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Make Changes Today that Affect Profitability Tomorrow.®

According to the Wall Street Journal, 60-80% of business owners don’t know what their financial statements are telling them. I know what you’re thinking. “That’s not me.”

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Budgeting for Analysis

Nobody likes creating a budget. If it’s done correctly, it’s a lot of time consuming, hard work. But budgeting is vital because it’s the company’s plan for the coming year. No plan can be created without good, reliable data and analysis. If the proper analysis is done, then the budget becomes a tool to guide the company forward.

Bring Value through CFO Insights:

Like any forecasting tool, proper budgeting allows management to make decisions that can help the company avoid future problems. Budgeting is a process that may result in multiple iterations before the resulting numbers are acceptable. The secret to proper budgeting is twofold:

Accurate source data allows creation of a realistic budget.

A management plan based on that budget to achieve the desired result.

  • Business – CNC Machine Shop
  • Location – West suburban, Chicago, Illinois
  • Sales – $25,500,000
  • Ownership – Sole owner (with son actively involved)

Initial Contact –

The owner started the business 35 years ago. Even though the son was eager to take over, the father wasn’t ready to let go yet. The son realized that they needed to do more planning, including a much-needed budget. Their in-house CFO was too busy to take on the task.

Significant Findings and Recommendations:

Create a New Budget

A detailed set of reports, complete with sales and costs by item group created a good starting point. The company had seven different revenue streams. In addition, the owner was heavily into developing prototype parts for aerospace companies on a speculative basis. These parts were produced as a favor, in the hope of getting big contracts that had yet to materialize.

Recommendations

  • Produce a set of trend-line reports for each item group for the past three years of sales. Then extend that trend-line till it shows the estimate of next year’s sales.
  • Examine the manufacturing variances over the past year to identify any continuing variances that might require a change in process to improve performance
  • Include additional expenses related to speculative promotional programs involving samples for new programs.
  • Determine seasonality by charting monthly sales for each product group.
  • Chart payroll by department and by month. Plan for any changes in staffing for the coming year – new hires and terminations.
  • Draft a list of overhead expenses, including utilities, rent, leases, service contracts, and loans.
  • Create an initial budget for evaluation.

Evaluation

The initial draft of the budget projected a year end loss of over $3.3 million. Discussions with the owner provided an explanation. His plan projected a significant improvement in sales. Without a plan to bring those sales forecasts to fruition, the projected loss would indeed become a reality. The analytical approach to budgeting created a new opportunity to put hard thought behind business changes:

  • Sales in some product group projected an increase as the result of improved sales efforts.
  • Salary freezes, and/or temporary reductions in pay reduced payroll expense.
  • Lay-offs (i.e., reducing manufacturing staff to skeleton crews).
  • Ending development of speculative projects eliminated that ongoing expense.
  • Exploring additional sources of revenue – doing subcontracting work – (e.g., bringing in work from other companies).

Company faced a deepening cash shortage

The budgeting process laid bare the issues the company had been facing but management had been ignoring. Use of the operating line had been increasing. The owner loaned additional money to the company to shore up cash needs.

Recommendations

  • Develop a cash flow forecast. This projected an increasing shortfall over the next six months. Planning allowed the company to identify specific areas in which they could extend payments or delay purchases until the new sales activity produced results.
  • Improve cash visibility by instituting a daily cash report showing the ins and outs of company operations. Projections aren’t enough when you’re running short. It’s important to look at cash daily to assure that you don’t overextend your availability.

Financial reporting was erratic

Monthly reports showed inconsistent results, making it difficult for management to make decisions that had a positive impact on company results. Changes in standard entries and more careful posting of expenses and revenues would smooth out reporting inconsistencies.

Recommendations

  • Depreciation entries should be made monthly, rather than at year end. This spreads those adjustments throughout the year, and eliminates massive adjustments at year end, providing more accurate monthly reports.
  • Institute accrual basis accounting, which posts certain expenses monthly as they apply to the business. Payments for insurance, marketing, trade shows, and travel should be spread over 12 months to allow for more accurate presentation of monthly results.
  • Posting Expenses. Costs should be posted to inventory for the purchase of raw materials, rather than being expensed. Outside service expenses should be posted in the month in which they occur. Posting them in the same period as revenue avoids huge swings in profitability that were not easily understood, in addition to obscuring true operating results.

Although a budget won’t change the way your company runs, it may well change the way you manage it. In this case study, the owner’s sales projections for next year were significantly different from the trend-line analysis. In addition, he felt the continued efforts to deliver speculative prototypes was fully supported by the earnings of the company—and worth the risk. Unfortunately, the company’s sales had been declining in five of the company’s seven product lines over the past 4 years, and the expectation for a dramatic turnaround was unlikely. Without the detailed analysis that led to this budget, the company would have spent the next year digging an even-deeper hole in the cash available to run the business.

It is data – information – that provides the window through which a business should be viewed. Many business owners have good instincts—solid gut feelings about the decisions they make for their company. But digging into available data provides a window into the details of how the company operates. Rather than only looking at the results, examining where the data originates and how it has changed can shed new light on future planning.

A Business Growth Case Study

Nearly every business owner I talk to is interested in growing. But sometimes the plans are erratic, spur of the moment, or not fully formed. That doesn’t mean that they won’t work, it’s just more painful that way.

Bringing Value Through CFO Insights

Growth can come from a number of different approaches – new product lines, an acquisition, new channel of distribution. How do you make sure that the right plan is in place, and there’s enough money to do it?

  • Business – Sales, installation, and service of industrial compressed air systems
  • Location – Suburban Chicago
  • Sales − $11,500,000
  • Ownership – Three brothers who rotated management positions regularly in the business

Initial contact-

The company was profitable, but after some moves to expand the business, they were worried about depleting their cash reserves and using up their line of credit with the bank—which would put a halt to further expansion plans.

Significant Findings and Recommendations:

Inventory Control

A plant tour revealed a huge rack with old, rusty, trade-in equipment that they didn’t know how to value or deal with. Additionally, they started importing private label equipment to sell. This was speculative expansion that required a major cash investment. In light of their growing service business, inventory in the parts department was, unfortunately, bursting at the seams.

Recommendations

  • Refurbish the trade-ins, making use of the service techs’ spare time. With a fresh coat of paint and a refurb, they were salable. The company opened an eBay store and turned the trade-in losses into a new profit center.
  • Carefully watch inventory turns and margins of the new line of private labeled equipment to determine if the expansion was worthwhile. (Time will tell).
  • Reduce spare parts inventory to parts that are regularly used—considering that major suppliers had parts depots within a one-day delivery window. A service call today would be finished tomorrow if the parts were ordered as needed, eliminating $200K in inventory!

Business Expansion

The company had acquired a business in a neighboring state. The price was right, the acquisition well-managed, and it earned a quick payback. The decision was made to add another location.

Recommendations

  • Select another city in a neighboring state, allowing easy servicing and management.
  • Be pragmatic, and make sure that the numbers make sense. Don’t get emotionally involved in the purchase.
  • Start from scratch instead of purchasing an overpriced opportunity. Rent a building; relocate a senior manager and senior technician to select and train new hires. This resulted in out of pocket savings of $1.2 million and a break-even in six months!

Cash Flow

Considering that the company had gone through most of their credit line and prior year’s profits, there were questions about where the cash went. The recent acquisition, inventory in their new private label line, and the increase in parts inventory had cost $850,000.

Recommendations

  • Conduct a cash flow analysis to verify how much money was spent and where it went.
  • Develop a 13-week cash flow forecast to identify the needs of the company in the coming months, eliminating surprises.
  • Sweep excess cash back to the credit line daily, reducing interest and increasing availability.
  • Create a GL account on the balance sheet for Customer Deposits. Leaving those deposits in AR artificially reduced the AR balance and obscured expected cash receipts.

Financial Reporting

Since data drives decisions in any business, the accuracy and presentation of information can eliminate misunderstandings about the company’s financial position.

Recommendations

  • Review financial statements as a team, so the management team can be assured that they all understand the status of the company and where improvements are needed.
  • Establish accruals—especially for labor—so expenses and revenues are better aligned, assuring accurate profitability reporting.
  • Create inventory reserves to offset the value of slow moving or obsolete items.

Even well run, profitable companies can find ways to improve. Every company has dark corners where troubled items have been placed. Out of sight, out of mind. Accurate reporting ensures that everyone is on the same page so that agreement is more easily reached on the best next step forward.

Since everything that happens in a company flows down to the financials, an experienced CFO can provide clarity not only through financial reporting, but into operations that directly impact the bottom line.

Cash Management Saves The Day

Problem

The owner, with a fresh MBA, had recently acquired the hardware store in an industrial park using a government loan. Store performance had been declining for years. One of his well-remembered lessons was to improve cash flow. So, the new owner decided to reduce inventory as a means of increasing inventory turns and improving cash flow. But this resulted in less inventory to sell, and store traffic declined even faster than before as more hooks on the display shelves stood empty.

  • Business – Industrial Hardware Store
  • Location – Chicago, Illinois
  • Sales – $5 million
  • Ownership – Single owner

Solution

In order to track cash flow, a 13-week cash flow forecast was created. Using existing financial information and current overhead costs, a full picture was created about the company’s cash burn.

To fully understand the company’s successful sales, product sales were evaluated using historical data. Items were ranked by sales volume, gross margin percent, sales per square foot, inventory turns and adjacency sales impact. That information was used to determine which products should be kept and which should be eliminated. A physical inventory was taken of all the items in the store and warehouse. A plan was established to use clearance to quickly reduce stock of any items that were being eliminated, saving valuable floor and warehouse space for items that would sell.

A plan-o-gram was designed for the physical layout of the store, making sure that different physical areas of the store are set aside for bulk product, racked product, impulse and seasonal products, and a service area location. These changes reset the customer flow through the store to lead customers to either quick buys, or seasonal and impulse items. Inventory was purchased to return the store to proper stocking levels for existing and new products

Result

A new marketing program announced the store’s grand re-opening. The addition of the service desk provided factory repair services and boosted revenue by 12%. With stale inventory gone, and new promotions running, store retail volume immediately jumped 38%, and continued to rise through the end of the first year, reaching a 72% increase year over year. Understand your customer and revise your business practices to meet their needs. Convenience and customer service are sometimes more important than competitive pricing. But even with prices adjusted to be more competitive with on-line retailers, the immediate availability of stock kept bringing customers into the store, solving the cash flow problem and stabilizing the store’s future.

Computer Retailer – Accounting Methods

There is a lot of money to be made selling online. But understanding your company’s profitability is critical to making the right decisions. Confusion over cash-versus-accrual reporting creates continuing questions for business owners. Using the wrong approach can obscure the results with disastrous consequences.

