Posted on Tuesday,

Predicting the Future without a Crystal Ball

As a business owner, you need to be able to predict the future.

Verbeck Associates has been doing a lot of business modeling lately. It must be the time of the year and the type of clients I’m working with now. I am currently working with two turnaround companies and four startups – both require financial modeling for forecasting results and developing successful strategies to deal with tight cash flow.

We use business modeling to:

Develop internal goals and targets – and provide a budget and scorecard.

Determine feasibility and what-if scenarios to test growth and survival strategies.

Pitch new financing or new equity capital to show cash investment needs.

Evaluate capital investments and strategies.

Produce forward-looking financial statements for your bank and existing lenders.

Keep in mind: projections are wrong by definition. They are future-state, and no one has a crystal ball.

We can certainly get in the weeds with modeling – I run that risk all the time. That’s why I aim to keep it simple. The more complex, the more confusing and subject to error. My models are generally simple 24-month forward-looking financial statements. Here’s how to take a simpler approach to reduce the number of inputs and reduce potential errors.

Take a higher 30,000-foot view first thinking more strategically in both the short-term and down the road. For example, “Based on this revenue, we require this headcount and should be able to deliver x net income and cash flow.” What would happen if we do this or if we do that? This then develops into a more granular approach with a 24-month working model.

It’s interesting to observe the thought process of many business owners. Most understand the income statement, but many have trouble with the balance sheet and the statement of cash flow. All business models start with the income statement so it is important that we understand the revenue model, the go-to-market and sales plan. But that’s not enough. Owners need to understand product costing, product mix, margins by segment, customer acquisition costs, etc.

When I review all this with owners, I start with historical financials numbers for the last 24 months: revenue, margins, headcount, operating expense growth, accounts receivable and inventory turnover, accounts payable days, debt repayment schedules. For startups, historical information is non-existent which can make this more challenging! We work with whatever information we have, and/or consider the following elements and questions:

Plan: The essence of a model starts with the sales plan. What are the expected monthly sales by customer and by segment for this coming 12+ months? Consider the basic business model of:

Leads x conversion = customers x number of transaction x average selling price = revenue. See more discussion in an earlier article

Process:

Develop a realistic sales plan by customer and by product segment. Understand units sold per month and sales potential growth.

Develop a detailed personnel plan (see template). People are generally your largest cost and your biggest asset.

Based on the sales plan, understand the timing of raw material purchases. This obviously depends on your business. For one of my current clients who purchase a product from China, significant lead times must be considered.

Document all assumptions. What is true and what you predict will happen. Prepare a summary of significant assumptions document to attached to final projection printout. The document walks through the income statement sections discussing the thought process with units shipped, sales growth, cost of sales, gross margin by product segment, selling costs, customer acquisition, personnel costs, operating expenses, interest, and depreciation – each line of the income statement. Do the same with the balance sheet – documenting the turnover and asset velocity assumptions, cash and debt needs. (The forecast model and assumptions support the 13-Week Cash Flow process if your company is tight on cash. More on that later.)

It’s essential that the assumptions are reasonable, supportable, and documented. And updated.

I like to go through this plan/process in three ways, producing a conservative, moderate and aggressive model. This helps a business owner make wise decisions, and the more historical data that surfaces as time goes on, the more accurate the modeling can become. But you have to start somewhere — because you probably don’t have a crystal ball (at least not one that works.)

Image by Alexas_Fotos on Pixabay

Posted on Tuesday,

Business Leaders Must Understand the Basics of Financial Statements

As a financial business consultant, one of my primary responsibilities to clients is to create timely, accurate financial statements and quality performance metrics. As the treasurer of several organizations, I also lead reviews of monthly financial statements. Annually, we review the year-end CPA financial statements at the annual meetings.

I like to start off these presentations by explaining the three basic generally accepted accounting principles (GAAP) financial statements. As a business owner, it is so important to understand each specific financial statement and how they relate to each other. The financials tell a story of the entity’s financial performance.

