with the owner to accomplish the plan. Like the owners, the CFO is focused on the where the business is going. They deal with the financial implications of anticipated events such as the future purchase of equipment, inventory fluctuations, and projected cash flow requirements. They focus on the future.
Every business owner should have a CPA on his or her team of advisors. If they don’t have one, I will help them find one. But, CPAs usually have limited contact with the business owner, – generally only at tax time. Rarely does the CPA conduct a monthly or even quarterly review of the financial position of the company and provide recommendations for improving operations. Due to the nature of the work of the CPA, they are required to be independent, which precludes them from making such recommendations. The CPA is an outsider.
The CFO works closely with the business owner and should be a member of the management and financial team. B2B CFO partners strive to become a trusted advisor and actively participate in discussions that have financial implications. For example, the CFO works closely with the accounting staff to monitor cash flow and working capital planning. He or she will identify and teach the staff on how to monitor key performance metrics. The CFO designs systems and processes to ensure the integrity of financial information and they design the system of internal controls to ensure physical and financial security. The CFO is an insider.
Monitoring historical financial information is important as it provides a record of the accomplishments of the company. But, charting a course for the growth of the company requires a different perspective – that of the CFO.
Nov 11
17
Is There Really “Good Debt”
In his best selling series Robert Kiyasoki makes a distinction between “good” debt and “bad” debt. As he defines it, good debt is that in which the debt is used to generate a positive cash flow. Application of this definition results in the elimination of personal debt as good debt. Some error in believing that all business debt is good debt.
But is any debt, even business debt, really good? Thhis article addresses three arguments frequently used to justify business debt. (1) Interest on business loans is deductible from the taxes of a business. (2) A mix of equity and debt is a prudent business decision and expected by lenders/investors. (3) Businesses in the early stages of growth don’t have an option but to incure debt. Let’s examine each of these arguments.
(1) Interest on business loans is tax deductible. Some seem to think that the interest deduction essentially means free money. Suppose you pay $10,000 in interest during the year for a business loan. Let’s assume the business is a S-Corp or LLC and that the net income from business operations passes through to the owner. With the loan, the income from the business is $10,000 less then without the loan. If the owner is in the 35% tax bracket, the tax deduction is only $3,500. In order to take advantage of the interest deduction, the owner paid $6,500 for the privalege. So is it really prudent to pay $6,500 to write off $3,500. Ah, let me think.
(2) A mix of equity (ownership) and debt is prudent and expected by lenders. If you were a lender and approached by a business owner for a loan, would you really be excited that other lenders had precidence over you? As a lender would you rather lend to a business that had no debt or one that had 50% equity and 50% debt. In the first instance, should the business default on the loan you as the lender are first in line to attempt to recover the unpaid amount. In the second case, all other lenders stand ahead of you. You my not recover any or all of the amount owed. Which position would you prefer to be in?
(3) Businesses in the early stages of growth don’t have a choice but to incur debt. While I don’t deny that obtaining necessary capital is difficult during the early stages of growth, I believe too many business owners seek the easy path by incurring debt rather than agressively seeking out investors. SBA loan guarantees have reduced / almost eliminated the risk to lenders and thus have made it considerably easier to obtain a loan. Business owners are also attracted to debt because the lender doesn’t expect to have some degree of ownership in the business. What owners often forget is that there are required payments that must be paid on time. In contrast, partial ownership doesn’t mean required payments nor that there is any involvement in daily business operation by the investor. In a young business, isn’t it better to remove as many required cash outlays as possible.
So, ith there good debt? The intent os this article is to suggest that no debt is good debt. What do you think?
Posted in Business by .
Oct 11
31
Avoiding Financial Suicide
What business owner would intentionally destroy their business? Yet, that is essentially what is being done when an owner intentionally neglects to use the key financial reports that are basic to their business. While I contend that an owner should master all of the financial statement triad, I have been shocked at the number of owners that don’t bother to use the cash flow statement. That, I believe, is tantamount to financial suicide. Perhaps you think that is a bit overzealous. Allow me to make my case.
