Top Tips for Tidying Your Balance Sheet

Follow these steps to ensure a clean balance sheet as the New Year dawns

Last time, we talked about the importance of cleaning up your balance sheet at year’s end.  Now let’s discuss how you’ll achieve that tidy balance sheet.

While the steps needed to complete a year-end cleaning of a balance sheet aren’t terribly difficult, many company owners don’t tackle them because the owners don’t have the time.  The result?  The lack of balance sheet analysis nags at owners’ thoughts, preventing them from focusing all energies on the task of growing their businesses.

Balance Sheet Tip: Equipment

Take a tour of your facility, and identify those pieces of equipment long unused and sitting idle.  They’re just taking up space, but should be generating income.  You must find a way to convert these items into cash, by either selling them or having a service dispose of them.  Once those pieces of equipment are gone, they come off the balance sheet.  The difference between what you’re carrying on your books, and what you get back in cash for the equipment, goes into your profit and loss statement under “other expenses.”

Balance Sheet Tip: Inventory

Take another facilities tour, and this time look for inventory gathering dust.  It could be a product you once manufactured, which didn’t sell as well as expected.  Today, it’s filling valuable space and tying up your money.  Get rid of it, gaining some cash in return if possible.  The difference between its book value and the cash you garner goes into the profit and loss statement as a “other expenses.”

Balance Sheet Tip: Receivables

Many small business people believe they’re going to collect on long overdue receivables out more than 90 days.  But if it’s not collectible, let’s write it off.  It’s a bad debt, and it goes off of your balance sheet and onto the profit and loss statement as “other expenses.”  Down the road, if the entity owing the money is able to forward you the long overdue payment, it will become “other income” in the year in which it’s paid.

Taking these steps will result in you, the business owner, being fully informed about what’s on your balance sheet.  Your questions have been answered, and you have a higher degree of comfort than you otherwise would have about the veracity of that balance sheet.  If you need help undertaking the process, don’t hesitate to get in touch with me.

I offer a 100 percent guarantee on my interim CFO work.  I take on only clients I can help.   Call me and let’s talk about your business.  My phone number is 630-269-7646.

Cash Flow Management Woes Call for Expert Analysis

You can’t fix a problem you can’t see

As discussed in my previous article, cash flow mismanagement is a common problem among small and mid-sized businesses.  Many owners do not have the experience to precisely pinpoint where cash flow mismanagement has occurred, nor the background to develop plans designed to counter those cash flow issues.

Cash Flow Analysis and Financial Statements

A typical small or mid-sized business owner can spend hours examining his or her company’s financial statement, and nevertheless fail to see the underlying causes of cash flow problems, whether they be mismanagement of receivables, problems in pricing strategy, erosion of margins, escalating operational costs or other cash flow problems.

Reviewing the same financial statements, I will spot red flags in cash flow that to my eyes just about jump off the page.  The experience I’ve gained as a high-ranking officer of corporate finance departments makes the errors almost instantly recognizable.

What’s more, having witnessed similar cash flow problems countless times in my years as an Interim CFO, I can not only pinpoint the problems, but expeditiously lay out a strategy the business owner can employ to help counter the cash flow quandary.

Of course, helping business owners recognize and overcome a cash flow management problem they are currently experiencing doesn’t necessarily help them down the line, when problems with cash flow are likely to crop up again.

Learn to Read for Cash Flow Issues in Financial Statements

That’s why I take the time to teach the business owners with whom I work how to accurately “read” their financial statements for potential cash flow red flags.  I can show the owner I’m counseling what lies behind those numbers.  Those business owners who are serious about understanding their own financial statements begin to have their eyes opened to cash flow threats.  They come to more fully grasp what they should be looking for in financial statements as the enterprise evolves.

Build a Custom Financial Reporting Template

For many business owners, I also build customized templates specific to their individual businesses.  Each template provides a schematic that enables critical figures to be pulled from the company’s financial statement and more carefully tracked over time.  The template is a way of ensuring a current problem doesn’t become a recurring one.

Does your company have cash flow problems that would benefit from analysis?  Put me to work and I’ll ensure your small cash flow problem doesn’t become a fatal one.

