Tag Archives | operations

Problems When Experiencing Business Growth

Problems When Experiencing Business GrowthGrowth is great for companies, right? Not always. There are so many problems when experiencing business growth that can occur if the leadership is not careful. Besides the uncertainty of how long this growth period will last and how big the company will grow, companies loose focus on some basic key factors. This can include not managing working capital, hiring the right employees, not scaling effectively, customer service, and having less efficient operations.

What Happens To Growing Companies

What happens to growing companies? It all revolves around sales. The sales team and CEO are so excited about all the additional new sales and customers. Unfortunately, some of the day-to-day items fall through the cracks. This includes cash management, internal processes, management/leadership, and systems. But growth can be managed if financial leadership is looking far enough ahead and close enough in. Growing companies don’t always land into sticky situations, but there are some issues that need to be addressed.

Problems When Experiencing Business Growth

Cash Poor

Cash is king. Growth usually comes at the price of consuming cash… Buying more inventory to meet the sales, hiring more people and increasing SG&A. I say that in almost every single blog I post because I cannot emphasize it enough. The #1 thing business growth does is make companies cash poor. The management and forecasting of working capital is critical in a high growth situation. Before you know it, vendors are collecting their accounts receivable yet you have not collected your A/RInventory is consuming cash in order to meet sales. It’s a recipe for disaster!

Need help managing your cash? Inside our SCFO Lab contains 13-Week Cash Flow Reports, Dynamic Cash Flow Projections, Cash Flow Tune-Up Tool, Daily Cash Report, and the A/R Optimizer. Click here to learn how you can access all of that and so much more.

Inefficiencies in Operations

Another thing that happens to growing companies is the increase of inefficiencies in operations. The goal is to push out as much product as possible, but oftentimes to do that, corners get cut. Product quality decreases. And customers are not happy. It also may be the inconsistency between products and/or services as there are no standard operating procedures (SOPs) written down.  If you customers get hurt by a decline in quality or service, then you may have some permanent damage. In addition, companies may have an influx of new employees that are not being trained effectively and/or at all.

Management Mistakes

While management mistakes covers a variety of potential issues, let’s look at two. One of the biggest mistakes is not taking care of the employees. Management is scrambling to scale-up to push product out the door and to continue bringing in the sales. But when stress is high and people aren’t being taken care of, you risk increasing employee turnover. This also includes knowing when to bring on new talent. If management is not continually recruiting and looking for new talent to help even the load off of current employees, then you risk further increasing employee turnover. Remember, the cost of employee turnover is on average $65,000 in the U.S.A. according to some studies.

The second biggest mistake is letting inefficiencies run high. At some point, there has to be a stop to letting inefficiencies continue. Financial leadership should be working with other departments to find better solutions that will deliver the same results. Your basic dashboards are very critical in a high growth situation.

If there are no other solutions, then you need to focus on the customers you have now versus continuing to grow.

Not Scaling

Another problem that occurs during a high growth period includes not scaling up. Are you getting the systems you need to run your business effectively? For example, a company is using a customer relationship management (CRM) system like Zoho or Bitrix – designed for small companies. However, this company triples overnight. They have outgrown their current CRM system. Instead of choosing a system that was for where they were at, they should have forecasted where they thought they were going and on-boarded a system that was maybe a little bigger for them to grow into.

Problems When Experiencing Business Growth

Some of the problems when experiencing business growth include the following:

The best way to address problems when experiencing business growth is to first look internally. Access our Internal Analysis whitepaper to analyze your company’s strengths and weaknesses.

Case Study

Let’s look at a case study about a company I worked with recently. They are manufacturer of industrial parts and had experienced growth for $20 million in revenue to nearly $100 mm in revenue in just three years. The company had a basic accounting staff but no financial professional on staff. Why? Because according to the owners, they are too expensive. The company quickly outgrew their accounting system. In addition, they purchased raw materials aggressively. The sales guys were living the dream with non-stop sales orders. They literally could not keep up with all the new sales orders. The manufacturing facility was now on three shifts to cover all orders. The company also did not want to spend the money on a second plant supervisor.