Bringing Value through CFO Insights

  • Business – E-commerce computer retailer
  • Location – Southern Wisconsin
  • Sales – $45,000,000 annually
  • Ownership – Two partners

Initial contact –

The business’ part-time CFO was providing financials that didn’t match the reports they received from their accountant. Plus, internal statements showed wild swings in profitability, which meant that until year-end, the owners were never able to truly understand whether they were making money or not.

Significant Findings and Recommendations:

Cash Flow Shortage

The company had very limited cash, large AP balances, and was increasingly relying on their limited credit availability with vendors to purchase product. Since the owners weren’t drawing large salaries, and sales were increasing, questions arose as to the actual use of cash and the company’s profitability.

Recommendations

  • Develop a cash-flow forecast so that the company could understand cash availability and plan on payments to their vendors and primary lender.
  • Negotiate agreements with their largest vendors for a write-down of amounts due and a payment schedule—or converting their accounts payable balances into term notes with scheduled payments and a balloon payment at the end.
  • Eliminate the sales manager position. This department was managed by one of the owners, so the contribution of the sales manager was not significant.

Financial Reporting

The company’s financial results varied wildly from month to month. Some months had huge profits, which alternated with other months containing huge losses. It was only at the end of the year that they felt that they had any idea as to the actual profit results of the company.

Recommendations

  • Change to accrual basis accounting. The company was currently using cash basis as an accounting method. Since they were delaying payments to their suppliers, and sales were growing, financials showed significant profitability, instead of the mounting losses that were the actual results. Accrued basis accounting would align sales with the actual costs of each sale in the same fiscal period, providing an accurate view of profitability.
  • Identify the actual costs of the items that they were selling. A cursory evaluation showed that many items were being sold at or below cost. Pricing needed a more careful evaluation.
  • Conduct more frequent physical inventory counts. Inventory was a significant item on the balance sheet, and yet a physical inventory was only done at year-end with significant write-offs. Doing weekly cycle counts would remove the heavy staff burden at year-end, and smooth out the posting of variances, allowing for regular operational changes to improve inventory management.

Returns

As with many internet retailers, the company had its share of returns. Their channels took a credit on their payments for items that they returned to the company. But although these returns showed up on the income statement, there was only a minimum amount of returned stock in the warehouse. In addition, there was little promotion of the returned items for resale.

Recommendations

  • Gain better control over returns coming into the warehouse. Each return should be tracked and entered into the system and matched against the credits taken by their vendors.
  • Build a secondary market for the sale of returned and refurbished merchandise. This provides a basis for reselling the items, even if at cost or less than cost, to recover some of the dollars invested.

Software Evaluation

The company used home-grown software to automatically set item prices. The markets move quickly, and the software automatically changed prices online to keep the company’s sales among the low-priced leaders. Sales volume was high, so sales and cost transactions were posted in aggregate, rather than individually. Therefore, it was difficult to identify the true margin of any individual sale.

Recommendations

  • Do a detailed evaluation of the internal software to verify the accuracy of the algorithms used to price items. Assure that all elements of the cost components were included in the calculation, including all channel costs, freight, and marketing add-ons.
  • Flag any sales that fall below a certain margin level, assuring that management was notified if any pricing started to get too close to cost.
  • Modify the software so that a detailed report was available to allow analysis of all sales on an individual basis. This way, channels and products could be evaluated not just by gross sales but profitability as well.

The first red flag that gets raised when a business gets into trouble is a cash shortage. If it’s not a significant change in business that’s causing the shortage, then the ultimate culprit is profitability. Ironically, many businesses look at cash basis financial reports because their accountant has recommended that they use cash basis for tax reporting. But even though that might be a good decision for taxes, there is no reason to use cash basis to determine your company’s operating profit on a monthly basis.

Revenue and expenses for each transaction need to be aligned so that they fall into the same period—otherwise, there is no understanding of profitability. In addition, it’s not just the accounting method that is responsible, it’s the timeliness of the entry of AP and AR activity that assures the accuracy of financial reporting. Without the right information, it’s impossible for business owners to know what they should do when questions arise. It’s vital to make sure that the information is timely, accurate, and financially significant.

Customer Concentration

There’s always comfort in working with people you know. But if those people hold the key to 75% of your sales, you may be at risk of having too many of your eggs in one basket. Even though it’s easier to expand your sales with an existing client, it also may create additional risks that you might not be willing (or financially able) to take.

Bring Value through CFO Insights

Rank your customer base. How many customers account for 80% of your sales? Certainly, having more customers to manage creates more work for the sales team and administration. But it also provides additional security for the company. There are obvious inherent risks in having a large percentage of your sales with one or two customers. There is revenue risk, collection risk, negotiating risk, competitive pressure risk, and certainly borrowing risk.

  • Business – Distributor of private-labeled machine tools
  • Location – Chicago, Illinois
  • Sales – $47,000,000
  • Ownership – ESOP

Initial contact –

The president of the company reached out at the bank’s request. Customer concentration had become an ever-bigger problem as borrowing increased. Pricing pressure, inventory requirements, and product development costs had greatly affected profitability. In addition, there was pressure from the ESOP Trustees to improve share price for the employees.

Significant Findings and Recommendations:

Reduce Customer Concentration

The company started 40 years ago with a single big box customer, producing exclusive branded tools. Over the years, the big box continued providing opportunities for the company. They eventually developed a relationship with one other big box customer. True to form, the big gorilla became less of a partner and more of a task master during the coming years. With only two customers accounting for 95% of the company’s business, there was increased risk to the company’s viability with each passing year.

Recommendations

  • Identify the company’s core competencies – developing and sourcing industrial items as a high-quality, low-cost producer. Use that expertise to develop new product lines for both B2B and B2C customers.
  • Work with existing manufacturers to identify other products that are not imported to the U.S.. Select the best options as potential new products for import.
  • Use those sourcing skills to move into new areas where they could develop accessories, or competitively priced alternatives to high-cost domestic items. Market those to new clients.
  • Evaluate the product lines of other big box companies, identify product holes in their offerings, enabling an opportunity to propose new items for sale.
  • Leverage the company’s logistical skill at importing, warehousing, and large-scale distribution—canvass other big box companies to develop new opportunities to provide logistical support for their operations.

Cash Flow Shortages

The big box forced extended payment terms on the company, in addition to increased marketing support. The increased pricing pressure reduced margins, creating additional cash flow problems. With the bank getting nervous, current liberal advance rates were at risk.

Recommendations

  • Discontinue year end bonus program. The company had been paying a generous 30% annual bonus to all employees. This program should be suspended until cash flow and profitability improved.
  • Push overseas suppliers for more generous payment terms. Standard payment terms were Letters of Credit (LCs), opened at the time POs were issued. These LCs immediately drew down the available line of credit. Since these relationships were long standing, change the payment terms from LCs to wire transfers at the time of shipment. If those payments were delayed till the time of shipment, it would provide between 3 and 4 weeks of additional availability.
  • Reduce staffing. Over the years, the warehouse had become less efficient. Instead of demanding better performance from existing staff, additional staff was hired. Tightening up productivity standards would allow a reduction of staff without affecting company performance.

Chargebacks from the Big Box

One insidious draw on cash was chargebacks from the big box for shipping and paperwork errors. The quantity seemed to grow over time, as the accounting department turned a blind eye. It looked like the big box had found another revenue source, at the company’s expense.

Recommendations

  • Improve quality control review. The big box had very specific requirements for positioning of labels and placement of boxes on skids. A fine of $10 per label placement becomes a big expense when there are 48 boxes on a skid, and 5 skids in the shipment.
  • Add label placement to the QC check for incoming inventory. Put non-conforming product on hold and charge manufacturers the cost of relabeling cartons.
  • Verify accuracy of shipping paperwork placed on skids. Assure the license plate on each skid is properly placed so it can be quickly scanned by the receiving dock.
  • Fight big box chargebacks. AR chargebacks were increasing over time. Review showed that there were significant inaccuracies in the chargebacks. Push back to the big box aggressively on each of the chargebacks. In some cases, consider documenting the proper placement of labels or skid pack by using digital photos of each skid that shipped.

Finding new customers is hard. Customers that continually order larger quantities, ask for new products and pay their bills on time are highly sought after. If you find them, there is a strong desire to keep feeding them and building that relationship. But, if you don’t watch carefully, a company can find itself increasingly dependent on a single or a few major clients. That dependence carries a significant risk as you build infrastructure and staff to support that single client. What happens if things change – the purchasing agent you worked with leaves, their product focus shifts, or they find a new “favorite” supplier? Suddenly, there’s a big hole in your ongoing sales that isn’t easy to fill.

Many companies view 20% of your total sales as a limit on customer concentration. The easiest (but painful) question to ask yourself is “how badly would it hurt if Client XYZ stopped buying from us?” The loss of every customer is painful. But, what if you:

  • can’t replace that revenue stream in 6 months,
  • have to eliminate staff,
  • must change your facilities dramatically, or
  • find yourself “stuck” with significant inventory that nobody else wants?

If that is the case, then you need to seriously evaluate your current customer concentration. Maybe it’s time to reach out and find a larger customer base.

Data Drives Decision-Making

Every business owner looks for the information that they need to make the right decisions. Sometimes the information is not available, sometimes they don’t understand what data is needed to move the company forward. So often, information is just outside their reach, both practically and mentally. As a result, decisions are either not made, or made in a vacuum. In either case, the result can be expensive.

Bringing Value through CFO Insights

Computer systems and the software programs that run on them generate significant capabilities and information for businesses. Automation completes tasks in seconds that previously needed hours. The great secret to the proper use of an ERP system isn’t just the automation of mundane tasks, but the collection of data that wouldn’t normally be available or would take an inordinate amount of manpower to compile.

  • Business – Lease Abstraction and Administration
  • Location – Chicago
  • Sales – $5,000,000
  • Ownership – Single owner with a minority partner

Initial Contact –

The owner had purchased a Lease Abstraction and Management company several years earlier that was spun-off from a large real estate management firm. At that time, the company was profitable. Although sales have stayed constant over the past few years, profitability has shrunk significantly. With a change in accounting policies driving more business to his door, he needed to determine what happened to the profits they had become used to receiving.

Significant Findings and Recommendations:

Revenue Tracking and Billing

The company tracked orders in a number of spreadsheets with universal access. Proper billing was dependent on staff accurately color-coding specific cells while others identified what work was completed. By acting on the correctly colored cells, invoices could be generated. Missed invoices and double billing were not unusual in this environment. In addition, pulling together month-end data was done manually and wasted crucial staff time.