I often get the “I’m not an accountant” or “I’m not a numbers person” feedback (excuse?) when I make these presentations. However, to me, if you can add, subtract, multiply and divide, you know enough about numbers to fully understand what the financial statements are telling you.

The three basic GAAP financial statements are the balance sheet, the income statement (or profit and loss — P&L), and the cash flow statement. They all show different information, but each financial statement is connected to the others.

The balance sheet show assets, liabilities, and equity of the company, organization, or medical practice. It is for the specific day – a snapshot at that day. It shows what you own and what you owe with each category listed in liquidity order in three sections: Assets, liabilities, and equity.

For the asset section, the balance sheet shows cash, accounts receivable, inventory and fixed assets — in that order. Cash is cash. Accounts receivable will become cash soon, inventory will become A/R then cash. Fixed assets can become cash if necessary in a liquidation.

The income statement is the financial statement most business owners understand. It presents sales, cost of sales, expenses, and net income for a period of time – a month, a quarter, or a year.

The statement of cash flow ostensibly shows the sources and uses of cash from operating, investing, and financing activities.

The way to understand the what these financial statements are telling us can sometimes be confusing. It helps to ask questions such as:

How we are doing?
Has our output improved?
Are we moving in the right directions?
What improvements do we need to make to do better?

Use basic techniques to understand the financial performance by comparing actual results last year’s results and to your business plan – looking at vertical and horizontal ratio comparisons. I like to do this monthly, quarterly, and annually.

I compare the overall income statement results to the prior years (periods) and compare to the business plan. I look at sales, gross margin, significant expense categories like salary expense and supplies. How are we doing compared to last year and how are we doing compared to our budget and business plan? I look at simple ratios to measure output – gross margin to sales, payroll to sales, interest to sales. I also like to use trailing twelve months (TTM) of income statement data to mitigate potential timing and seasonal fluctuations.

I compare the balance sheet to the prior period and to the business plan. Why are the significant assets and liabilities significantly different than those of last year? I calculate some turnover ratios and leverage ratios. I look at days sales outstanding, inventory turnover, accounts payable days, etc. Again, why are these better/worse than last year and how are they relating to our business plan?

I look at the statement of cash flow for large sources or uses of cash. Do these sources and uses make sense versus our increase in output? What improvements are necessary to improve cash flow?

These questions and processes may seem complicated or even boring to those not interested in numbers. But if you own or run a business, you HAVE to be interested in the numbers, at least to some degree. You don’t have to be the CFO, but you should have some understanding of how financial statements work and the health of your business. If this or any of my content hits home, please contact me for a free 15-minute strategy session.

Posted on Tuesday,

The Q3 Push – Assess and Realign to Better Meet Your Goals

As summer winds down and the kids head back to school, it’s time for the Q3 Push for your business. It’s time to review where you are and make a concerted push to the end of the quarter on the right foot.

Here are some questions to ask and steps to take:

Are your revenue and expenses tracking going as planned? Look at your income statement and balance sheet by month.
Consider each of your revenue segments. Are goals tracking as expected? Did you make or miss your projections? What needs to be adjusted?
Sort your expenses in descending order and compare to your plan. Do you need to slow down on spending? Can you afford to purchase that needed item now?
Assess whether your Key Performance Indicators need to be adjusted.
Ask: Are our margins holding as expected or are we seeing reductions?
Recast your projections and your 13 Week Cash Flow with better data to finish the year strong.

Additionally…

Start planning the year-end CPA audit now. Schedule a planning meeting with your CPA firm to discuss fieldwork timing, update them with any changes in debt structure and new agreements if any, outline risk areas, etc.

I am working with a client now where we recently revamped the sales forecast. We had been hitting the targets, but we already know that the next three months are going to be well below what we initially expected due to two large customer’s purchasing expectations changing significantly. We were able to proactively make some necessary personnel adjustments, and we expect the bottom line now to exceed our initial expectation even with the anticipated lower sales volume. Asking the right questions and taking intentional steps each quarter will help your company navigate the ups-and-downs of income and expenses, and thrive.

