Debt Financing

There is an old adage that banks only loan money to those who don’t need it. Since 2007, that adage has more and more become reality as we have faced such a severe credit crunch. Organizations that have had bank relations going back two to four generations are finding themselves with reduced credit at a time where credit is vital to staying in business. And they are sometimes the fortunate ones.

It’s not that the banks are purposely squeezing their customers. Many are faced with regulators telling them they have to reduce their exposure in certain industries. The bank can’t comply by calling the notes of their underperforming clients as those loans might slide into the non-performing loans. The result is that good long term customers are forced to find financing at a different bank.

How do you prepare for the unexpected in such turbulent times? The first step is to focus the organization on producing Cash Flow from Operations. The difference between cash flow and Net Income is that cash flow for an organization is like blood flow for our bodies. It also tells a bank how their loan will get paid back. Adding a cash flow statement to the monthly financial reports allows management to monitor cash flow and set in motion events that can improve it. Building a cash flow forecast to the documents a company presents to its bank allows the bank to see when it will be re-paid. Of course a forecast needs to be revised and adjusted to meet market conditions.

An increase in revenue may lead to an increase in Net Income. However if the resulting sales are increasing Accounts Receivable and are not being collected, cash flow will suffer. At the same time, collecting Accounts Receivable quicker than sales, you will be generating cash flow from operations. Accounts Payable also feeds into cash flow. Paying down accounts payable consumes or reduces cash flow while stretching your payables improves cash flow. That as well as non-cash expenses are all accounted for in the Cash Flow statement. We start with Net Income, add back non-cash expenses and then adjust out changes in Balance Sheet accounts to determine how much cash flow we generated from operations.

There is an old accounting saying “Profit is an opinion, Cash is fact”. Managing cash flow allows an organization to be proactive in planning what it needs to do to in order to meet its obligations while implementing its strategic plan. Keeping your bank aware of your progress builds a relationship. However, building relationships with multiple banks is a strategy that will allow an organization to survive difficult credit markets and have cash to be ready when the economy rebounds.

© Strategic Financial Leadership, Inc. 2009

Internal Control

Internal Control is a very broadly defined process designed to provide reasonable assurance of the achievement of objectives regarding three main categories. They are: Reliability of Financial Reporting, Effectiveness and Efficiency of Operations and finally Compliance with applicable laws and regulations.

To be effective, an internal control system needs to set the moral tone of the organization, influencing the control consciousness of the organization. Setting the tone also examines the integrity exhibited by both the managers and employees.

Management should set organizational objectives that are reasonable and obtainable given the nature of the organizations business. Management also needs to analyze both the internal and external potential for violations. Finally, Management needs to develop and implement a strategy to manage the risk that has been identified.

Management also sets in place policies and procedures that enforce management’s directives. However, without the monitoring of the policies and procedures, their usefulness will quickly fade.

Organizations also need to define what information is to be communicated and to whom that information can be communicated to. This includes defining document retention policies.

In a smaller organization, internal control is made difficult because often there are not enough people to truly segregate responsibilities. Larger organizations are better equipped to have a solid control system. Regardless the size of the organization, there are some fundamental components that any organization can adopt:
· Establish a code of Ethics for the organization
· Careful Screening of job applicants
· Proper assignment of authority and responsibility
· Effective disciplinary measures

© Strategic Financial Leadership, Inc. 2009

Strategic Forecasting

I have mentioned forecasting in my blog a few times, some people refer to forecasting as budgeting, which can be a much more pain inducing process. I like to refer to strategic forecasting as beginning with what we know about the organization, add in trend analysis for the major drivers, as well as the growth or changes coming from the Strategic Plan of the organization.

We begin our journey with the drivers of Net Revenue, once we have mapped out what we expect to see happen there we can begin looking at the costs. Some of those costs will be fixed and easy to calculate. Others are going to fluctuate or be variable depending upon the amount of activity in the organization. For the variable costs, you need to determine how they relate to the generation of Net Revenue. This will allow you to forecast them in a reasonable manner. Your fixed costs are generally easier as they will not be changing as Net Revenue changes.