Recommendations

  • Confirm the information that the company needs for each invoice—including client detail, specific leases abstracted, employee or contractor working on the lease, expected completion date, and time spent.
  • Create a database for staff to enter each lease as it is accepted for abstracting and track the progress of the work done.
  • Establish a means for outside contractors to enter their work into the database remotely, eliminating time-consuming dual entry of data.
  • Create standard reports that would be used for billing, reporting project status to clients, open orders in house, expected revenue, etc. This eliminates the complex spreadsheets and provides data for the cash flow forecast.
  • Develop a tool to import information directly into QuickBooks, creating invoices on a timely basis. A simple report would provide a cross check of recently completed abstracts within the database to confirm the accuracy of the import.

Profitability

The company set targets for Gross Margin and Operating Margin, but the complexity of collecting detailed information (e.g., payroll, payroll taxes, PTO, medical insurance, and others) stalled the efforts to understand and rein in costs.

Recommendations

  • Create a standard cost for each labor type, rather than tracking those costs in such detail. Treat staff hours as inventory units and compare “standard” costs to actual costs monthly (eventually moving to a quarterly basis) and adjusting for variances. This would significantly simplify calculating profitability by client.
  • Use the data collected to measure direct labor hours for each abstract. This allows analysis of each abstract individually and by client as well.
  • Define what costs go into Gross Margin and Operating Margin. Determine which costs contribute to better decision-making. Gross Margin should include direct expenses relating to abstracting and labor costs. Expenses like management payroll, rent, and insurance are overhead and should be used in calculating Operating Margin, rather than being allocated to costs of abstracting.
  • Set specific targets for both Gross Margin and Operating Margin and track those monthly, using trend analysis to show improvement.

Planning

Lacking historical data on the number of abstractions, hours billed, and contractors/employees used, doing any planning was difficult. There was no budget for the current year, no cash flow forecast, and no KPIs or targets for key metrics of revenue and costs.

Recommendations

  • Determine the accuracy of financial statements for the prior year and use that until the new database provides accurate, provable data.
  • Set a target for revenue, labor costs, operating expenses, Gross Margin and Operating Margin for the next year. Include metrics that will be used when the database is completed.
  • Create a budget for the coming year. Use a modeling format, so certain key components can be modified, allowing results to ripple through the model. This will allow management to determine which factors have a greater impact on profitability, inside-versus-outside staff, small-versus-large clients, productivity increases on a per-abstract basis, etc. This knowledge will direct the efforts of management to drive profits to the bottom line.
  • Create a list of Key Performance Indicators (KPIs) that will help predict success in the coming year. Metrics such as number of abstracts, number of clients, type of leases to be abstracted, hours per abstract and average number of leases per client will help model profitability increases.
  • Develop a cash flow forecast to plan for cash needs for the next 13 weeks. Cash availability is always an important metric for any business owner.

Data should provide the basis for any decision-making in a company. An accurate set of financials provides information that allows a business owner to make important and necessary decisions. The key to true business management, though, is getting into the details. You can’t manage large numbers or combinations of activities. You need to get to the individual causation, the activities that are the heart of the transaction. To do that, you need more than just total revenue, total payroll, and/or total COGS.

At its heart, data accuracy is critical to the most basic function of any company—issuing an invoice. But data is used for far more than just invoicing. It is the root behind all decisions. If that data isn’t concise and actionable, the CEO or even the line manager is unable to make decisions that drive efficiency or effective use of material and staff—which are critical in bringing more money to the bottom line.

Dealing with Obsolete Inventory

For manufacturers, retailers, or wholesale distributors, inventory is likely the largest item on their balance sheet. A particular problem that often rears its ugly head is the issue of obsolete inventory. So, the question becomes: how do you decide when to just let it go?

Bringing Value Through CFO Insights

Companies are very careful about what they pay for their inventory—as they should be. For many companies, but especially those that have seasonal inventory, a policy should direct what to do when items become obsolete. There are two major issues here: (1) how do you decide when something becomes obsolete and (2) how do you price it for quick sale?

  • Business – Dress Manufacturer
  • Location – Chicago, Illinois
  • Sales – $10,000,000
  • Ownership – Family

Initial Contact – The business owner reached out because the company was running out of cash. Their bank didn’t have confidence in management’s ability to guide the company and was limiting their borrowing—in spite of their line having plenty of availability. Unfortunately, financial reporting had been inconsistent, so the owners wanted help putting together a set of financials that the bank would accept.

Significant Findings and Recommendations:

Obsolete Inventory

The company’s mainstay was formal, high-fashion dresses that they sold to small designer dress shops. When that market began to weaken, the inventory of unsold dresses began to grow. The company also started a sportswear line, but that didn’t sell due to a significant manufacturing error in incorrectly sizing the items. The result was that the 100,000 sq. ft. warehouse was filled with inventory that wasn’t being sold. Some of it was nearly 10 years old. Obviously, this was costing the company money.

Recommendations

  • Reduce the price of the inventory to minimal levels and promote the sale of the garments through internet channels.
  • Look for a distressed inventory company to buy the inventory in total, at any price.
  • Find charities that will take the inventory. This would at the very least provide the company with a tax deduction.

If these three efforts are unsuccessful, the last resort is to just dispose of the old inventory in order to regain usable warehouse space.

Establish a policy of what to do with product left over from a season just past, so that this inventory build-up doesn’t happen again.

For example:

  • Provide a range of increasing discounts over a period of months immediately following the season. This should reduce inventory significantly.
  • Donate any inventory left after six months to free up warehouse space.

Financial Reporting Inconsistencies

The company had lost significant money over the past few years. In addition, the projections and budgets for the last few years bore no resemblance to the actual results. The bank reported a loss of confidence in management as a result of the inconsistent financial reporting.

Recommendations

  • Change the company’s operating financial reports to accrual basis, rather than cash basis.
  • Reconcile the general ledger balances from the start of the year. This will provide an accurate starting point for all the upcoming transactions on an accrual basis.
  • Verify the accuracy of certain classes of transactions for the current year, one month at a time, to build accuracy to the current month.
  • Review the operational workflow to verify that the financial transactions were accurately mapped from the operational transactions.
  • Verify inventory receipts. This may be after the fact, but the shipping paperwork and accounts payable detail should match.
  • Ensure the sales register matches the individual invoices.
  • Match cash receipts to bank activity.
  • Match AP payments to bank activity.

Aging Computer System

The company was using an old IBM computer system that was costly to operate. Outside resources provided maintenance and programming. Their inventory records and order processing flowed through that system, and it appeared accurate. There was consistent detail and many reports available. Although they were slowly migrating to a new ERP program, they were having difficulty leaving the comfort of the old system. Since business operations were still processed in the IBM system—and there was no import tool available—weekly activity reports were printed and then manually entered into the new ERP software.

Recommendations

  • Custom program an import tool that will transfer the needed data from the IBM system so that it can be imported into the new ERP.
  • Put a strategy together to eventually migrate all of their transactions to their new ERP system, saving costs and the need to use multiple software programs.

Business owners are always concerned about company profits. Unsold inventory doesn’t show up on the income statement. Products sold at a loss push down margins and profits, so in an effort to maintain strong profits and “good looking” reports for the bank, there may be a tendency to hold on to items that don’t sell, rather than disposing of them at a loss.

But that’s the wrong approach. Inventory is a tool to achieve profitability. A company can only make money when business is transacted. So, inventory sitting on the warehouse floor is just like money under your mattress. It may have value, but you can’t use it. Obsolete inventory consumes space and ties up cash. There is no upside. For every day that passes, it loses more and more value. So, even selling inventory at 50% of cost would provide the company with cash that they can use to buy products that will generate income. Holding on to obsolete inventory just locks any remaining value in a box that you can’t touch, until there is no value left.

Every decision that you make flows down to the financials. Some, like introducing new and exciting products, will improve the bottom line. Other decisions, like disposing of obsolete inventory, can’t contribute. But you always need to look towards the future. Think about how that decision will look in two weeks or two months. Will the situation look better? In the case of hanging on to that obsolete inventory, not likely.

Every Man for Himself

Just as companies have multiple products to provide diversification to their revenue stream, some parent organizations have multiple companies that sell products that are counter cyclic to assure that if one business has a difficult year or season, others may have a better year, and be able to support the corporation overall. The decision as to whether to stay “in the family” or spread in other directions is a philosophical one.

Bringing Value Through CFO Insights

But the larger issue may come down to how those companies operate under the corporate umbrella. Do they work independently, or do they work together for the company’s greater benefit? This can provide a bigger challenge when companies become more vertically integrated. It simplifies the supply chain and provides strength and pricing security up-stream. But challenges arise when the pricing of the sister company is not as competitive as others in the marketplace.

  • Business – Temporary Staffing Company with multiple divisions
  • Location – Chicago, Illinois
  • Sales – $87 million
  • Ownership – Single owner

Initial Contact –

The business owner was a very successful serial entrepreneur. He had built his family of companies over many years and used the profits to live a rather lavish lifestyle. Every new idea generated a new company under the overall umbrella. Some of them were vertically integrated, and each was led by a strong, independent division Vice President. As a result of the amount of cash the owner had taken out of the business, the balance sheet was weak, and the bank suggested some cash flow control and profitability analysis. They brought us in to help guide the company financially.

Significant Findings and Recommendations:

Division Profitability

The company had a janitorial division that provided cleaning services for hotels and restaurants. They purchased a lot of cleaning chemicals. Another division sold cleaning supplies to janitorial companies. But they never did business with each other. The janitorial and chemical company Vice Presidents were so driven by their own profit motives that they refused to discount their prices or pay more for their supplies. The result was that cash was flowing out of the company into the pockets of their competitors.

Recommendations

Establish a separate pricing category for in-house reselling. This would provide some discounted pricing to the sister company while restricting that pricing to in-house sales only. Pricing could be set at a middle ground so that both companies share in the “cost” of doing business with each other.

Bonus structure for the two division Vice Presidents should be adjusted so that selling in-house on a cooperative basis provides a benefit, not a penalty to them. The issue is that any money spent in-house stays in-house, money spent outside sends cash, profits and volume outside the company. The president of the company needs to provide direction to the division Vice Presidents that they need to work together for the benefit of the company overall.

Cash Flow

Cash availability had become an issue over the years. Most of the company’s clients were large corporations who clearly had the money to pay their bills, but were always running late. The company was short on cash, and the AR totals were growing, as over 60-day and over 90-day balances rose. There was nobody in the accounting department looking at collections, and the owner didn’t want to pay for additional staff.

Recommendations

Hire a “collector” to call on past due invoices. One important issue was how to approach the calls. Long term customers needed to be cared for, large companies needed regular ongoing contact. Someone who had the responsibility to provide follow up would have a great impact. Result – Hired a full-time employee to make phone calls on collections. In less than 6 weeks, she collected more than $2 million of the $3 million that was over 90 days past due.