Posted on Tuesday,

The Importance of Making Your Invoices Customer-Centric

What do your customers feel when they receive your invoice? Do you make the process of getting paid as painless for them and easy for you as possible?

I have discussed in the past how important it is to be centered on customers and the processes we use to reflect that. (If you want a quick review you can check out me previous post focusing on this very topic; the importance of customer-centric processes.)

Since everything we do is a process, I’ve decided to take this time to focus on invoicing.

Do you ever get confused by invoices? It doesn’t have to be a legal or medical invoice, it can even be from a phone company or internet provider. Each company has their own format for providing information on the invoices they send out. It seems rare to find any two that look the same.

I remember a time that I spent my weekend helping clients with their accounts payable. I entered a variety of invoices, probably totaling 25 in all, and I noticed that each format was unique.

It seems that most invoicing processes are designed by some accounting type or IT pro. In fact, I noticed that most of the invoices I was inputting were not very clear on what the invoice was actually for. Now for this task I found that all I needed was the invoice date, invoice number, the items purchased, the total due, and the date it needed to be paid. I found out pretty quickly that none of the 25 invoices made it easy to find the things I needed. I also noticed that not one thanked the company for their business. None of these vendors were being customer-centric.

Sometimes we have to step back and look at what we are sending out to our customers. We need to see it as a customer would, with their perspective in mind. In a separate situation I found myself working with a law firm. We were discussing their billing process and the physical invoice. Since I’m usually a process guy, I was looking at the cash flow perspective because we were shooting for a 4-day improvement to add approximately $100K of cash flow.

From there we moved on to the mindset of the customer and we found that their invoices were customer friendly. There was a long tedious invoicing process that required multiple steps and most invoices were several pages long. When we stepped back to see how we could make the invoices more customer-centric we found that their customers – like me with my startup accounts payable invoices- just wanted the invoice date, invoice number, what was purchased, total of the amount due and when it needed to be paid by. Of course a “thank you” would be nice too.

Because of this we revised the law firm’s billing to completely streamline the process. The invoices are much cleaner–and now they are completed within seven days. Cash flow is estimated to increase by approximately $200,000, and as an added bonus they are now thanking the client for their business.

All it took was changing perspective and putting the focus on the customer’s needs! Is there anything you can adjust to help your invoicing be more customer-centric?

Posted on Thursday,

Does Your Company do the Basics?

Every time I start a new relationship with a client, I try to put basic financial controls, processes, and reporting in place.

I’m amazed that many of the companies I work with don’t have these basics down.

As I work with turnaround companies, I notice a basic commonality with their financial systems that indicate why they are in bad shape. Simply put, their financial statements and results reporting are not completed in a timely and accurate way.

One company I’ve worked with used to employ over 500 people. Their workforce is now cut in half. They experienced terrible results, evident in large part by their inability to pay vendors. Halfway into a calendar year, they had no financial statements yet. The prior financials had questionable credibility.

How can anyone run a business without timely and accurate financial statements? How do they know how they are doing? It’s like playing a game with no score card. Can you imagine a soccer game where no record is kept of any goals made? The players just run around kicking and heading the ball for 90 minutes, the horn blows, and no one knows who won or lost.

Without good numbers, you have no idea your direction.

250 families are dependent on the survival of this company. 250 more were affected by its troubles. It’s not fair to either set of families to run a business in such a haphazard way.

This is a leadership issue. The former CEO never believed the numbers they did have. He doubted the costing system; he questioned the financial results; he manufactured “facts” (that simply weren’t true.) He pushed his team to do stupid things, thinking his way was the right way. It sounds crazy, but I’ve seen it time and time again.

Underperforming companies sometimes don’t like to look at bad numbers. But in reality, that makes no business sense. You need to be brutally honest with where you are, in order to make informed decisions for the future. Ignoring the bad numbers won’t make them go away anymore than avoiding the dentist will help your toothache.

We finance pros must do a better job. We need to be adamant about getting accurate, credible and timely reports to the leaders that need it. If they doubt our accuracy, the info will be useless. They will start making decisions only on ‘feel.’ While intuition is something to be considered, it works best when informed by reliable data. Steering a ship by feel alone is dangerous.