What were the results? It created a high stress environment. Cash became very tight and sales were being generated, but the order to cash cycle increased to almost 100 days. In addition, the quality of the products suffered because there was not proper supervision for the second and third shift. The accounting records were also not correct and reliable. Instead of the records being generated for large accruals and proper costing of products, they were generated by a basic accounting staff who were no equipped. Furthermore, margins were not reliable for management to use. Cash got tight quickly. The line of credit was maximized very quickly. When the lender challenged the compliance certificates and the financial statements, the ownership started to get concerned about the “back office”.

This financial distress and stressed out employees/ownership could have all been avoided with proper planning and forecasting.

Navigating Business Growth

When navigating business growth, it is important to know both your strengths and weaknesses. Ignorance to those two things risk inviting for unoptimized strengths and weaknesses that turn into major threats. Access our free Internal Analysis whitepaper to assist your leadership decisions and create the roadmap for your company’s success.

Problems When Experiencing Business Growth, Navigating Business Growth

Problems When Experiencing Business Growth, Navigating Business Growth

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Cash Basis vs Accrual Basis Accounting

Cash Basis vs Accrual Basis Accounting

Believe it or not, we deal with this issue of whether to use cash basis vs accrual basis accounting all the time. Many companies start from scratch with one person doing the accounting from home or a small office. Over time, their needs grow. It’s normal to see changes within the organization, especially when companies grow. As you grow, it is critical that you do not neglect the accounting process.

Cash Basis vs Accrual Basis Accounting

What is the difference between cash basis vs accrual basis accounting?

Cash basis accounting is, in its form, the most basic way of tracking your income and expenses based on the actual cash that comes in and goes out every day. Imagine the one employee/owner hot dog stand on the street corner. That business owner goes out early in the morning, pays $2 in cash to the vendor that sells him the hot dog meat and buns. Then, he goes out to the street corner and sells the hot dog for $3 in cash and puts the cash in his pocket. That vendor made $1 profit in cash from the sale of a single hot dog. He sells many hot dogs during the day. This business person is on a cash basis way of tracking his business. In this business owners company there is no difference in timing of transactions between periods.

Moving to Accrual Basis Accounting

If you are bigger than the hot dog stand, then you should probably consider moving to accrual basis accounting for capturing your transactions and accounting. Why? Because we live in an accrual world. Not a cruel world.

If you are reading this blog, then you probably sell a product or service. Most likely, you give your clients terms to pay your invoice. Maybe it is 10 days, 15 days, or even 30 days… But you give your clients time to pay their invoice. You just created accounts receivable (A/R). In the same respect, you purchase things from your vendors – material or services. Likewise, you most likely do not hand your vendor a check or cash that day, but they give you time to pay for the item you just purchased. So, you have accounts payable (A/P). This is probably more realistic. Guess what? You just created accruals.  In this example there are differences in the timing of the actual transaction and when the transaction process if totally complete and settled.  You have to track what is owed to you as an asset, and you have to track who you owe as a liability.

In reality, this is the world we live in and accrual basis accounting is recommended for virtually any business. We live and transact in an accrual environment.

Keep up to today’s expectations when trying to grow or add value to your organization! Click here to access our Top 10 Destroyers of Value whitepaper and protect against anything that may be destroying value.

Accrual Basis Accounting

There are a reasons why major businesses and small successful businesses keep their accounting records on an accrual basis.  One reason is because that is how they generate financial statements that accurately reflect their operations and business, the other is because Generally Accepted Accounting Principals (GAAP) requires companies to be compliant using the accrual basis. A crucial part of the accrual basis is the matching principal – matching revenue and expenses.