Provide a discount for prompt payment. The cost of not having cash available was restricting growth of the company, and forcing additional use of the credit line. Providing a discount could be less expensive than paying interest to the bank, and stretching the credit line to its max.

At a time when the economy is in a state of flux, it is prudent to review the payment terms and credit lines for clients. Just because a credit line is established, doesn’t mean that it’s cast in stone. Credit policy is based on risk. Adjust the available credit based not only on payment experience with your customers, but based on the general economic risk to your business overall. If the economy is shrinking, changing your credit policy to protect the company may be a prudent decision.

As management makes decisions to grow their companies, they may either stay in their area of expertise, or delve into new areas. But another approach is to go vertical. Stay in an area where you have expertise and expand within the supply chain. Controlling costs and delivery is an important part of any company’s plan for success. But it’s up to senior management to keep their eye on overall company profitability and the factors that contribute. If a company doesn’t buy internally, that cash goes out the door.

It’s a two-way street. Is the reason the products aren’t cost competitive the result of greed on the part of the supplier, or a failure of their supply chain to cost effectively source their products? Not being price competitive everywhere in their supply chain might be the cause of other issues, such as increasing competition in the marketplace, or falling sales. It’s the responsibility of the president of the company to keep an eye on inter-departmental competition. When individual division leaders hold their ground to protect their own bonuses, then profitability of the overall company might be the victim in the long run.

Family Business Case Study

A family business can be a great source of pride for everyone involved. However, working with loved ones can present its own challenges. So, whether you’re a small- or medium-sized business, maintaining a strong cash flow and ensuring the business’ profitability can go a long way when legacy and transition issues arise.

Bringing Value through CFO Insights

This case study tells the story of a family-run company and provides recommendations from the desk of a seasoned chief financial officer. A lot of family members worked here, and the owner was concerned about what would happen to his entire family if the business wasn’t successful. Having started in his garage, this retail powerhouse had grown without any significant internal structure. It was time to put the pieces of the puzzle in place.

  • Business – E-commerce retailer
  • Location – Suburban Chicago
  • Sales – $11,500,000 annually
  • Ownership – Single owner (many family members as employees)

Initial contact –

The business owner was concerned about cash flow and profitability. He was thinking about turning the business over to his two sons. His fear, however, was that if the company failed, his entire family would become unemployed.

Significant Findings and Recommendations:

Cash Flow

The company was short on cash and had used up most of its operating line of credit. The company had an inadequate cash flow forecast. It was maintained out of house, making it difficult to manage.

Recommendations

  • Bring the model in house and simplify it to make it more understandable and usable.
  • Clamp down on immediate purchases, until cash became more readily available.

Inventory

The company has many items available in low quantity. More than 29 percent of the inventory had not been sold in the last 90 days, and 16 percent hadn’t been sold in about two years. More than 1,000 items had a quantity of one, which took up space and resources, but contributed nothing to sales.

Recommendations

  • Get rid of all the items in the warehouse that have only a quantity of one. Donate or dispose of them.

Purchasing

The company had no dedicated purchasing function. His sons had no strategic purchasing plan or control of economic order quantity, safety stock, etc.

Recommendations

  • Assign one person to the purchasing of all inventory items.
  • Determine if items are restocking, or one-time specials.
  • Decide which channel is best for the sale of individual products.
  • Establish cycle counts to keep more accurate inventory.

Sales Channels

The company sells primarily on eBay, Amazon, and Overstock plus other outlets. They are held hostage by the operating requirements of each channel and have not developed a consistent strategy to support each of the channels individually.

Recommendations

  • Evaluate what their business model is and direct the resources in that area. Do they sell specialty products? Close-out sales? Outdoor products? Focus on one segment rather than being scattershot.
  • Determine which channels are more ideally suited to their product lines and specifically identify the needs and requirements so that they focus on “favored vendor status.”
  • Understand what the actual cost is of operating within each of those channels so that they understand the expected profitability and set KPIs to track their performance.

Decisions, Decisions, Decisions

All businesses face issues in operations and finance. They can be even more pronounced if it’s a family-run business. With an experienced CFO, these issues can be identified and resolved on a regular basis saving the CEO time, money, and headaches.

We hope this case study is helpful to you and your business operations and have one question to ask: Who is making these finance and operational recommendations in your organization?

Financial Reporting Drives Good Decisions

Problem

The company used Cash Basis accounting for their operating statements because taxes were calculated on a Cash Basis. When sales grew, profitability looked strong because cash came in within 48 hours, but the company’s bills weren’t due for 60 days. As a result, reporting always showed today’s sales with COGS from two months ago. When sales slowed, the company experienced a cash crunch for the first time.

  • Business – E-commerce retailer
  • Location – Central Wisconsin
  • Sales – $45,000,000 annually
  • Ownership – Two partners

Solution

Accurate financial reporting is critical for any company. Financial reporting must be on an Accrual Basis. Revenue and expenses for each transaction need to be aligned so that they fall into the same period—otherwise, true profitability is unknown. The bigger issue is that inaccurate reporting masks other financial issues.

To facilitate quick price moves on the internet, a homegrown computer program automatically set prices for their various on-line stores. Unfortunately, the program miscalculated costs, and in many instances, items were sold at a loss. To eliminate this problem, the company switched to well-known software that didn’t need continued testing and rewriting for accuracy.

A cash flow forecast was developed to manage the company’s cash shortfall. Knowing the amount of cash the company was going to have at any point in time allowed for better planning with suppliers for payments, future hiring, and buying inventory to support company growth.

The company had three major debtors, their bank, and two major suppliers for items the company sold. After a year of flat sales which resulted in shrinking cashflow, the company was near the top of their credit lines with all three. Intense negotiations with the two suppliers resulted in developing term notes with each.

Result

The new financial reports and cash flow forecasts brought a clearer picture of the business’ financial position to the owners. The company’s negotiations with the two major suppliers gave them the leeway they needed to be able to purchase more inventory to build profitable sales. Within the first year, they were able to cut their AP balance with both suppliers by 30%. The owners could finally take competitive salaries for the first time in 3 years.

Identifying the Real Cost of Production

Knowing the actual cost of production is critical to setting accurate pricing and therefore profitability for any manufacturing company. How are your costs being confirmed and posted?

Bring Value through CFO Insights

Setting the proper pricing for any product is the result of understanding the market, your competition, and your cost of goods sold (COGS). The problem arises when the actual costs are different than the ones that are being “understood” by production staff, estimating, and the sales team. Getting to the real numbers are the key to profitability.

  • Business – Printer
  • Location – North Central Illinois
  • Sales – $19,200,000
  • Ownership – Single owner – second generation

Initial Contact – The business owner had used a part-time CFO for many years, but they recently moved on to a full-time position elsewhere. Current financial staff consisted of an accounts payable clerk, an accounts receivable clerk, and an accounting manager.

Significant Findings, Recommendations and Course of Action:

Monthly Reporting Package

Their ERP system was a shop floor package designed for the printing industry. Cost segregation and production reporting were excellent, but financial reporting was weak. The dashboard created by the former CFO had items on it that the owner didn’t understand, and he focused on a few numbers on the income statement rather than truly understanding how it all fit together.

Recommendations

  • Create a monthly dashboard with numbers that were relevant to the owner, with additional dashboards for each significant department within the company, highlighting different KPIs based on the department activity and goals. On a monthly basis, review the dashboards, KPIs and analysis with each department manager.
  • Assemble a month-end financial package consisting of Balance Sheet, Statement of Cash Flows, Income Statement, Operating Expense Schedule, YTD financials, 12 month rolling financials, YTD to Budget comparison, Schedule of Prepaid and Accrued Expenses, Inventory Report, and pending production orders.
  • Include—as part of the month-end package—analyses that include a trend line analysis of sales, profitability by type of printing job, and sales by customer type.

Variance Analysis

The accounting manager cleared out the manufacturing variance account monthly by adjusting it against COGS. This created wide variations in profitability that were unexplained. The prior CFO convinced the owner that the variances were caused by a bug in their ERP package. The owner had gotten used to the variability month to month, and looked at quarterly, or 12 month rolling reports instead to determine how the company was performing.

Recommendation

  • Assemble and review a table of historical monthly variances to determine their direction and scope.

Detailed Analysis and Course of Action

  • Two different types of variances were discovered.
  • Variances that balanced themselves out exactly in two or three-month cycles.
  • Variances that were highly variable and increased over time.

Half the variances balanced out exactly in two or three months. Analysis of production showed that not all items produced were ready to ship upon completion, due to quality issues. Closing the production orders prematurely caused improper financial reporting of manufacturing. Therefore:

  • Upon completion of the printing job, good product was shipped, but unapproved items were moved to a holding area for correction. The production team closed the production order. The ERP system calculated a significant material loss when raw materials used were compared to the much smaller quantity of approved finished goods. The result was a significant financial write-off as scrap.
  • When the remainder finally cleared through QC, they went back into inventory at zero cost, having already been written off. This resulted in significantly increased profitability.
  • c) The fix was to leave production orders open till the final items had cleared QC, with a greater priority given to product correction. With all good inventory being posted prior to closing the order, the system accurately calculated the proper COGS for each item.

The remaining variances were the result of differences between the estimates and actual production costs. A variety of production problems were the cause.

  • The estimator stated that their estimates were always accurate. The IT department clarified that the estimate became the standard cost, so any variances weren’t seen in individual product COGS, they were seen in overall manufacturing variances.
  • Manufacturing variances were caused by a variety of factors, but the summary GL postings didn’t provide an answer. A weekly list of each product sold was matched to the actual manufacturing cost of each lot. This information was available from their ERP System.
  • Initial variances were calculated at between 15% and 35% per lot run, which in many cases exceeded the planned margin. Each production lot was scrutinized to determine the specific cause(s) of the variance.
  • Primary reasons for the variances included – Production on the third shift; excessive set-up time; slow press run rate; broken printing plates; slow response time from QC in verification of pre-press samples.
  • Issues were brought to the Production Manager and the Team Leads on each press. Responsibility for production was then assigned by the Production Manager to the Team Leads. A weekly production variance report was reviewed with the Production Manager and the Team Leads. Production cost variances were reduced to less than 5% in 90 days.

Financial statements tell what is happening on the production floor. If the detail isn’t sufficient to identify what needs to be fixed, a deeper analysis of the financial impact of company operations will identify where the problems lie. In some cases, the fault is in carelessness on the production floor, causing wasted raw materials, or wasted time. In other cases, the cause is procedural, where production posting doesn’t accurately reflect available product and thereby impact the company’s financial results.

The astute business owner doesn’t just look at the top line and the bottom line to determine the success of the company but reviews the accompanying analysis to see if expectations are met. The key for many companies is management by exception. Set standards and guidelines for financial and operational performance. Certainly, strive to improve. But exceptions to standard results need to be scrutinized and resolved, or the exceptions become standard practice – and quality and profitability suffer.