Most businesses operate (or should operate) using an accrual basis for accounting. Under this method, income is recorded when an invoice is sent to a customer and expenses are recorded when a bill is received from a vendor. Neither have anything to do with cash coming in or cash going out. So what, you say? It’s all about timing. Let’s look at the revenue side of the business.
You sell a product to a customer, with the understanding that they will pay you in 30 days. You have a great bookkeeper and he/she bills the customer as soon as the product is shipped. This results in the recording of Income and the creation of a current asset called accounts receivable. Prior to the sale and up to the point at which you receive a payment from the customer you are incurring costs for labor, material, overhead, selling and administrative expenses. If this were your first customer, you would have had a lot of money going out and none coming in. However, your income statement would show that you had earned income. Your income statement might look like this.
Revenue from the sale 1,000
Less Cost of goods sold
Material 200
Labor 300
Overhead 100
Total COGS - 600
Gross Income 400
Less Selling expenses - 50
Less Administrative expenses -150
Net Income 200
So you made money, right? Lucky you, you get to pay taxes on the income you made. But what about cash flow. What does it look like, assuming you actually had to pay half the expenses reported on the income statement?
Cash coming in: 0
Cash going out:
Materials 100
Labor 150
Overhead 50
Selling expenses 25
Administrative expenses 75
Total Cash out 400
Cash balance -400
So what’s the big deal? It will all work out when the money starts coming in, right? Maybe, maybe not! It is very possible for a business to have increasing sales and go bankrupt. How can that be? A business can be on a path of increasing sales, which showS up as revenue and a growing accounts receivable (you are being a bank for your customers). However, if customers are not paying on time or there is insufficient cash reserves (line of credit) to pay the ongoing expenses of the business, the owner can find themselves in a negative cash position. Unless some kind of relief is found, the business will be bankrupt.
Sound far-fetched? That is exactly what happened to a foundry (a company that made bronze castings for artists) here in Northern Colorado. During the interview the owner stated: ”I didn’t see it coming. I looked at my income statement and it showed I was making money.” Yet, his business was declared bankrupt and the assets seized. If the business owner had been monitoring a cash flow statement, he would have realized he was heading for a cliff. In essence, he committed financial suicide.
Some may say, but there are many businesses that use a cash basis for accounting. This isn’t a problem for them, right? Yes, professionals such as attorneys, CPAs, physicians, chiropractors and others use cash based accounting and that is appropriate. Without getting into a lot of detail, they should not ignore the cash flow statement either. While software such as QuickBooks does a good job of tracking cash in and out, there are some non-cash expenses, such as depreciation, that can show up income statement. They would be wise to review a cash flow statement as well.
Posted in Business by .
Oct 11
27
Boots First Exit Strategy
One of the key drivers in the emerging world of business owner exit planning is the realization that there are many options for an owner to exit their business. Typically the problem isn’t having an option, it is knowing which of these options is best for you and which will produce the optimal result for your exit. However, amongst many of the exit options that are commonly discussed, there is one that is not too often analyzed and is what we will call the ‘Boots First’ exit plan. This is the intentional plan to one day be carried out of your office – that you are simply going to work until you cannot work anymore.
A Default Strategy for Many
The sad reality is that most baby boomer business owners do not have a plan for the exit or succession of their business. As a result, the ‘Boots First’ strategy is their default strategy. This simply means that since these owners have not proactively planned for their exit, the default planning inside an outdated will or trust or, worse yet, the estate distribution laws (and tax rates) will apply to your estate – business assets and all.
How to Proactively Choose the ‘Boots First’ Exit
One of the common misconceptions is that ‘exit planning’ is about selling your business. This is simply not the case. The truth is that exit planning is all about learning the options for your exit and finding a customized solution that works best for you, your company and your family situation. If working in your business until you cannot work anymore sounds like it is the best strategy for you, then we are suggesting that this is a form of exit planning that can be proactively addressed. To implement a ‘Boots First’ exit plan, you need to start by determining the things that you do not want to happen as a result of ‘over-staying’ your time in your business.