You Are 60-90 Days Behind Your Company

The fact is that you are 60 or 90 days behind running your company if you are keeping your books and records on a cash basis. I have actually seen 30-year-old companies with revenues north of $100 million dollars and millions of dollars of expenses on a cash basis. And the recurring comment I get from these business owners is that they have trouble forecasting their business and they think they know what their margins are but really they are not sure. Especially in a business where there is manufacturing or assembly involved, or a service business that is beyond a half dozen people in size, you can bet your margins are wrong if they are on a cash basis.

By not having your accounting records on an accrual basis you are truly 60-90 days behind your business, you are not able to measure or forecast working capital and you will eventually run in to problems.  Some of these problems may be life threatening to your business if there is a downturn in the market or global economy.

It is More Than Margins and Operations

Knowing your margins on an accrual basis and understanding your profit and loss statement is critical. But you also need to know that your balance sheet is correct and truly represents what you have and owe. If you are on a cash basis, then you do not know what you have or owe. For example, prepaid insurance, payroll liabilities, purchase orders entered into your accounting system have not been invoiced by your vendors. As a result, these are all things that will not show up on your balance sheet if you are not keeping your books and records on an accrual basis.

At our firm, we’re are often engaged to help a client company transform their accounting records from cash basis to accrual basis. And the outcome is always positive as management is very happy to know that they can now get good accurate reports and their margins finally make sense. Now they can use their financial statements as one of many tools to run their business.

Cash Basis vs Accrual Basis AccountingA Valuation Perspective On Cash Basis vs Accrual Basis Accounting

You may have a very profitable company on a cash basis, but your financial statements are not going to be accurate. Your company will suffer when it comes down to valuation. Sophisticated financial buyers, strategic buyers and bankers understand that some private companies are still run on a cash basis, but guess what? They are going to discount the value of your company because it is on a cash basis. Eventually, the buyer will want the company they acquire on an accrual basis anyway. This is just another way that you can leave value on the table during a transaction to exit.

Switching from cash basis to accrual basis accounting is just one example of how to protect your company’s value. But there may be other destroyers of value lurking in your company. Don’t let the destroyers take money from you! Access our Top 10 Destroyers of Value whitepaper here.

Tax CPA vs Management CPA

What is ironic is that many Tax CPAs that prepare their clients tax returns or keep books and records do not care if you keep you books on an accrual basis. Actually, if you file cash basis for the IRS and your tax return, it will be easier for your tax preparer to keep your books on cash basis. But that is hurting you from a management perspective. Do not let your tax preparer tell you that you can just as well run your business on cash basis. He or she is simply wrong and too lazy. We can assume that they have never run a business. As a business owner, you need management books/records and management financial statements on an accrual basis and hopefully complaint with GAAP to run your business. They must be kept on an accrual basis so that they are more meaningful as a financial leadership tool.

Remember, CPAs are not all alike. Many of my friends still ask me if I am busy between January and April because I am a CPA. What the heck? I do not even prepare my own tax return, because I am not a Tax CPA.

CPAs are actually very different. The following are some of the different areas CPAs specialize in and many times do not cross other areas:

  • Taxes
  • Audits
  • Management and Operations
  • SEC Reporting
  • Forensic Accounting

Why Not Keep Your Accounting Records On An Accrual Basis?

There is no reason why you would not want to keep your accounting records on an accrual basis. (I am not referring to your tax books and records.) Your operational management financial statements should be kept on an accrual basis. Any decent accountant or controller can help you keep your books and records on an accrual basis. We can also assist you convert from cash basis to accrual basis as we have done this time and time again. We have our process in place to make this as efficient conversion.  In conclusion, there really is no good reason to keep your books and records on cash basis.

To discover other potential destroyers of value, click here to access our free Top 10 Destroyers of Value whitepaper.

Cash Basis vs Accrual Basis Accounting, Moving to Accrual Basis, Cash Basis vs Accrual Basis

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What is Cash Flow?