Ill-Defined Statement of Work

Any business doing custom work needs to carefully define the terms and expectations of the delivered product. Having open-ended, or ill-defined terms for a project can lead to many issues—none of them good. Primary among them is the challenge between cost, pricing, and customer satisfaction. In the struggle to keep the customer happy, the amount of work increases, costs rise, and frustration sets in—often on both sides.

Bringing Value Through CFO Insights

There are many ways that a customer and vendor can come to agreement on the terms of a transaction. When the inventory items are stock, the questions and solutions are easy and readily available (e.g., “… just look on page 105 in the catalog.”). But when an item is custom produced, whether it be hard goods, soft goods or an intangible, the line of accepted terms and conditions becomes blurred, and the longer the project takes, the greater the company’s costs, and the more blurred the line becomes.

  • Business – Software development company
  • Location – Suburban Chicago
  • Sales – $3,500,000
  • Ownership – Two equal partners

Initial Contact –

The company had grown steadily in its five years of operation. The two owners were initially salesman and programmer. As the company grew, staff was added, and responsibilities for project sales and completion was passed down to staff-level employees. As projects took longer and longer to complete, cash became stretched, and customer satisfaction went out the window. This was coupled with frustration among the programming staff from working on “unending programs.”

Significant Findings and Recommendations:

Project Specifications

The company’s entire “product line” was built on their ability to develop custom applications or modify standard software to meet their clients’ needs. Statements of Work (SOW) were loosely written in terms of functionality, but never signed off on by the programming staff. Since sales were at a fixed price, soft specifications resulted in missed communications and unending projects with no increase in revenue.

Recommendations

  • Involve the programming staff in the sales effort. Then, the specifications and programming time needed would be fully understood by both sides of the house, and realistic pricing could be established at the outset of the project.
  • Develop a detailed SOW that not only lays out the functionality, but the programming methodology, so that both the client and the internal staff agree and are committed to time, functionality, and price.
  • Require that changes in programming need to be fully documented by the salesperson and programmer, with a sign-off by the client, along with pricing changes.
  • Establish milestones, and a series of functionality tests—conducted by both programmers and the client—for verification of completion of the project.

Sales Efforts

The company promoted itself as industry agnostic. This allowed the sales team to approach any company as a potential client, to sell them the programming services of their staff. In spite of their success, each new industry ended up being a cold sales effort, since there were no referrals.

Recommendation

  • Identify specific industries for some of the company’s more successful projects and use those as a basis of case studies and promotional pieces for their work.
  • Use those promotional efforts to approach other businesses in the same sector, showing their skill in solving problems specific to that industry group.
  • Join trade associations and attend meetings to promote their abilities to resolve specific industry problems.
  • Get referrals from clients, especially from companies who are respected and used as examples in the case studies.

Profitability

As the company stretched to find new customers, they provided discounts to new clients to keep their staff busy. In addition, projects that were “extended” involved additional work and expense even though revenue had been fixed.

  • Be careful with discounts. Since value is often tied to expectations, discounts sometimes have unintended consequences. The client who got the work for 60% of the initial quote may consider the work only 60% as valuable. Value is in the mind of the beholder.
  • Use change orders to ensure fair compensation. As projects are developed with a tighter SOW, any changes requested by the client would require a change order which would, in turn, include additional charges for the additional work.

Cash Flow

The young owners of the company had short-term goals and wanted to live life to the fullest. The result was spending money on their personal pleasures rather than using it to develop the company more fully. The company, therefore, was often short of cash to pay bills or cover upcoming payroll.

Recommendations

  • Decide on, and stick to, long-term business goals. Is the goal to own a company that will last long into the future or work in a business that will support a certain lifestyle for the next few years (before they run out of money)?
  • Develop a policy of partial payments during the length of each project. With milestones established, they could arrange for payments at the completion of each stage, providing continuous cash flow during each project.

Project work is rewarding but needs to be properly managed. There is continued creativity required to sell and complete unique work. But when the program is ill defined, or has aspects that are open ended, it is sometimes difficult to agree when the project is complete. This creates a lack of communication between staff, company management, and the client. That difficulty affects customer satisfaction, profitability, and cash flow.

It’s important to clearly identify the terms of each project during the sale. Involving all members of the team during the planning and sales portions of the project assures that everyone is on the same page. This leads to a greater likelihood of satisfaction for both staff and client. In the end, that positive experience yields referred sales, better profitability, and more consistent cash flow.

Internal Controls

Many entrepreneurs have one person they trust implicitly with their business operations, finances, and administrative activities. But the real question is: Should they?

Bring Value through CFO Insights

Often, the first person an entrepreneur hires when starting a business is an administrative professional. This person learns all the ins and outs of the accounting system and everything else about the business. They become more than just a capable employee, the entire day-to-day operation rests with them. Unfortunately, that can mean unnecessary risks that can either be easily resolved, or ignored at great cost.

  • Business – Call center
  • Location – Suburban Chicago
  • Sales – $17,000,000
  • Ownership – Single owner LLC

Initial Contact –

The office manager was integral to the business, and the owner was interested in finding someone to backstop her. Also, although the company was profitable, it wasn’t building any cash balances.

Significant Findings and Recommendations:

Internal Controls – Cash Operations

The office manager controlled the company’s financial operations. She did payroll, accounts payable, invoicing and cash receipts. She rarely took time off, and even then, came back when they needed to run checks or payroll. The owner viewed her as key to running the business.

Recommendations

  • Segregation of duties is critical so that everything isn’t done by one person. Having one person do everything can lead to fraud and theft. Oversight can help, but segregation of duties is the best alternative.
  • Take the three primary cash responsibilities—accounts payable, accounts receivable, and payroll—and cross train others so that they can take over if needed.
  • Provide close oversight of cash operations:
  • New vendors should be approved by management.
  • Checks should only be signed by senior management.
  • Bank reconciliations should be reviewed by management. In addition, each payment that clears the bank should be verified.
  • Any direct payments (ACH or wires) should be signed off on by management. Credit card bills should also be reviewed.
  • The payroll register should be reviewed by management following every payroll.
  • The cash receipts journal should match bank deposits. Any credit memos should be approved by management.

Cash Management

Although the company was profitable, the owner wasn’t able to take as much money out of the business as he wanted. He didn’t understand where the cash was going.

Recommendation

  • Develop a cash flow forecast, identifying cash to be received and cash expenditures each week.
  • Match the forecast to actuals on a weekly basis. Any variances need to be identified and understood.
  • Pay the owner a pre-determined amount of cash as a regular draw, whenever the employees get paid.
  • Analyze last year’s cash payments to identify where the company’s money was spent.

Financial Reporting

He proudly gave me a monthly report, to show how much information he was getting. That report—the Income Statement—was over 90 pages long! It provided significant detail in every account. But the owner wasn’t able to get a handle on the overall performance of the company. He was drowning in granular data.

Recommendations

  • Create a summarized Income Statement and Balance Sheet so they each fit on one or two sheets of paper. Eliminate the extreme amount of detail so that management can see at a glance the overall operations of the company.
  • Create a list of critical KPIs with monthly tracking, so that management can review the progress of the company in reaching goals that are meaningful for everyone.
  • Develop a series of subsidiary reports that provide worthwhile detail on each critical aspect of company operations. Focusing on those important numbers will improve critical decision-making to operate the business.

It’s not unusual for a business owner to have total faith in the employees that have been with them for a long time—or handle important administrative and financial functions. But time and time again, a lack of internal controls provides an avenue for honest people to find little ways to “share” the company’s wealth. Soon the numbers become larger, and there’s no going back. Proper internal controls keep honest people honest, and make sure your business hangs on to its profits. When an employee is so devoted to the company that they won’t take a vacation, that should be a warning sign to management.

Financial reporting should be clear enough to allow understanding of trends and identification of improvements that are needed. If not, then the month-end package needs to change so that decisions are not made in a vacuum. Visibility is the key to good decision-making.

Keep Proprietary Processes Secret

Companies create products or develop services to deliver to their clients. Many find a unique approach that gives them an advantage over their competition. Some of these ideas can be patented, but many cannot because they’re either an operational approach, or a unique blending of services. In either case, your unique advantage still needs to be protected.

Bringing Value Through CFO Insights

When a company creates a value proposition that brings clients to their door, it may be the result of an operational twist, innovative thinking, or a new way of assembling components. Companies are very proud of what makes them unique and shout it from the rooftops. But that pride can disappear in a hurry when others take that idea and incorporate it into their own business model. When the unique becomes commonplace, the advantage is lost, along with profitability.

  • Business – Manufacturer of industrial models
  • Location – Northern Illinois
  • Sales – $11,750,000
  • Ownership – family owned

Initial Contact –

The father served primarily as a guiding light to the business, while the son led daily operations as the president. The son had reached out to help identify issues that were affecting their ongoing profitability. The family had two companies operating within their facility. One made stock models that were sold from a catalog, and the other produced structural prototypes of critical manufacturing components for major corporations.

Significant Findings and Recommendations:

Business Operations

The company producing stock models had been profitable, while the prototype company lost money consistently. More recently, the stock model company had experienced a drop in sales, and some customers of the prototyping business were not returning, leaving the company with idle manufacturing capacity.

The prototype company had made a major investment in metal 3D printing. When Fortune 50 companies approached them for prototypes, the company proudly showed off their manufacturing floor, with six machines costing over $500,000 each. For the company, this was a huge investment but their clients saw it as an instruction manual on how to produce the prototypes themselves. Soon, some customers set up their own prototype production.

Recommendations

  • Close the door on plant tours. Even though the machines are readily available, this is still bleeding edge technology for most companies. By leaving the actual production methodology a mystery, customers will appreciate the quality of the prototypes produced, unaware of how they were made.
  • Shift focus of company expertise from prototype production to design with rapid delivery of the prototypes. The machines are becoming more readily available with each passing year. By using their extensive expertise in the design of prototypes for metal 3D printing, they can become a specialty engineering design company rather than just a manufacturer. This will allow them to create a new market niche with their core competency.
  • The stock industrial models were being sold through distributors. The distributors were availing themselves of internet-based sales opportunities, eliminating the need for a direct sales force. To maintain margins and profitability, the company needed to consider changing their sales approach, eliminating the middlemen, and going direct to consumers through the internet marketplace.

Financial Reporting and Accounting

The general ledger layout is generic in nature. The chart of accounts doesn’t reflect the unique nature of the products that the company sells, nor the specific cost elements of manufacturing. Some account allocations are miscoded, leaving zero balance accounts negative. The non-standard reporting creates minor issues with annual bank audits. The company has never created a budget for planning purposes.