As we get to the half-way point of the year, it’s time to evaluate your financial systems and processes. Are you providing/receiving timely, accurate monthly financial statements and daily/weekly key indicators. If not, address the problem NOW before you negatively affect even one family relying on your company to stay strong.

Posted on Tuesday,

A Key to Financial Survival: Predict and Manage Cash Flow

Predicting and managing cash and cash flow is one of the most difficult things small businesses do.

If your company is growing, it’s important; we have all seen many growing companies blow-up and run out of cash as they’re going gang busters. If your company is not making money, it’s obviously paramount to survival. You need to watch every dollar – make payroll and keep the business operating.I like to put two process tools in place that really help any business predict and manage their cash flow.

The first tool which is essential for most small businesses is the ‘13 Week Cash Flow’. This should be updated, reviewed and revised every single week of the year. Put a reminder on your calendar.

The 13 Week Cash Flow worksheet is simple – it has weekly forecasts for cash receipts and a weekly forecast of cash disbursements. The trick twofold:

Being able to predict the timing cash receipts
Having place holders for planned disbursements

Predicting Cash Receipts

In smaller companies, I like to detail expected payments for all outstanding invoices. In the most companies, however, due to the size of receivable aging, assumptions must be made based on current expected cash conversion. Accounts receivable turnover is measured on a weekly basis and strategies are developed and implemented to make improvements. Small improvements in accounts receivable turnover has a dramatic effect on cash flow.

For example, a $10,000,000 parts distributor with $1,500,000 in accounts receivable, decreasing accounts receivable on average of days 5 days, increases cash approximately $139,000.

Disbursements

The worksheet needs to contain placeholders for every disbursement. Bi-weekly payroll, benefits, rent, debt payments, operating and admin expenses, A/P, inventory purchases, cap ex, debt and other payments. Look at your historical spends, open PO’s, current A/P. No surprises.

Each week, review the prior week’s worksheet with actual receipts and disbursements, and recast the next 13 weeks.

The process is straight forward and over time you get better at your predictions.

Forecasting cash flow in your business makes life much better. Less stress, more predictability, ability to make commitments, etc.

See an example of a 13 Week Cash Flow here with this simple Cash Flow Tool

The second tool to predicting and managing cash and cash flow is an Operating Plan forecasting the basic financial statements: balance sheet, income statement and statement of cash flow. The Operating Plan uses key business drivers as its base.

I’ll discuss this in more detail later.

As always – Think Profit and Think Cash Flow!

Posted on Tuesday,

The Art of the Turnaround

A business turnaround is part art and part science. The art portion can be timing, external factors, luck, ability to get people to change, etc. The science part is the numbers, the forecasting tools, communication, fixing internal factors, and negotiation techniques. I focus on the science part.

The fact is most businesses are not performing the way we expect them to. We have high expectations for our businesses. Why shouldn’t we? Why be in business with all the challenges and headaches unless you’re going to make money, create value, and fulfill your mission. If the business isn’t profitable, the business isn’t viable in its current state – something needs to change. Profit and cash flow certainly makes things more fun and allow different opportunities for growth and excitement.

If the business isn’t performing the way we expect it to, we need to turn it around. We need to go the other way.

So for me, the basic principle for turnarounds is: take decisive action to improve productivity with improved processes or systems and hold the team accountable.

I have lots of experience with turnarounds some good, some not so good. Did I mention, I was recently awarded 2017 Turnaround of the Year! The team did an excellent job addressing the issues with this company, and we had fantastic results.

The turnaround process is certainly challenging, it can be fun or it can be ugly. As leaders, we are managing time, money, and people. We need to focus on each. In my observations over the years, I find there are several key leadership principles for turnaround success:

The CEO needs to be ready and confident. This is an opportunity for change. The key is overall leadership with the need for immediate direction. Leaders need the courage to make changes and call the shots. It is time for quick decisive decision making

Pick your team. Remember, the people who got you where you are now may not be the people to get you where you need to go. The core team needs to recognize whatever you’ve been doing is wrong and needs to change – you likely need to bring in professionals and assistance. Redevelop your relationship on the floor – these people know what’s going on and what needs to be changed and improved.