See also:
Free Cash Flow Definition
How Growth Affects Cash Flow
Why Use a 13-Week Cash Flow Report as a Management Tool?
Why You Need to Have a 13-Week Cash Flow Report

What is Cash Flow?

Cash flow is a term describing the money into and out of a business. This includes all transactions that transfer cash. Furthermore, the business’s sources of cash are separated into three areas in the company’s cash flow statements. Some of the different categories for money spent or earned to fit into the following:

Cash flow in vital to your business. It is the blood or oxygen for your company. Without it, there is no company.

What is Net Income?

Net income is a measure of revenue after subtracting all expenses. This means you take the total revenue for a period and subtract cost of goods/services as well as overhead. This gives a rough idea of whether a business made ‘money’ during the period. However, net income is not a good way to determine the cash usage in a business.

Key Differences Between Cash Flow & Net Income

Some of the key differences between cash flow and net income include the following:

  1. A business can be profitable and go out of business from lack of cash.
  2. A business can have cash flow but remain unprofitable.
  3. Cash flow is reflected on the cash flow statement and not the income statement or balance sheet.
  4. Analyzing cash flow is a way of planning for future cash needs.
  5. Investors can tell where the cash comes from and where it goes from statement of cash flows.
  6. Loans show up as cash on an income statement; Loans are shown as positive financing activities in the statement of cash flows.
  7. Watching cash flow helps notify a business of cash shortages and shows when to borrow money to keep operations going.

Click here to read more about Cash Flow vs Net Income.

What is Cash Flow?

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What is Cash Flow?

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Case Study: Pricing for Profit

Several years ago, I was consulting with a client in the staffing industry that was having a profitability problem:

We have happy customers and seem to be doing well, but we just aren’t making more money

Sound familiar?

After visiting with the frustrated owner of the business, I visited various departments to understand the people and processes behind the numbers.

Operations

My first stop was at the operations department to learn about how the jobs were staffed.  I found out that on any given job, the company utilized both 1099 employees and W2 employees.  I asked them if they had the ability to track which type of employee worked on which job and they let me know that they could.

(Intuit offers a great visual aid on the difference between 1099 and W2 workers here).

Sales

Next, I met with the sales department to determine how they were setting prices.  I learned that they priced their services on a cost-plus basis using a markup of between 30% and 50%.

Their sales force also related to me that they were constantly being beaten up on price by their customers.

Accounting

My last stop was to the accounting department to see what the financial statements could tell me about the company’s lackluster profitability.  Among other things, I found that overhead was running 20%-25%.

Findings for Pricing for Profit Case Study

Based upon all of my investigating and conversations with the various departments within the company, I found several issues:

Additional costs were not reflected in price.

The type of employee that would be used on the job (1099 vs. W2) was not taken into account when the job was bid.  Consequently, the additional cost of the payroll taxes for using W2 employees was not being captured in the price.

Margin and markup were used interchangeably.

The sales department had assumed a 30%-50% markup was the same as a 30%-50% margin when setting prices.  Further, they did not understand the impact this confusion had on profitability.

margin does not equal markup

(See Margin vs. Markup for further explanation of the difference).

Overhead couldn’t be covered.

The current pricing structure was not sufficient to cover the company’s overhead and still allow for a profit.

The answer seemed simple; the company had a pricing problem.

The wrinkle was that the sales force was already feeling great pressure to keep prices low in order to keep their customers, and didn’t have the confidence to approach them about a price increase.

Solution

My solution was to put together a communication tool for the sales force.  The tool was nothing more than a spreadsheet that broke out all the costs associated with delivering the service down to net income.

But its real value was in the confidence that it gave the sales people.  Not only did it allow them to understand what it would take to make a sale profitable, it gave them…

  1. A justification to go to their customers and ask for a nominal 1%-2% increase in price
  2. A working bid model for new customers

Takeaway

In a situation such as this one, it’s easy to default to the old & trusty fix: Reduce overhead. Cut costs.