Once the forecast has been created, it is important to review it to make sure that it is reasonable and can be executed against. The problem with budgeting and forecasting is not the difficulty in creating the budget or forecast but in the organization being able to execute against it. If you have forecasted that Cost of Goods Sold (COGS) will be 30% of Net Revenue and COGS is historically 35% of Net Revenue, you had better have a realistic executable plan for reducing 5% out of the picture. At the same time, just because the historical number is 35% nothing is stopping you from asking what it would take to reduce it to 30%. That’s how a plan comes together.

Just having a forecasted P&L statement is not the goal of Strategic Forecasting. You next need to forecast the Balance Sheet. You begin with the historical Balance Sheet and determine how the different lies relate to the historical P&L. Once you have determined those relationships, you can then forecast based upon your forecasted P&L. It is also helpful to then forecast a Cash Flow Statement combining the forecasted Balance Sheet with the forecasted P&L.

Now that you have your three forecasts completed, you need to analyze them for reasonableness in addition to asking the question, do these forecasts take us to where we want to go? When your forecast does not take you to where you want to go you need to determine why and what needs to be changed. Then you need to change it.

Finally, I find that forecasting works best if it is refreshed and extended each quarter. While you are refreshing it and adding actual results for the prior quarter, you can test the relationships you built the forecast upon and adapt them as needed.

@ Strategic Financial Leadership, Inc.

Formulized Cost Containment

I am often asked what the difference is between a CFO and a Controller, Staff Accountant or even Cost Accountant. My response generally has to do with a long-term global view of the organization. A Controller or chief accountant is primarily concerned with reporting the financial results of the organization. A staff accountant may have a more limited role in assisting the Controller as well as being responsible for Accounts Receivable or Accounts Payable etc. While a Cost Accountant is responsible for gathering, compiling and communicating a variety of information about an organizations activities. All three, the Controller, Staff Accountant and Cost Accountant are responsible for generating reports that compare actual results compared with planned results. These reports enable management to make changes to activities in order for the organization to exceed its plans.

Another way to look at these roles is to say they report the recent history in order to help steer the organization through the future. Reporting the organizations history is a vital role that also allows the organization to fulfill its legal obligations to owners, creditors as well as taxing authorities. However, if you are only going to use reports of past activity to operate your organization, it’s kind of like driving only looking through the rear-view mirror of your car. Starting from the financial reports, adding trend analysis, future expectations and market conditions allows you to create a Financial Forecast.

The Financial Forecast becomes part of your operating plan and will demonstrate where you need to either increase pricing or reduce costs. I am sure you have heard that not all costs are the same. Companies that reduce costs without measuring the full impact of the reduction cause customer service and quality problems. The costs that should be reduced are those that do not harm either one of these key components of sales. No matter how much you reduce your costs, if your company is unable to sell the products or services you bring to market, you will still be out of business.

Recently the morning newspaper in Cincinnati cut out re-delivery, which is sending somebody out with a newspaper should your carrier miss your delivery. I am sure that when they were looking at all of the costs of delivering a newspaper this was a minor one. However, it also has caused at least one subscriber to drop daily delivery. Not a big revenue hit. Less than $150 per year, however, the real revenue for newspapers comes from the display advertising. Those rates are based on paid subscriptions. Hopefully somebody found out how many subscribers could be lost by dropping re-delivery and what that would cost in lost advertising and circulation revenue.

See, there is much more to cutting costs in order to maintain profitability.

@strategic Financial Leadership, Inc.

Strategic Pricing

One of the most difficult problems an enterprise encounters is how to price its goods or services. The price has to be high enough to cover all of its costs and generate overhead coverage and profit. The CFO can assist the organization by making sure that it does not just use cost containment in setting price. By introducing concepts such as Break Even analysis, Fixed and Variable costing analysis we can begin a discussion that will lead to strategic pricing guidelines. I say guidelines because the pricing needs to be flexible to match market conditions that will occur over time.

The CFO will look not just at the present costs but will also use forecasts of future cost changes. This long-term globalized view of the organization is necessary in order to maintain sustainability for the organization. A Controller or cost accountant will generally be more focused on past or present costs since those are what they are charged to focus on.

I am not advocating that the Strategic Pricing decisions be made solely by the CFO, I am advocating that she or he be at the table to allow the organization to have its strongest team making its most important decisions. This team may be led by the CEO/President/Owner but should also have somebody who is fully versed in market conditions for the industry the organization finds itself in.