Exit Stage Left – Making a Smooth Transition for the New Generation – Week 4

Week 4: Leaving?  Check In Later

The big day has arrived. All of your financial documents have been reviewed, your successor has been announced and you are finally able to step back from the rigors of your business. Whether you are serving as the Chairman of the Board or simply the Chairman of Your Recliner at Home, you will want to stay engaged in your company in some form or fashion.

Your executives, investors and staff share an interest in guaranteeing that leadership changes hands smoothly. And you as an outgoing executive will also have much to gain: The value of stock options and holdings in your retirement plan will depend on the company’s future performance and will directly reflect on the value of your legacy.

Leaving the CEO or President position can be difficult, but there are options for you to check in later and monitor the future progress and financial health of your business. Here are the options:

First 30 days: Stick around. Attend a few meetings with the new executive and endorse his or her knowledge, savvy and amazing ideas for the future of the company. Your in-person recommendation at client meetings may quell any fears that your existing clients have about keeping on with your company.

First 90 days: Review the company client lists. Are your 20-, 30- and 40-year relationships still being maintained since the transition? You will also want to determine how much new business has been generated since your departure.

First 180 days:  Meet with the CEO 1:1. How have they found adjusting to your role to be? Do they have any additional questions for you? Your input is invaluable and may help the new CEO make any needed corrections quickly, or inspire new creativity among leadership.

After the first year: Review the annual report. Which goals were achieved and which ones were missed? What trajectory has your company taken? Will you give this CEO or President one more year or will you join the Advisory Board in a search for a new superstar?

When was the last time you had to coach an individual or team through a new situation? Tell us your story!

Small Business Fears

business fearSmall businesses need to step through the uncertainties. Work on increasing sales. Inflation is already here. We are paying more now for our purchases. So increase prices now. Here’s how to do that, for example: If your health care costs are 5% of sales and you expect (or assume) that these costs will increase 20%, that puts health care costs at 6% of sales; the bottom line result is a 1% decrease in margin; to make that up, increase selling prices by 1% to keep pace. Continue to apply this technique to other cost items. Remember, “a penny makes a difference.” A 1% margin improvement for $10 million in sales is $100,000. That is big-time money! CFO-Pro says, “Walk right through that fear! You’ll feel a lot better. Don’t wait to figure out what the government is doing. They will never get it right! Now–what are you going to do?”

Using Z-Score Predictor

The media reports we’re experiencing the most unusual economy in 40 years. Interest rates are low, however banks are reluctant to lend; hence stalling the contribution of our nation’s small businesses. A growing percentage of home owners are upside down on their mortgages and struggling to find the motivation to pay their debt since there appears to be no benefit to them. Education costs are exorbitant and our students are saddled with school debt. Unemployment is 11%. Although these trends have been developing for years, businesses and consumers alike ignored the facts and continued to spend freely. What is there to learn from the wisdom of 40 years ago and how can we apply it to the reality of today’s situation?

What is there to learn from the wisdom of 40 years ago and how can we apply it to the reality of today’s situation?

Altman’s Z-Score Insolvency Predictor

Edward Altman (1941 – ) presently Max L. Heine Professor of Finance at the Stern School of Business, New York University created the Altman Z-Score in 1968. Professor Altman combined a set of 5 financial ratios to determine, with tremendous accuracy, which businesses would flourish and which businesses could be headed for bankruptcy.

The Z combines a set of five financial ratios. It uses statistical techniques to predict a company’s probability of failure using eight variables from a company’s financial statements.

The Z-Score formula can be applied to publicly traded competitors, acquisition candidates, suppliers, customers, and other companies of interest. The Z-Score may also be useful for establishing trends in the financial condition of your own company. Sometimes a Z-Score analysis is needed to convince management and board of directors of the seriousness of a company’s condition so that turnaround efforts can be initiated.