But this is where the rubber meets the road in being a financial leader or CFO. The problem is so often more complex than large expense accounts on the P&L. You must interact with various departments, think critically and problem solve.

Identifying opportunities like those detailed above comes more naturally after years of experience, but these skills can also be acquired through training. Check out our Financial Leadership Workshop Series if you or someone in your company is eager to learn and develop.

Act!

Are you in the same boat as our client? Does it feel as though you should be making more money than you are? Download our Pricing for Profit Inspection Guide below.

pricing for profit, Pricing for Profit Case Study

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More Questions Your Banker Wants Answered…

monopoly bankerIn a recent post, I talked about a conversation I had with our banker and the three questions she’d most like answers to.  In case you missed it, her questions were…

  1. How are you feeling about your business and the local economy?
  2. What is the outlook for the rest of the year?
  3. What are you doing about it?

More Questions Your Banker Wants Answered…

In response to the article, several of you reached out with questions of your own to add to the list.  Not surprisingly, the questions largely focused on what is going on in the Houston economy right now as a result of the decline in oil prices. Here were your thoughts:

1.  How is the current economic situation impacting your specific industry?

If you’re doing business in Houston you’ve likely felt (or will soon feel) the effects of the drop in oil prices.  Even if you’re not in the energy sector, your banker wants to know that you’ve taken a look at how the economic situation may affect you.

2.  What are the recent trends in your industry that impact your operations?

What other trends are affecting your industry?  Government regulation, increased competition, technology, substitution, etc.?  Your banker wants to know what your plan is to deal with these trends whether it entails mitigating risks or exploiting a competitive advantage.

3.  What are your 5- and 10-year goals and what are you doing today to achieve those goals?

It’s important to your banker to know where you’re headed in the long-term.  It’s easy to get wrapped up in the day-to-day operation of a business, but your banker wants to know that everyday decisions are made with the bigger picture in mind and not just reactions to the situation on the ground.

In the original article, I talked about the 5Cs of credit and how Character was the most important “C”.  Based upon your comments, I’d have to say that Conditions may be of greater importance (or at least more immediate) to you in the current economic climate.

Thanks so much for your feedback!  I’d love to hear what other questions you have.

Questions your banker wants answered

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What is Inflation?

See Also:
Economic Indicators
Consumer Price Index
Supply and Demand Elasticity
The Feds Beige Book
Z-Score Model

What is Inflation?

What is inflation and what does it measure? Inflation measures the rate at which prices increase for consumer goods and services. Inflation also measures the rate at which a currency’s purchasing power declines. If consumer goods and services are getting more expensive, then inflation is rising. As inflation rises, the relevant currency’s purchasing power declines. As prices increase, the amount a consumer can purchase with one unit of currency decreases.

Inflation Information

Inflation is a consistent increase in the general level of prices in an economy. The inflation rate is a measure of this phenomenon.

What causes inflation? Many economists point to an increase in the rate of growth of the money supply in an economy as the primary culprit. In comparison, others point to sudden changes in aggregate demand and aggregate supply, following a Keynesian approach to macroeconomic analysis.

Inflation Rate Example

For example, let’s take the price of a can of soda. Let’s say last year a can of soda cost $1.00. And let’s say the inflation rate for the past 12 months is 5%. We could then assume the cost of a can of soda today is $1.05. The price has gone up by 5%. The dollar’s purchasing power has gone down – one dollar is no longer enough money to buy a can of soda.

Inflation Measures

There are two important inflation measures in the U.S. They are the headline inflation rate and the core inflation rate. In addition, these inflation rates are published monthly by the U.S. Bureau of Labor Statistics.

The headline inflation rate, also called the consumer price index (CPI), measures the rate at which prices are rising for a wide selection of consumer goods. Headline inflation is designed to measure the rate at which cost of living expenses increase over time.