Strategic Pricing decisions should be model driven so that they can be flexible and the organization can be responsive to the market changes that occur daily. The goal of strategic pricing is not always to obtain the maximum profit available. It is to maximize profits and market share without being so excessive that customers are driven to alternative products or services. Simultaneously, it must generate enough profitability that the organization can continue to refine its products or services to meet the needs of a changing market.

What does this mean to a smaller organization without a CFO or Marketing talent on its payroll? The pool of consultant talent that can fill these gaps is growing daily. Hire one before you price yourself out of business.

Cash Flow Management

Cash is to a business what blood is to a human, no matter how much you have, it won’t do you any good pooled in one place. That may sound rather strange coming from a Chief Financial Officer, but in order to grow and sustain itself, every organization must have cash flow. Simply sitting on a pile of cash will not allow for long term growth.

There are three sources of cash flow that we monitor, Cash from Operations, Cash from Investing and Cash from Financing. Combined these three sources tell the story of the organization for the most recently completed period. When we look at these sources over time, we can tell the completed story.

Cash from Operations begins with the Net Income for the period and then adds or subtracts the Balance Sheet changes for the same period that consumed or produced cash. This translation of the Income Statement proves out the old accounting saying ‘Profit is an opinion, Cash is Fact’. A set of financial statements that show Net Income but cannot show positive Cash from Operations should cause some alarms to be ringing in the mind of the reader.

Cash from Investing takes into account the use of cash to purchase assets or invest in other organizations. Any organization that is not regularly spending on replacement of its assets may be hurting the organizations chances in sustaining itself over the long haul. Periodic drops in investing in assets as a result of economic conditions are not as harmful as not doing any investing over time. One of the keys is to have a plan, you may have to modify the plan to match circumstances, but reviewing Cash from Investing over time will demonstrate what the plan has provided over time.

Cash from Financing demonstrates how much the organization either borrowed or paid back to its lenders or investors over the period. It is not unusual for an organization to consume all of its Cash from Operations on its Cash from Investing section and therefore have to borrow additional funds from its bank. In today’s environment, most banks are asking their clients to lower their borrowing, which can be done either by reducing its Investing activities or increasing the Cash from Operations.

As a child, I remember a television station would say, its 11 PM, do you know where your child is? I would like to paraphrase that, we are knee deep in a recession; does your organization know where its Cash Flow is?

©Strategic Financial Leadership, Inc.

Profitability Analysis

Most people think that this is the easy part of running an organization. Yet it is often ignored because usually the financial results are not available until after the fact. An Outsourced CFO can provide four resources to advance this analysis.

The first one is to streamline the Financial Statement process in order to have interim statements available while the data is still fresh and something can be done to improve the operating results. It may be as simple as downloading Banking statements instead of waiting for mailed statements, or streamlining the Expense Accrual process, or automating the Payroll and Accounts Payable processes. Often a fresh set of eyes can find ways to streamline a process without compromising the integrity of the results or violating standards of Internal Control.

A second resource is the ability to determine what drives the business process and how can we measure it. As an example, If we know that our Sales Force needs to average 15 appointments per week to land enough sales to continually grow Revenue, then reporting weekly activity as well as process results can help decision makers to direct the organizations efforts to be more profitable. Or the CFO maybe able to analyze a Not for Profit’s contribution patterns and establish what activities drive donations.

The third resource the CFO can bring to bear is the ability to create models that allow a small amount of data to forecast results. This is very important when an organization is considering making a major change to its processes in order to have an idea what the impact the change will have on sustainability of the organization. Sometimes these models can substitute for the interim Financial Statements for more real time decision making.

Fourthly, the CFO can provide historical trend analysis to the data to help identify what story the recent history is telling us.

I was once the Finance Director of a Not for Profit, our accountants were producing statements showing the changes in expenses from last year compared to the spending for this year. The variance was almost 50% and caused a good deal of concern for the Board. However, the analysis was not complete, it failed to show that we were serving 90% more people and generating 65% more Revenue than the same period of time in the previous year. So if Revenue grew by 65% while expenses only grew by 50% (assuming we ended the prior year at no worse than Break Even) than that is actually a Good Thing. Adding a small amount of data to the report gave a truer picture and allowed for better decision making.