Develop a written plan with short-term action and accountability. Need planning and accountability with solid dates – The plan should be 3-week/3-month viewpoints. See my resources for a Turnaround Checklist. If you don’t know where you’re going, any road will take you there – from George Harrison’s song “Any Road”. Develop an operating plan with forecasted P&L, Balance Sheet and document assumptions and KPI’s.

Get the facts and face the facts – get the numbers and determine exactly where you are. You need to know where you are and figure out where you want to go. Be skeptical of the data. The fact is most underperforming companies generally have bad, inconsistent data. Ensure you have accurate, timely data.

Know your numbers:
- Understand your cash flow. Use a 13-Week Cash Flow Forecast Model. See my resources for a template. Make the weekly cash flow update meeting with your key team part of your process. Keep a short-term approach focused on liquidity and cash.
- Understand your profit – 80/20 customers and products – best if we can allocate all the operating expense to get true cost with activity based costing
Have regular key communication with vendors, banks, and employees

Be prepared for Chapter 11. Liquidating assets is very bad for the bank and can be a powerful negotiating tool, but it can become a slippery slope. If necessary, understand the process.

I would love to help you through your turnaround process.

Think profit and go long,

/jon

Posted on Thursday,

Flying Solo

It’s a love/hate scenario. The client I’ve worked with for the last 16 months is finally ready to get back on his own. Goals have been met and the company is in great shape. So, it’s time for me to go. I love it because this has been a successful relationship and the improvements we set out to do have been accomplished. I hate the idea because I love working with this company and yes, leaving will hurt my income.

When we started working together, our goal was to turn his company around. It had some major problems at the time and the books were in bad shape. Over those 16 months, we developed an operating plan, did the weekly cash flow updates and re-forecasted cash, developed a month-end close, worked on the inventory costing system, and many more processes.

The client did a fantastic job of making changes. He worked diligently with sales, the production staff, and customers. The company went from a retained deficit to consistent profitability and $2+MM EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) with very little capital injection. I loved working with the controller and the finance team. They went the extra mile to implement the processes for the necessary improvements. It truly is a great success story. But as we wind up the CPA audit and the second quarter, it’s time for the bird to fly on its own. I believe the company is ready to soar, despite my mixed feelings on leaving.

However, I will stay involved on a quarterly basis and the company may have some specific project work, but the day-to-day assistance will end. It will be good to still have a connection and get to witness growth and success as the company moves ahead. After all, a fractional CFO comes in to create the foundation and educate owners on how to be his or her own CFO. That is exciting work and personally rewarding as processes are put in place that makes that goal happen. The reality is when the owner is ready to fly solo, they are ready to fly solo and I move on to help the next client realize his or her business success.

How can I help your company soar? Contact me and schedule a call.

Posted on Thursday,

Business Owner Mistakes: No Timely Review of the Numbers

Business owners don’t want to look at their numbers. They think things are going well or not going well based on an overall feeling of how the business is doing. I see this all the time, but I don’t understand that mindset. I appreciate their positive thinking, but how do they really know? We need to look at the numbers, check the score, and make corrections.

My advice to business owners is to know their numbers well and frequently compare actual results with expectations, using both the income statement and the balance sheet. Where are we compared to where we’d thought we’d be?

Projections are wrong by definition. We know that, but we’ve made certain assumptions for business growth and profitability. Plus, we generally approach growth as linear with a steady growth path. Growth is never linear. It’s up, it’s flat, it’s down, it’s up, repeat. The trend line is up, but the actual results can look like an EKG. Growth is tricky that way. The stair step growth graph, can make cash planning difficult. So, we need to make corrections based on data and real information.