The core inflation rate is the headline inflation rate but without food and energy prices. Food and energy prices are considered more volatile than other consumer prices. Therefore, some consider it important to view the inflation rate excluding these two components.

There are a variety of other approaches to estimating the inflation rate, such as calculations based off of the US Producer Price Index (PPI) and the US Gross Domestic Product (GDP Deflator).

Inflation and Monetary Policy

Most central bank’s have a target inflation rate. For example, the U.S. central bank, the U.K. central bank, and the European Central Bank prefer to keep inflation at around 2%. A nation’s central bank can use certain monetary policy tools to influence inflation. These includes the following:

  • Foreign exchange market intervention
  • Open-market operations
  • Adjusting the reserve requirement ratio
  • Adjusting key interest rates.

Central banks often implement monetary policy tools to influence the inflation rate towards the target inflation rate.

Market Intervention

Foreign exchange market intervention refers to a central bank buying or selling currency in the open market in order to influence the nation’s money supply. Increasing the money supply devalues the currency and increases inflation. Whereas, decreasing the money supply appreciates the currency and decreases inflation. Ergo, a nation’s central bank can purchase currency in the open market to fight inflation.

Open Market Operations Definition

Open-market operations refer to a central bank buying or selling government securities. Buying government securities increases the money supply and spurs inflation. But selling government securities decreases the money supply and curbs inflation. Therefore, a nation’s central bank can sell government securities to fight inflation.

Reserve Requirement Ratio

The reserve requirement ratio is the amount of cash a commercial bank must hold relative to the value of its customer deposits. For example, if a bank receives customer deposits totaling $100, and the reserve requirement is 10%, then that bank must always have at least $10 cash on hand. A central bank can either increase or decrease the reserve requirement ratio for the nation’s commercial banks, thereby decreasing or increasing the domestic money supply. Furthermore, increasing the reserve requirement curbs inflation, decreasing the reserve requirement spurs inflation.

Key Interest Rates

Central banks can also raise or lower key interest rates in an effort to influence inflation. In the U.S., the central bank’s key interest rate, the fed funds rate, is the rate at which banks lend to each other overnight. Raising the interest rate can reduce the money supply, damp economic activity, and curb inflation. But lowering the key interest rate can increase the money supply, stimulate the economy, and increase inflation. A central bank can raise interest rates to fight inflation.

Inflation Protection

When faced with the threat of rising inflation, which can erode the value of investment returns, investors may seek investments that are protected from inflation. One option is to invest in U.S. Treasury Inflation Protected Securities (TIPS).

TIPS are U.S. Treasury securities that are protected against inflation. The coupon payments and the principal value automatically adjust according to the headline inflation rate. This protects investors from the negative effects inflation can have on investment returns. The downside is that TIPS offer a comparatively low interest rate.

Download your free External Analysis whitepaper that guides you through overcoming obstacles and preparing how your company is going to react to external factors.

what is inflation

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Red Herring Definition

See Also:
Ten In-House Secrets for Reducing Your Company’s Legal Costs
Board of Directors
Benefits of an Advisory Board
How to Form an Advisory Board
Why is Intellectual Property Risk Everybody’s Problem

Red Herring Definition

The red herring definition, or preliminary prospectus, is a legal document that must be submitted to the SEC for approval prior to an initial public offering (IPO). It is prepared by the company that is planning to go public in conjunction with the investment bank syndicate that is underwriting the IPO.

Red Herring Document

Furthermore, the document includes details about the company. It includes an explanation of the company’s operations and competitive position as well as copies of its financial statements. The document also includes the details of the IPO, including the type of security (common stock, preferred stock, etc.) offered, the number of shares offered, and the anticipated share price.

Don’t leave any value on the table! Download the Top 10 Destroyers of Value whitepaper.

red herring definition

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LEARN THE ART OF THE CFO