The following is a list of potential negative outcomes that can result from an unplanned, ‘Boots First’ exit plan. Review this list and identify the things that you do not want to be remembered for:
- Leaving a mess for your spouse
- Paying excessive taxes
- Having the business fail
- Having employees lose their jobs
- Having family members fight over the company
- Having future ownership transfer to family members who don’t want it
- Having your wealth disappear to advisory fees
Potential Solutions to Accompany Your ‘Boots First’ Strategy
One of the first items that you can address if you plan to be carried out of your desk is your estate planning. By updating your estate planning, you can state your intentions for the future ownership of the business. Hopefully your named successor to the business actually wants to own it, run it and has the skills to do so. While you are planning your estate, be sure to make certain that the proper amount of insurance is purchased and held and titled properly (this includes disability insurance). In doing so, you can at least provide for your family with insurance proceeds to compensate for the loss of your business income and the dissipation of wealth that occurs from leaving your primary, business asset illiquid at your passing.
Beyond estate and insurance planning, the next best thing that you can do with a ‘Boots First’ strategy is start moving more and more assets out of the company, growing your personal liquid wealth. The ‘Boots First’ strategy assumes that your business will essentially end when you stop running it. Therefore, you can avoid the loss of some of your wealth by taking that wealth out of the business over the many years that you continue to run it. This form of diversification assists you both with your personal lifestyle as well as with any form of legacy planning or gifting that you would like to do. Remember that illiquid stock remains worthless until someone is willing to pay you for it. Therefore, gifting stock to children and heirs when you’ve predetermined your company’s demise with this strategy is essentially an exercise in futility.
Closing Thoughts
If you are going to choose the ‘Boots First’ exit plan, at least take the time to fully understand what you are choosing. Many business owners who take this time to reflect on their decision typically realize that they have worked too long and too hard on their business to not reap the financial rewards or to not have a say in how that business will continue into the future. Hopefully you’ve gained an understanding that an ‘exit’ isn’t really a final step, but rather the finish line that you and your business should be inline with and working towards.
Posted in Preparing for Exit by .
Aug 11
31
5 Tips to Stop Employee Theft
In a previous article, I addressed the risk that an employer faces from employee theft. I also introduced Donald Cressey’s Fraud Triangle and noted that of the three factors common among fraud cases, only the Opportunity is controllable by the employer. This article provides 5 tips for stopping employee theft and thus enhancing the success and survival of the business.
So what can you do to stop employee theft? Susceptibility to fraud can best be minimized by the business maintaining a strong system of internal controls. Space precludes at complete description of an internal control system, but several principles can be identified.
- Separation of duties – record keeping should be separated from physical custody of the assets. For instance, the person who receives money or writes checks should not keep the bookkeeping records. A person responsible for inventory should not have access to the inventory records, nor should they have the ability to ship or receive goods. The person who has custody of a tangible asset – computers, cell phones, and other equipment – should not have access to the property records.
- Paper trail – Every transaction must be supported by documents authorizing the transaction such as sales invoices, shipping documents, and the like. No asset, tangible or intangible should be moved into or out of the business without supporting documentation.
- Physical control – Tangible assets must controlled to prevent unauthorized removal. Sufficient physical security should be established to prevent easy removal of assets. A simple control is to limit employee comings and goings to a single entrance that is continually monitored during working hours. Access to intangible assets such as data should also be controlled. The use of unique user names and passwords and limitation of access will help prevent inappropriate to sensitive information.
- System of Approvals – any transaction that may result in the movement of goods of services to outside the business must have a series of approvals by persons in authority. Policies and procedures should be set up that identify who has the authority to approve purchases and sales at various monetary thresholds. Purchasing staff must be aware of the thresholds and should be held accountable to make sure guidelines are followed.
- Checks and balances – a system should be established in which persons not involved in the transaction are responsible to validating balances or verifying transactions by other departments. The results of these validations must be sent to persons in positions of authority and any discrepancy thoroughly investigated.
Can employee fraud be completely eliminated? While it’s unlikely that employee fraud will be 100 percent eliminated, the occurrence and magnitude of the loss can most certainly be reduced. Admittedly the tips are lacking in detail. You are invited to contact any B2B CFO partner to obtain detailed information on a system of internal controls.
Posted in Business by .