Recommendation

  • Redesign the chart of accounts so that balance sheet and income statement accounts are properly classified and present a more standard financial report for both management and the lender.
  • Prepare a budget for the coming year for each company. Consider refinancing current company debt providing more cash and longer payment terms, relieving monthly cash flow pressure.
  • Develop a set of Key Performance Indicators with dashboards for manufacturing and monthly company performance.
  • Make use of fraud protection services offered by the bank, including Positive Pay and Fraud Protection on ACH transactions.

The business climate is always changing, and companies are continually struggling to find unique ways of delivering quality products or services to their customers at a lower cost. In the process, they may make use of new technology, or find unique ways of creating products, or reducing costs through operational efficiencies. It is often that creative approach to business that is indeed their core competency.

But whatever the company is doing, there is a fine line between promoting your capabilities, and giving away the store. Ever expanding technology will make things more available to the greater business market. However, providing a window into the way you became successful may not only bring you new customers, but increased competition as well. Carefully identify your unique offering to the marketplace. If it can be easily replicated, then be cautious about publicizing the details. By keeping the details close, you may protect your position in the marketplace.

Logistics Can Beat Product (Even Santa Needs Help Sometimes)

There are many elements involved in developing and manufacturing products for a customer. In fact, most of a company’s concentrated efforts go to the creation of what they’re going to sell, and with good reason. Because that IS the only purpose of any company – product development, so they have something to sell. But creating a great product is only half of the story. Companies need to be able to deliver it to the consumer, or all of your efforts are wasted.

Bringing Value Through CFO Insights

The issue of delivery can be extremely complex. Some limit their marketing geographically because they can’t deliver everywhere. Some change their source of supply because deliveries of raw materials can’t get to the manufacturing plant. Plus, delivering on time can sometimes become a critical aspect of the sale. Assuring that product arrives JIT (Just In Time) has become a focus of many manufacturing partnerships, smoothing out manufacturing, and reducing inventory expense.

  • Business – Seasonal gift manufacturing
  • Location – North Pole
  • Sales – Charitable institution
  • Ownership – Husband and wife

Initial Contact –

The timely delivery of seasonal gifts has been a problem for generations. Every year, the CEO has been challenged by the same issues: Massive manufacturing of a nearly unlimited variety of items; Deliveries which needed completion within a very specific timeframe at night. We were approached as a result of the continued outcry by the CEO’s wife, who felt that the age-old methods used to amass inventory, control order processing, and deliver to untold destinations in the twinkle of an eye, needed a fresh approach.

Significant Findings and Recommendations:

Order Processing

In the past, product requests sent from individual consumers were delivered in huge bags to the order processing center. Not only was a massive number of staff needed to open and categorize each request, but tracking the delivery addresses was a continuing nightmare. Picking orders so they could be placed in the right delivery vehicle created bottlenecks in every part of the warehouse and dock. In addition, misdirected gifts would result in a huge public relations nightmare for the company the following morning. A loss of faith as the result of incomplete deliveries would never be forgotten by customers.

Recommendations

  • Rather than depending on letters, create an online store accessible through the internet. The shopping cart would be limited to only one item selected by each customer to avoid consumers “gaming” the system.
  • Addresses would be stored along with the item selection, in a cloud-based database. New entries will be continually sorted by zip code so that shipments are consolidated at the time items are picked.
  • Pick tickets should be eliminated in favor of scanners. Warehouse workers would first select country of delivery, and eventually zoom in to individual delivery addresses, so that orders could be grouped during picking.
  • Large red bags, able to hold product being delivered to individual neighborhoods, should be used so that they can be easily fit into the vehicles used for delivery.

Logistics

There are two major issues facing the company. First, all deliveries need to be completed within a very specific time window during the night. Since deliveries must be unseen, the unique nature of the delivery vehicles, and deliveryman’s uniform make nighttime deliveries mandatory. Secondly, deliveries are made throughout the world, requiring an understanding of navigation that has surpassed the capabilities of most manual mapping systems.

Recommendation

  • Historically, deliveries have been made by antiquated open carriers pulled by animals. Although the advent of delivery drones is something that could be adopted in the future, an enclosed vehicle with nearly unlimited storage can be used in conjunction with RF tagged, pre-programmed homing devices on each delivery.
  • Rather than focusing on proximity to home base, beginning deliveries at the international date line, and moving west from there will provide the greatest time window for delivery. In effect, the deliveries would be chasing the sun.
  • With the advent of world-wide cloud-based accessibility, tracking can be supported no matter where the delivery vehicles are located. Use of traffic routing software like Waze, expanded for an extended number of locations would be automatically updated upon each delivery, guiding the deliveryman to the next several locations in turn, while avoiding unnecessary traffic delays.
  • The requirement for the deliveries to be undetected necessitates an early warning system for the driver to avoid areas where he might be seen. An advanced network, with sensors connected to the network of Fitbits, would identify locations where the residents are fast asleep, facilitating unnoticed drop-offs throughout the route.

The logistical issues surrounding successful delivery of any product are key to customer satisfaction. Most often, the expectations and even requirements of delivery are part of the purchase agreement. But customer satisfaction is always the key to any product delivery. Conventional wisdom often takes the place of legal text in guiding the operations of any business, and the issues faced by this once-a-year delivery system are no different than other companies. It just needs to be done in a shorter time window.

It is the coordination of manufacturing, organization of outbound processing, and the use of modern technology that assures that products get to customers when they are needed. On-time deliveries are expected by the customer and must be guaranteed by the manufacturer for the delivery cycle to be successful. The expectations for this annual flurry of deliveries are no different than for any other supplier. Strategically, plans need to be made to keep current with technology and the often-unrealistic expectations of the consumer. Unlike this case study, your customers have other alternatives. Don’t make their shifting to someone else an option. You may end up losing.

Marketing Services Company

Successful Schaumburg Marketing Services Company needed us to perform due diligence and assist with an acquisition. This is a family business owned by two brothers in their mid-60’s, each having children working in the business with no succession plan in place. We helped them devise a successful succession plan to allow the two brothers to retire, comfortable that the business they built was in good hands.

Succession Planning Services Provided:

  • With current trust and will documents being more than 8 years old, we assembled a team of advisors to help in the planning process. The team included a financial advisor, tax attorney, social worker and business valuation specialist.
  • A series of meetings were held with the Social Worker and the family members in the business to bring into the open any interpersonal issues that had been suppressed, but were affecting their business relationships.
  • Our Certified Financial Planner met with the family units to develop individualized retirement plans for each group, based on lifestyle expectations and earnings forecasts.
  • The Tax and Estate Planning Attorney taught the family members about the specifics of the current tax and inheritance law.
  • Based on the specific needs of the business owners and their families, as well and current laws, regulations, etc., we supervised the drafting of new trusts, wills, and Powers of Attorney for Healthcare and Property issues as needed to adequately protect the business, the owners and their families.
  • After the business valuation was completed, a buy/sell agreement was negotiated between the two brothers to provide a tax beneficial method of transferring the ownership of the company in the event of one of the brothers’ untimely death.
  • Conversations concerning the planned retirement of the owners and their successors are now part of an ongoing process, as circumstances may change from time to time.

M&A Advisory Services Provided:

  • Met with owners to discuss proposed acquisitions, which included two other marketing services companies whose owners were retiring.
  • We developed a due diligence plan to provide a full understanding of the risks and rewards of each contemplated acquisition.
    • A valuation was performed to assess the value of each proposed business, in addition to the synergy (integration) of staff and the product lines.
    • The importance of various elements of the acquisitions were evaluated and discussed with the proposed buyers (our client).

Results:

Succession Planning Results:  According to surveys (PWC), as many as 8 out of every 10 boomer business owners are facing retirement without a succession plan, as most of their time is spent working in the business instead of on the business.  Without a succession plan, 70% of family businesses won’t make it to the second generation.  And, in the case of family businesses, the people and their issues are a majority of the bigger picture.  CFO Simplified put together a qualified team to evaluate the bigger picture of this family business.  As a result the new succession plan we drafted eliminates any uncertainty and discord that may occur later, and increases the likelihood of continued success of this family business into future generations.

M&A Advisory Results:  To mitigate risk, an acquisition requires than an enormous amount of data (financials, taxes, accounting, labor, etc) about the target be evaluated.  Our expert and unbiased evaluation determined that one of the companies was a good fit, both business-wise and culturally. It was also determined that the other company fell short of being the desirable target they had anticipated, and any plans regarding its acquisition were discarded.

Overall, our expertise helped these buyers avoid a large risk in one instance, while also successfully negotiating mutually satisfactory contracts with the suitable target.  In this transaction, it was important for the seller to know that their employees would be taken care of, they were being paid a reasonable price for their business, and that they would be working for the next few years, assuring a successful and profitable transition, and acquisition result.  As for the buyers, they were delighted to have acquired a new business segment that enhanced, complemented and augmented their existing clientele and bottom line.

Mending Vendor Relationships

Managing cash is always a prime concern for business owners. Between balancing the demands of their lender, payroll for their employees, collecting receivables from their customers and paying vendor invoices, this is a point of continued pain for many companies. Often the greater pressure is on the collection of accounts receivable. This always seems to be the most available source for improving cash flow, but when vendor relationships become fragile, it’s not just because money is tight.

It’s not unusual for a company to start to push out their payments when cash becomes scarce. Some payments cannot be delayed, like payroll. Some can be pushed out a month or two, like utilities. Even though they can be delayed, payments for rent or insurance can’t be pushed out too far, because of the compounding risk to the company’s operations. Just as these payments can create risk to the company’s operations, pushing out vendor payments can be just as critical to keeping the doors open.

  • Business – Residential window manufacturer
  • Location – Chicago, Illinois
  • Sales – $65 million
  • Ownership – Single owner

Initial Contact –

The company was dramatically impacted by the change in the economy, and a significant reduction in residential construction. This was complicated by the fact that several large customers had gotten into severe financial trouble and weren’t paying their bills. Management had worked hard to keep its union employees on hand and working, but the increased financial pressure had to go somewhere. The company controller wasn’t just stretching out their payments, he had pretty much stopped paying bills. Then shipments of critical components ceased. This created even more problems, because without components for manufacturing, production was halted and employees sent home, even though they were still being paid according to union contract. Vendors were so tired of empty promises they demanded that funds be wired before they would even load up a truck for shipment. Then, the controller quit.

Significant Findings and Recommendations:

Re-establishing Vendor Relationships

When the controller quit, it was discovered that not only were many invoices unpaid, but there were over 100 voicemails on his phone. He had obviously stopped working long before he left the company. The company had used up all of its component inventory and was dependent on daily shipments of parts from critical local suppliers. The relationship with these critical vendors had totally collapsed and funds were being wired in conjunction with the issuance of each purchase order.