Business growth is like sailing. Based on our strategy and vision, we know where we’re going, but when the wind shifts, or competition and obstacles get in the way, people or processes can’t keep up processes can’t keep up. We need to tack back and forth to get to where we want to go. We can only focus on so many things at one time, so use your financials to focus on the right things that make a difference.

To make sensible corrections, it’s imperative to a) have accurate timely numbers, and to b) review the numbers on a frequent basis so we know where we are and where we may need to “tack” to get there.

I’m working with a growing start-up now and things look good. Cash isn’t bad, and sales are pretty good. But, when you look under the hood, the company isn’t hitting their sales plan, payroll is too high, sales expense is out of proportion and cost of sales is too high. Their path needs a correction. Without timely and accurate financial statements, reviewed against plan, they wouldn’t have seen the challenges coming. The Company reviews a “Monday report”weekly and was astute enough to see a dip in a customer’s buying patterns compared to expectation and a dip in overall gross profit. They were able to make some focused changes and get things back on the right track.

Business owners must understand cash flow, gross margin, working capital, the entire balance sheet, and the P & L. Without regular and timely reviews, you cannot plan wisely for the future and develop path corrections along the way.

Tips: Have a process in place to get accurate timely numbers and financial statements. Get to know your numbers. Book weekly and monthly financial reviews on your calendar for the rest of the year now.

Posted on Tuesday,

Business Owner Mistakes: The Backroom isn’t Operating Efficiently

What is the backroom?

I consider most of the business process other than the sales and production/distribution processes the backroom. I generally consider IT, Accounting and Finance, and Human Resource departments the prime backroom departments, and you could include some administrative positions in the backroom as well.

The backroom isn’t seen by the public a whole lot. The processes in practice there can have the appearance of adding little actual customer value, therefore they are frequently ignored. It’s not unusual for the backroom to live by the mantra, “That’s the way we’ve always done it.”

Many business owners I’ve worked with don’t appreciate the backroom at all. Their attitude is “We are a sales and customer service organization.” But the most efficient companies look at their backroom as value add (if it’s not, they may consider outsourcing many of its functions.) When I consult, I look at each department in detail–including the backroom–to determine if they are being organized in the most efficient and customer service oriented fashion as possible.

I like to flowchart all the backroom processes using the value map approach with yellow stickies and a white board, noting everything from the receptionist to cash receipts. I use a checklist and document the current state and then develop a future state. This exercise always makes things more efficient, but even more importantly gives an opportunity to evaluate if the process adds value and if we need to continue it all.

For example, when I call my doctor’s office, the entire auto-attendant process is ridiculous. “If this is an emergency, call 911.” No kidding. The attendant takes five minutes to get to the right person in an office of only three to four. Does this “efficient” system really add value to the patients?

Some backroom processes are obviously necessary–keeping the general ledger up to date, processing payroll, paying vendors, producing financial statements, etc. So when you consider the efficiency of your backroom, be aware that you may not be editing out a lot of tasks–just a few that really don’t add value to the overall business. Then you’ll want to make the remaining processes efficient as possible using simplification and (maybe?) technology (unless it complicates things like the above-mentioned example.)

As you evaluate your backroom processes, this is a good time to compile an operations manual. This can help dramatically over time with training and quality control. Some companies create an electronic repository of policies and procedures instead of the standard tangible notebook. A secure online version can make it easy for all employees to find, and simple for leaders to update. I highly recommend including recorded instructions (screen casts) for routine tasks. These videos can be a huge help in training new hires and eliminate some of the need for current employees to do hands-on training for each new person that comes on board. They also help to ensure a consistent, identical process. This improves accuracy and clear expectations. (You know I’m a big fan of checklists, and that is why.)

I just worked with a manufacturer that implemented a 100% final checklist for each production item. It was simple, but effective. Product quality based on customer feedback increased 30%, which in tern helped him increase his gross margin! All because he was attentive to the processes in the backroom.

I’m offering a free Alignment and Backroom Survey below. Take one process in your business or department, work with those involved with a white board and stickies, and simplify it!

Need more help? Contact me.

Receive the Alignment & Backroom Survey Free!