What’s the most embarrassing thing that has ever happened to you? How about the thing that angered you the most. For a business owner, theft by an employee has got to be right up there. Couldn’t happen to me you say. A quick search of the internet reveals otherwise. For instance, one site states: ”The chamber of commerce reports that 75% of employees steal from their employer; an article in the Denver post indicated that US companies lose over $400 Billion per year due to employee “time theft”; and the American Society of Employers estimates that 20% of every dollar earned is lost to employee theft.” Still think is can’t happen to you?
Where is the risk for employee fraud? I suggest that it is employERs. Edward Demming, the guru of Total Quality Management, stated that management is 80 percent of the problem in business. Sound a little harsh? I contend that employee theft largely occurs due to the absence or failure of internal controls and that is the fault of management. Perhaps the company has grown from a small startup to a company of significance, yet the knowledge and implementation of a system of internal controls has not kept pace. Maybe management wants to create an environment of trust and therefore certain internal controls are avoided. There may be a belief that management has a firm handle on the company and that any employee fraud would be easily detected. There may be a host of reasons that a system of internal controls are not implemented, often to the detriment of the business.
Who’s the culprit? An Association of Certified Fraud Examiners study revealed that 67.8% of those committing fraud were employees, 34 percent were managers, 12.4 of which were owners. While men age 40-50 committed the highest number of frauds, college educated older men cause losses four times higher. Women create as many frauds a men, but the amounts are considerably less. Because management is so often involved in the fraud, it is especially hard to detect. Also fraud is most often initiated by persons that do NOT have a pervious criminal history. Clearly, fraud is not easily detected.
Why do employees commit fraud? In his article, Other Peoples Money, Donald Cressey presented the Fraud Triangle which depicts the three elements that every fraud had in common – Pressure, Rationalization and Motivation.
Pressure suggests that there is something that has occurred in a person’s life that has caused such a significant need for money that they are willing to consider stealing to relieve the stress. Rationalization is the employee’s means of justifying their actions. They are only borrowing. No one will get hurt. The company wastes far more money than I am taking. They deserve it. Opportunity is reflective of the knowledge that employees have of the company’s operation such that they know how to circumvent whatever internal controls do exist. The one factor that employERs can control is “Opportunity.” A strong system of internal controls will minimize the opportunity for employees to commit a crime.
Posted in Business by .
Aug 11
30
3 Cash Flow Tips
In his book Danger Zone, Lost in the Grow Transition, B2B CFO founder Jerry Mills defines the “Danger Zone” as a condition when the cash needs of the business far exceed the cash availability. Well, how far is far? When do you stay the course and when do you throw in the towel? How bad do things have to get before they are too bad and how do you know? The questions are easy. The answers, not so much. This article attempts to provide some encouragement for those finding themselves in the Danger Zone.
Would it surprise you to know that you can have positive net income reported on the income statement and yet have a cash flow that can drive you into bankruptcy? It’s true. Lets look at some conditions that are suggestive of entry into the Danger Zone and then address some actions that can be taken to enhance the chances of a turnaround. Despite that this discussion is in somewhat conceptual terms, it contains principles that can be applied to businesses courting the Danger Zone.
The Symptoms:
Cash flow is reflective of cash coming in and cash going out of a business. Positive cash flow means that there is more cash coming in than going out and negative cash flow is the reverse. Cash flow is a function of three things: price, volume and timing. Cash flow problems begin to exhibit when the amount and frequency of the ins shrink to that of or less than the outs and the timing of the outs precede the ins by increasing measures of time. In other words, for a business to endure, the amount and frequency of the cash coming in must become increasingly greater than the amount and frequency of the cash going out. The third factor, timing, means that as the time between events causing the expenditure of cash and the receipt of cash resulting from those events increases, the risk to the company likewise increases.
The Treatment:
Price: While it may appear overly simplistic to state that the amount of cash coming in to a company must exceed that going out, it is a simple truth. A company must have a certain amount of revenues to cover the expenses of the business, the break-even point. As revenues increase beyond that point, profitability increases. However, it is a strange paradox that a company can increase revenues and yet suffer adverse cash consequences. One way to increase revenues is to increase the price of the product or service. How strange it is that companies have a tendency to decrease the price in order to stimulate sales volume.