Recommendations

  • Go through all of the voicemails and spend time returning each call, introducing the new controller to the vendors. Discussion then moved to the delay in payments and suggesting that a new plan would be put together to reestablish trust with them.
  • Talk to each of the three critical vendors and assure them that a new process and policy had been established, and the company was very interested in rebuilding a trusted relationship with them.
  • Trust had to be rebuilt. Establish a gradual easing of payment terms with the company as a means of getting reliable delivery. This will also loosen the cash stranglehold created by the wired payments before shipment.
  • The first step was to convince the suppliers to accept another form of payment instead of wiring funds prior to loading the truck for shipment. Once they accepted a check handed to the driver prior to unloading the truck, we were on our way. After a month of handing checks to the driver, and the checks didn’t bounce, we were ready for the next step.
  • The next step was mailing a check at the time the truck made the delivery. This demanded a leap of faith from the suppliers. But it gave us an additional 3 days of cash availability and continued to help build trust.
  • After a month of regular shipments and payments being made by mailing checks upon delivery, we asked for and received terms of Net 7 days. Once those terms were accepted, trust had been reestablished. Within another two months, we had grown our available terms to Net 30.

RESULT –

Although cash flow was still a struggle, delivery of crucial components was no longer a critical problem. The company no longer faced manufacturing shut-downs due to lack of material, and shipments from the three critical vendors were always received on time. With payment terms extended to Net 30 days, a significant amount of company purchases and cash expenditures were now on regular payment terms. This provided the company with an additional 35 days of cash availability, freeing up over $750,000.

As business owners work through the problems of the day, the balancing act that’s played sometimes misses a key component. Just as the manufacturing process couldn’t proceed without the parts that were needed for production, the failing business relationships had a dramatic effect on the entire company. This cost the company significant money in plant shutdowns and the loss of more than $750,000 in immediate cash flow. It’s important not to forget that businesses don’t work with businesses, people work with people. A sense of trust and dependability is all important in making sure that cash, purchase orders and parts flow back and forth.

Answering a phone call and being true to your word is more important than having buckets of cash in your office. Certainly, don’t downplay the importance of available money, but make sure that your word can be trusted. Know what you’re able to deliver, and don’t miss your deadline, whether it’s shipping a product, making a payment or calling to provide an update. Everyone around you is depending on information. If they can’t trust you at your word, then everything that you say or do is suspect. So, if this case study sounds familiar, maybe it’s time to make a change. If you are a victim of your own wishful thinking, it’s time to become more realistic. If your interactions suffer because you’re too busy with other things, it’s time to consider the importance of the people you work with. Let that guide your business decisions and your interaction with everyone – from your employees to your customers to your suppliers.

More Capacity Won’t Increase Revenue

Company owners are always looking for ways of increasing revenue. Adding customers, bringing on new products, spending more on marketing and buying new equipment are some of the many ways that businesses look at to grow their top line. But there is no magic bullet. The obvious solution isn’t always the best one. Certainly, throwing money at the problem isn’t the safest or most predictable way of achieving success.

Bringing Value Through CFO Insights

When a business owner is looking at growing the company, the focus rarely points at bottlenecks within operations. A search to provide new products that will bring in new customers may lead to a single train of thought that avoids considering all other options. Sometimes it is the simple solution that provides the end result – greater revenue – with little expense. Certainly, the drive to purchase new machinery as the only solution can lead you down the rabbit hole.

  • Business – Metal Finishing Services
  • Location – Washington State
  • Sales – $3,875,000
  • Ownership – single owner close to retirement

Initial Contact –

The owner was looking to retire in just 3 years. In a good planning move, he hired a consulting firm to help him increase the sale price of his business. They determined that if he could double company sales, the sale price would increase dramatically. Believing that the company’s production was limited by the size of their powder coating ovens, he insisted on buying new ovens to fill the gap. The consultants reached out to us for the analysis.

Significant Findings and Recommendations:

Business Operations

The company’s primary business was powder coating metal parts. The owner felt they were missing a significant piece of business – painting highway lighting poles – because their ovens were too small to fit the 18-foot-long poles. This single customer could propel them closer to their sales goal by bringing in $500,000 – $1,000,000 in business. The investment was $300,000 for the larger ovens and prep room.

Investigation showed that raw steel was moved into the prep room and ovens through the same narrow building that brought the painted steel to the dock. This combination building and prep room created a production bottleneck which limited the speed with which the ovens could be loaded and unloaded. And, since each piece needed to be coated twice during processing, the ovens stayed idle while the parts were prepped for the second firing cycle. As a result, the ovens sat idle 50% of the time, and production backlog extended to more than 10 days.

Recommendations

  • Construct a second building, costing $50,000, next to the existing combination building. Each building will then allow for traffic in one direction. Product went to the ovens through the first building, and product came from the ovens through the second.
  • Between the combination building and the ovens was a large space used for product preparation. A second prep room would allow the crew to prep steel in one building while the ovens were being used for a firing. Then, they could prep steel in the second building while the first building was being reloaded and the oven fired another batch. This brought utilization of the ovens up to nearly 100%.
  • Order analysis showed that the company was losing business because of their production backlog. Orders were going to their competition, who weren’t as busy. Adding the new prep building eliminated the bottleneck, so they could bring back the excess production they were losing to competition by nearly doubling their production capacity – without buying new ovens.

Accounting and Finance Department

The company has a small accounting department where multiple responsibilities were handled by each individual. Because of the small staff, there was little segregation of responsibilities. The month-end financial package contained standard reports which provided little insight into changes in the background data. As a result, excess costs in various areas of the company were hard to pinpoint. Most production involved customer inventory, but who was responsible for product loss or insurance coverage was unclear. Cash flow was not an issue, and the company self-financed most capital expenditures.

Recommendations

  • Since the company was profitable, there was a bit of laxness surrounding accounting controls and approvals. Invoices for services should be signed off by a manager before coding for payment. Invoices for product purchases needed to be triple matched to the PO, Packing Slip and physical count at the time of receipt.
  • The small staff made segregation of responsibilities difficult. So, to safeguard the company’s money, the owner should review every payroll, all check disbursements, and month end bank and credit card reconciliations.
  • Month-end reporting package should include profitability analysis for each production job, matched to the quote provided. This assures profitability and provided a check on the accuracy of work by the estimator.
  • Sales orders should clearly state who carries responsibility for loss of customer inventory or items that don’t meet QC standards. Value of customer inventory on hand should be maintained and reported to the insurance company to assure that coverage is available in the event of the catastrophic total loss.

In small companies, the owner often thinks that he has his arms around the operation of the business, and therefore decisions are made more by gut than by pragmatic analysis. Even though rules for accounting and finance are pretty standard across businesses, the ability to identify issues relating to operations is not easy. The coordination of space, manpower and product is not a simple matter to handle. Sometimes using a spaghetti diagram, where you trace the movement of each item with a pen on a map of the shop floor can help identify where product is really moving, and where the bottlenecks are.

Even though not every company has money to spare, it is not unusual for a business owner to just arbitrarily decide that new equipment, more employees, or more space will resolve a problem. A discussion with line employees, not just their supervisors, and a hands-on view of the way the production floor works may easily identify where the problem really lies. Buying an expensive piece of equipment may seem like the right answer, but if equipment and staff are standing idle, then the solution isn’t something that is newer, larger, faster or shinier. The answer might be standing right there, staring you in the face.

Not Making Decisions IS a Decision

Every entrepreneur makes decisions. Some are significant, and some are inconsequential. The more difficult ones require more information, and shared input from other team members. All decisions come with some risk, and major decisions might involve risk that is unacceptable. But delaying the decision doesn’t necessarily make the final answer a better one.

Bringing Value Through CFO Insights

One of the most difficult lessons an entrepreneur – or any manager – learns is delegating responsibility. A recent blog on delegation brings up the issue of passing responsibility for decision making to other members of the team. “Leaders earn their keep by making smart decisions. But sometimes the smartest decision is to delegate that decision to someone else.”[1] If all decisions rest in the hands of the leader, then every activity must wait for their decision, delaying action throughout the company.

  • Business – Outpatient surgical center
  • Location – Suburban Chicago
  • Sales – $17,000,000
  • Ownership – One doctor

Initial Contact –

The business coach for the CEO reported that analysis paralysis delayed decisions in every area. This forced last minute judgements instead of a more deliberative, time sensitive process. Putting together a fact-based process, based on hard information, would bring decision-making to a timely conclusion. This would likely resolve a lot of issues that the company was facing, from personnel to operations.

Significant Findings and Recommendations:

Project Management

The project list was the subject of weekly management meetings. New projects were regularly added to the list. The doctor continually raised new questions, delaying decisions week after week. Staff delayed project completion, knowing that each project was continually being changed, and might be shelved. Weekly management meetings took more than 5 hours as the doctor regularly raised new issues on existing activities, sending managers back again for more evaluation.

Recommendations

  • Assign decision making on projects to individual managers, giving them responsibility for completion, and taking them off the doctor’s desk.
  • Develop an agenda for management meetings to address only those projects that are nearing deadline. Discuss only progress towards the goal, rather than reviewing each item from the beginning every week.
  • Restrict fact finding inquiries to those that impacted everyone in the room. Perfect information is impossible. Minimizing risk is the goal.
  • Plan resolution for the week before the deadline. End new information inquiries so everyone can provide input before critical decisions need to be made.

Personnel Management

The doctor, in private, complained about many long-term employees, while praising them as star performers when introducing them to outsiders. In addition, he insisted on performing all performance reviews himself. This led to unrealistic expectations and higher than planned payroll raises.

Recommendations

  • Delegate performance reviews to the line managers. They have direct interaction with their employees and can relate more directly to their work quality.
  • Begin quarterly performance reviews, providing more regular feedback for the staff. This will prompt performance improvement throughout the year, rather than a rush to improve performance right before raises were due.
  • Set direct objectives for each employee, so that their job performance isn’t just based on “feelings” about their work, but on actual accomplishments throughout the year.

Financial Analysis

The controller provided not only monthly financial reporting but produced the company’s and the doctor’s personal tax returns as well. Separate departments managed invoicing, collections and insurance and Medicare payments. The company took an immediate write-down of all insurance and Medicare billings upon invoicing to eliminate large adjustments later.

Recommendations

  • Provide segregation of responsibilities by having an outside accountant produce the tax returns. With the controller being responsible for all internal financial reporting and external filings as well, there was no cross check on her work.
  • Develop a dashboard of Key Performance Indicators to provide standards whereby the doctor could judge the performance of the company and individual departments.
  • Prepare individual monthly financial reports for each of the company’s surgery centers. Grouping all facilities together obscured individual results, not allowing the doctor to evaluate the performance of each center.