Do you really understand what drives your organization? Are you able to get the full picture in a timely manner? Do your Financial Reports generate more confusion than clarity among your Board or Bank? Perhaps now is the time to invest in the resources that can lead your business into the future.

Outsourced CFO

Most people hear this title and connect with the Outsourced piece rather well. It is not hard to imagine in our economy outsourcing almost anything that a business or not for profit needs. However, a lot of people do not seem to fully understand the Chief Financial Officer (CFO) part of the title. I have found that while smaller organizations are looking for the specific tasks provided by a CFO, they often believe that they are too small to have their own CFO.
This is where an Outsourced CFO can fill the gap. Working on either by the project or on an hourly rate, the Outsourced CFO can become a valuable asset while assisting the organization in meeting its goals. Almost every organization has a different view of what a CFO is responsible for. However the following list contains some of the more basic needs that the CFO will fill.

• Profitability analysis and maximization: identifying the drivers of profit and how the organization can maximize the outcomes of those drivers. In the Not for Profit world, identifying the drives of the organization’s mission.

• Cash Flow Management: cash is the lifeblood of every organization, managing the cash flow well can be the difference between failure and success.

• Strategic Pricing: by helping to fully understand the organizations costs, serves to set pricing to maintain market share and grow the enterprise while maximizing cash flow.

• Formalized Cost Containment: What are the real cost’s of the organization? What expense reductions will actually make it more difficult to generate Revenue or Cash Flow?

• Strategic Forecasting: attempting to drive a business simply using its historical Financial Statements has often been likened to driving a car by only looking through the rear view mirror. The CFO can take historical numbers and use them to build a forecast to manage the future. This forecast will allow the organization to see the impact its Strategic Plan is expected to have on the organization. When compared to actual results, it will allow for faster and more strategic adjustments to the plan as conditions dictate.

• Internal Control: Smaller organizations lack the staff and training to design effective controls to safeguard the organizations assets and protect its staff.

• Debt Financing/Equity Development: the CFO is invaluable in making sure that the organizations needs are properly presented to investors and lenders.
If you are the CEO of or on the Board of a privately held organization, which of these items would best serve the organization?

Fourth of July

Since this is the 4th of July, I am reminded of the following; “When in the course of human events… And for the support of this Declaration, with a firm reliance on the protection of Divine Providence, we mutually pledge to each other our Lives, our Fortunes, and our sacred Honor.” The opening and closing words of that unanimous declaration that came forth from the Representatives of the united States of America, in General Congress, Assembled in Philadelphia on JULY 4, 1776.

The final sentence has always grabbed at my heart and mind. These guys (yes, they were all men) pledged to each other their lives, fortunes and Sacred Honor. They knew that by the mere signing of this declaration, they were providing the British with grounds for their immediate execution and surrendering of all their property. Books have been written about the fates these men suffered for having the courage and leadership to write and sign this document.

It is easy to sit in this 21st century America and criticize this group, I mean they were all men, some owned slaves, there were vast differences in their wealth and their view of who should lead and how. Yet they pledged to each other their lives, fortunes and sacred honor. We could spend the rest of our lives trying to figure out why they did this. But I fear that would be a waste of time. Instead I propose that we find a way to apply their example in our lives.

When we are entering into a business agreement do we bring into the agreement commitment and integrity from which we could truly pledge our life, fortune and sacred honor to the outcome? When we consider our neighbors, can we find enough common ground to allow us to pledge our life, fortune and sacred honor?

Our political leaders of today are the positional descendants of these men. Perhaps in the next campaign, we need to ask them, when have they represented us in a manner that would allow them to pledge their lives fortunes and sacred honor to each other and not to their party only.

What I am saying is this:

We need to return honor to all of our business affairs, our Yes needs to be Yes and our No needs to be No. The field of honor does not lie in the ethics of circumstances. We as a society need to re-discover how we can hold ourselves and our leadership to the standards that existed for the Congress of July 1776.

Welcome to my blog

Thank you for coming to my site and reading my blog. I hope to enlighten you on what an outsourced Chief Financial Officer can do. My plan is to post at least once a week relevant information for privately held businesses and Intentionally Not For Profits.

Bob Lynch