Here are the 5 ratios and their respective weight factors:

RatioWeight
ANet Sales/Total Assets
(simple measure of capital turnover using annual sales)
1.0
BEarnings Before Interest and Taxes (EBIT)/TotalAssets
(referred to as return on capital employed, this ratio incorporates all capital employed, both debt and equity)
3.3
CWorking Capital/Total Assets
(the difference between current assets and current liabilities divided by the total book value)
1.2
DRetained Earnings/Total Assets
(this ratio is lower for younger companies since retained earnings accrue over the lifetime of a company; this penalty for youth reflects the higher probability of failure among younger companies)
1.4
EMarket Value of Equity/Total Liabilities
(stock market capitalization for all classes of stock is used in this ratio)
.6

 

Each ratio is then multiplied by its weighting factor and summed to calculate Z:

Z = (1.0)A + (3.3)B + (1.2)C + (1.4)D + (.6)E

Scores below 1.81 indicate a high likelihood of bankruptcy. Scores above 3.00 indicate a low likelihood of failure. Scores in the middle of this range are not clear indicators, but they are less likely to be associated with failure than low scores.

Repeat the analysis periodically and plot Z scores for companies of interest on a graph with Z scores on the vertical axis and time on the horizontal. Significant downward trends in Z scores signal a potential problem, and even if the Z score does not fall below 1.81 the source of the problem should be identified and evaluated. Look at trends within the component ratios to see why the Z score is falling and decide whether it represents a serious problem.

For Privately Held Companies

If you want to analyze a company that is not publicly traded, you will not be able to compute ratio E for the Z score formula. Many companies use smaller suppliers and sell to smaller customers that are privately held. Although Altman did not extend his study to these companies, the other 4 ratios can be computed from D&B reports and a partial Z computed by dropping E. The resulting measure will tend to be lower than the standard Z score. It is best used as a long-term tracking device, with significant declines considered a flag requiring closer scrutiny.

Interested in a Z-Score analysis for your company, customer base, public or privately held competitors, or potential acquisition target? We can conduct an analysis, allowing you to make informed decisions for a reasonable flat rate. Please give me a call at 630.778.7646 or email me at jlafferty@cfo-pro.comto discuss.

The Wisdom of Henry Hazlitt (1894 – 1993)

It is exports that pay for imports, and vice versa. The greater exports we have, the greater imports we must have, if we ever expect to get paid. Without imports we can have no exports, for foreigners will have no funds with which to buy our goods.

The clearing house for these transactions is known as foreign exchange where, in America, the dollar debts of foreigners are cancelled against their dollar credits. In England, the pound sterling debts of foreigners are cancelled against their sterling credits.

This mechanism does not differ essentially from what happens in domestic trade. Each of us must also sell something, even if for most of us it is our own services rather than goods, in order to get the purchasing power to buy. Domestic trade is also conducted in the main by crossing off checks and other claims against each other through clearing houses.

Among the arguments put forward in favor of huge foreign lending one fallacy is always sure to occupy a prominent place. It runs like this. Even if half (or all) the loans we make to foreign countries turn sour and are not repaid, this nation will still be better off for having made them, because they will give an enormous impetus to our exports.

It should be immediately obvious that if the loans we make to foreign countries to enable them to buy our goods are not repaid, then we are giving the goods away. A nation cannot grow rich by giving goods away. It can only make itself poorer. No one doubts this proposition when it is applied privately.

If this proposition is so simple when applied to a private company, why do apparently intelligent people get confused about it when applied to a nation? The reason is that the transaction must then be traced mentally through a few more stages. One group may indeed make gains—while the rest of us take the losses.

The U.S. government has been engaged for years in a “foreign economic aid” program the greater part of which has consisted in outright government-to-government gifts of many billions of dollars. What conceals the truth from many supporters of the program is that what is directly given away is not the exports themselves but the money with which to buy them. It is possible, therefore, for individual exporters to profit on net balance from the national loss—if their individual profit from the exports is greater than their share of taxes to pay for the program.

The real gain of foreign trade to any country lies not in its exports but in its imports. Its consumers are either able to get from abroad commodities at a lower price than they could obtain them for at home, or commodities that they could not get from domestic producers at all. Outstanding examples in the U.S. are coffee and tea. Collectively considered, the real reason a country needs exports is to pay for its imports.

— Paraphrased From Economics in One Lesson (1946)