Volume: Price and volume are unavoidably linked. Total revenues can be increased by holding price constant and increasing volume, increasing price while holding volume constant or increasing both. Obviously increasing volume requires the increase in sales. Companies cannot simply rely on increasing price; increasing the volume of sales must be a priority.
Timing: One symptom of companies in the danger zone is that they have a long time between sales and collection. Companies must reduce the time between the incurring of the cost of a making a product or rendering a service and the collection of cash resulting from the sale of those products and services. One technique for reducing the collection time is to sell products rather than services. When one buys a product, a hammer for instance, you pay for the product at the time of the sale. When one sell a service, the service is provided, cost is incurred, an invoice is sent and the customer pays some time – 30, 60, 90, days later.
Cash truly is king. Owners place themselves and their companies at great peril. This article has addressed three factors impacting cash flow – price, volume and timing. A wise owner will initiate solutions employing all three factors.
Posted in Business by .
Have you heard of “Baby Boomers”. Probably it’s a dumb question. Who hasn’t? Maybe you haven’t given much more than a passing thought to this wave of humanity that is now entering the window of retirement. But, if you are an entrepreneur, one of the ranks of the baby boomers seeking to sell your business, you should be aware that the odds are against you. A US Chamber of Commerce study predicts that only 20% of businesses offered for sale will successfully transfer to another owner. Would you like to be part of that 20%? This series of blogs will address 10 actions you can take to assure the sale of your business.
Prepare your business to succeed without you. If your presence is necessary for the business to function, you don’t have anything to sell. The owner must develop the employees such that the business functions well without the owner’s presence. A potential buyer needs to feel confident that the business will continue to operate in a profitable manner while he or she learns the ropes. The E-Myth describes the situation in which a person with great technical skills starts a business that flourishes but then stagnates because the owner can’t make the transition from technician to manager. A business in this condition is likely to be one of the 80% that do NOT successfully transition to a new owner. There are three essentials:
- The owner must clearly assign responsibilities and give appropriate authority for the employee to complete those responsibilities.
- Employees must demonstrate problem solving skills such that intervention by the owner is not required which challenges arise.
- The business much continue to operate profitably during extended absences of the owner and without owner intervention
Sale of your business can not be left to chance. Owners must be intentional in preparing their business to be a marketable commodity. This is the first of 10 tips for building a business that will sell.
Posted in Business Preparing for Exit Selling Your Business by .
May 11
25
Nah, I Don’t Need an Exit Plan Now!
I dont’ think I have had a business owner deny that they wouldn’t exit their business some day. They just don’t think it will be anytime soon. Unfortunately many an owner is exited from their business sooner than they think.
About a decade ago my wife and I built our (a lot of it was my) dream house. We got the know the electrical contractor quit well and wished him well as he departed on a scuba diving trip in the Caribbean. A sudden and unexpected diving accident exited him from his business due to his death many years ahead of when he expected. It was fortunate that the son-in-law was a part of the business as there was no succession plan and the wife had no business or electrician skills. The son-in-law stepped in and kept the business in tact until a fair and equitable transfer of ownership could be made.
You will exit your business – some day. Are you prepared if the day is tomorrow?
Posted in Preparing for Exit by .
The truth is not every business needs a comprehensive Exit Plan. Some are simply not in a condition favorable for an owners exit. Some of the reasons why a business may not sell include:
- The owner is too involved in the business for it to transition successfully.
- Buyers in the industry cannot achieve financing.
- Keeping family and key employees in the business is more important than selling to an outsider.
- The owner has an inappropriate or unreasonable price expectation of the seller.
- The Risks associated with the business far exceed the Return that can be anticipated from the business.
In those situations, B2B CFO can help the owner identify and implement the changes necessary to prepare the business for the owner’s successful exit. We specialize in helping business owners craft an Exit Strategy with an emphasis on preserving their wealth. If it makes sense to you to get more information, contact the B2B CFO Partner nearest to you. Visit our website at b2bcfo.com for a complete listing of Partners in the 39 states in which we have a presence.
Posted in Business Preparing for Exit by .
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