Cash Flow

Growing to multiple locations within 5 years strained the cash available to the company. Capital investment had grown, but not every center contributed its share to company profitability. A new bank loan provided additional credit that was quickly eaten up by the operating shortfall.

Recommendations

  • A cash flow forecast for each facility would identify which were burning cash monthly, negatively impacting overall company performance.
  • Reduce expenditures overall to achieve a positive cash flow for each location. Adding staff to resolve operating issues is never a solution.
  • Develop a plan to pay down the operating line over time. Credit lines should be used to fill in the variances in working capital, not make up for operating losses.

Leaving things the way they are provides comfort to ownership. But changes can bring efficiency and additional profitability to the bottom line. Delaying those decisions because of the risk of choosing the wrong direction doesn’t solve the problem. Not acting to resolve an issue is still making a decision. But delay doesn’t move the business forward. There is never enough information to eliminate every risk your company faces. Delaying can affect employee morale, push customers to your competition, put your business at a competitive disadvantage, or ultimately increase your costs.

Carefully evaluate the decisions you make. Gather available information within a specific timeframe. Determine if you have enough information to minimize the risk involved. Realize that every business decision has risk. Make the decisions that you need to make to grow your business, and don’t let the remaining risk stand in the way of your progress.

Oh Brother – Hiring Relatives

Probably one of the greatest challenges facing any business is that of staffing and growth. Are you strategic and hire people in advance of the absolute need, or do you wait till the company is struggling to achieve its goals before you add to your pool? And even more so, do you hire people who are experts in their area (and therefore pay significantly more) or do you hire someone who will grow into their position? It becomes even more complex when there are family members who want a piece of the pie.

Many mid-market companies are family oriented. Some companies become a family affair, and as the business passes from one generation to the next, more and more of the family get involved in its operation. The decision of whether to hire relatives is complex and fraught with conflict. Will they solidly contribute to the betterment of the company, or did they climb aboard the gravy train just to have a comfortable ride? Sometimes the answer is obvious, sometimes it only becomes apparent on the heels of major company change.

  • Business – Cosmetics company specializing in hair care products
  • Location – Little Rock, AK
  • Sales – $72 million
  • Ownership – Husband and wife

Initial Contact –

The business had grown significantly since its inception. From a local brand, they had expanded not only across the country, but into Europe, Africa and South America. The owner, who was very family oriented, had hired many relatives to lead the various departments and divisions of the company. Each was independently run by the various family members, with overall direction and financial control by the company CEO. When the founder suddenly passed away, leadership was given to the number 2 son, who had previously been involved in the marketing of the company’s products. With the father’s financial controls no longer in place, the company had gotten into financial trouble.

Significant Findings and Recommendations:

Staffing and Payroll

When the patriarch passed away, there was a lot of scrambling for position. His wife named her most accomplished son as President. He had never previously had a role with that much responsibility, and the many family members took advantage of his inexperience by telling him that his father had promised significant raises for all of them prior to his passing. As a result of the other operational pressures he was facing, the new president agreed to the raises, putting a large additional financial burden on the company.

Recommendations

  • Evaluate current staff. It was important that every employee be evaluated to assure that they were effective in their jobs. First, job descriptions needed to be confirmed for all management and supervisory positions. Then a review needed to be completed on how each employee – especially family members – were contributing to the company’s needs and goals.
  • Establish regular performance reviews. As a pioneering company in their market segment, the company gained success easily in its early years. With increased competition, profitability had suffered, and now each family member had to show the contributions they were making to the bottom line.
  • Determine proper salary for each position. Since salaries had largely been set for family members based on their relationship with the founder, an industry correlated compensation plan needed to be created, and each employee’s wages reset so that they fell within the accepted industry standard. Bonuses should be tied to individual performance; not overall company gains.

Succession Planning

Before the loss of the founder, there were no plans made for who would direct the company when he was gone. Now the gap was painfully obvious. He hadn’t taken the time to train his son to take over in the event of his untimely death. The company needed to make some decisions about who was going to run the company not just for the short term, but in coming years, and future generations. The issue became whether the family was going to become a passive investor or remain active, managing the family’s primary asset.

Recommendations

  • Since the new president was inexperienced at running the company, the family should hire an outside executive to run the company for at least a year or two, putting the company back on track, and training the new President along the way. This would quickly put the company on a path to recovery and provide the family’s company with solid, experienced direction.
  • A family council should be established so that the major decisions on the company’s future would be made by an internal board of directors and not just a single individual. This would broaden the company leadership, and not confine the future of the company to a single individual.
  • The family should develop future generations well before they are needed. Summer internships for high school and college age family members would pique their interest in the company. Entry level positions for those with management ambitions should give them experience in each aspect of running the company, from sales to manufacturing and from finance to HR.

Running a company that you’ve built from the ground up is difficult, and it doesn’t necessarily become easier over time. But making plans to exit can be even more difficult. These plans should be made over a period of years, not overnight. Usually though, it is some event that forces a change in management. Whether the CEO suddenly dies, or there is some other event that causes an abrupt change of direction, the result is still the same. The company hierarchy and operations are thrown into unfamiliar territory.

With a family-owned business, these changes impact not only the company, but the family dynamic as well. A relative that is well liked isn’t necessarily the one that should be making the decisions about how to operate the family’s livelihood. These are pragmatic decisions that need to be thoughtfully made. And the best plan is likely one that is laid out by the hierarchy of the family, many of whom depend on the company not just for their weekly salary, but for their long-term financial future as well.

Profitability – Identifying Real Costs

Problem

Product pricing is often based on understanding cost of goods sold (COGS). The problem arises when the actual costs are different from the estimates used. This CFO Simplified customer watched profitability slowly disappear — till they incurred a $250,000 loss. Understanding the cause was the first step to returning to profitability.

  • Business – Printer
  • Location – North Central Illinois
  • Sales – $19,200,000
  • Ownership – Single owner – second generation

Solution

To identify where the losses were occurring, job estimates were first compared to the final production cost. Manufacturing variances were caused by a variety of factors, but the summary GL postings didn’t provide an answer. Pulling raw data from the company’s production system allowed a comparison between the estimate and the actual cost of production of each item shipped in the prior week. This information was available from their ERP System.

Initial variances were calculated at between 15% and 35% for each production run, which in most cases exceeded the planned margin. Each production run was scrutinized to determine the specific cause(s) of the variance.

Digging into each of these production orders showed a variety of issues, including – Third shift production; excessive set-up time; slow press run rate; broken printing plates; slow response time from QC to verify pre-press samples. Each one was discussed individually with the Operations VP and Production Manager.

Responsibility for production improvement was then assigned to the Production Manager. The weekly production variance report was reviewed by the Production Manager with the Team Leads.

Result

The reports identified that production problems weren’t unique. They were nearly epidemic. Greater scrutiny of the causes, with variances being reported daily, brought the issues of cost over-runs to prominence. With everyone keeping their eye on the ball, the number of production problems dropped. This resulted in cost variances being reduced to less than 5% in 90 days. That reduction drove a dramatic change in profitability, since removing wasted materials and wasted time turned each printing press into a profit generator. Monthly results showed an immediate turnaround, with Net Income moving from a loss of $250,000 to a profit of $490,000 in the first year, an increase of $740,000.

Quality Control Can Impact Cash Flow

It’s critical that manufacturers deliver what their customers need and want. But sometimes manufacturers are so concerned about sales, that they overlook the specifications on the POs that they receive, acting like they know the client’s needs better than the client does. This is not a place for ego to get involved. When there is a dispute between the customer and the custom manufacturer of a product, it is the customer who wins—and it can be costly.

Bringing Value through CFO Insights

Quality control should set standards for both sides of the manufacturing plant, inbound and outbound. If the raw materials that are received don’t meet the job requirements, it’s possible the manufacturing process might not be successful—either for you or the customer. And, if the quality of the items that are produced don’t meet the specifications that the customer has set, then all of the time and material that’s gone into that production run are at risk. This might be a momentary hiccup, or a long-term disaster for the company, but why take a chance?

  • Business – Manufacturer of cold-formed screws and bolts
  • Location – West suburban Chicago
  • Sales – $7,500,000
  • Ownership – Single owner with a major investor

Initial contact –

The owner of the company had been introduced by their corporate attorney. For more than three months, the owner insisted that he could handle their situation. In the end, he called and asked us to start work “tomorrow.” When we arrived, he ushered us into his office and said, “I’m glad that I finally have a CFO to help me out. Your first job is to figure out how we’re going to cover payroll on Friday.”

Significant Findings and Recommendations:

Cash Flow Shortage

The company started with seed money from the owner’s father. The owner was a skilled engineer with little business experience. The company had been losing money for years and had burned through the owner’s nest egg.

Recommendations

  • Create a cash flow forecast to determine the ongoing cash shortage. This was needed to understand how much cash the company was burning through monthly, in addition to determining how much more cash they’re going to need in the coming weeks/months.
  • Develop an ongoing evaluation of each manufacturing run’s profitability. In that evaluation, be sure to include all the elements that might have been coded to operating or overhead expense. Use these evaluations to reset the estimating process to assure accuracy.
  • Identify any ongoing variances. Determine if those are unique to an individual run or indicative of a mispriced production process.
  • Look for ready sources of cash to take care of the current shortage. Contact existing customers to ask for early payment of invoices. Reach out to customers placing new orders, asking for deposits on the orders to cover raw materials. Stretch out payables one to two more weeks to get more cash availability to take care of immediate obligations.

Quality Control

The owner, who was also the head of engineering, would quote and then accept orders that were beyond the capabilities of their manufacturing equipment. The result was returned product, wasted production time and materials, and significantly increased freight costs.

Recommendations

  • Develop an initial review of Requests for Proposals, verifying that the requested specs match the equipment capabilities on the production floor.
  • During the quoting process, assure that the quality requirements and part specifications requested by the customer are agreed to by the production manager.
  • Submit pre-production samples to the customer for approval prior to full production runs—especially when there are any questions about the specs or where the customer has rejected product previously.

Rush Charges for Outsourced Services

Since cash was in short supply, needed raw materials were not ordered until production was set to begin. The result was that there was no time available for normal manufacturing delays. Many orders required further processing by other suppliers, who at times of heavy production, were unable to process orders on a timely basis without resorting to overtime, rush, or break-in charges. Those charges added up to a significant amount month after month.

Recommendations

  • Order raw materials far enough in advance to ensure enough time to properly produce product for customers, including the time needed by outside processors.
  • Approach outside vendors to pre-schedule time in their plants to match upcoming production demands, avoiding delays and scheduling problems.
  • Negotiate a more favorable schedule for processing based on production volume.
  • Locate additional processors with more flexible schedules, or greater production capability.

Quality control can be a big problem for any company. The biggest problems occur when production is rushed or management overrides the decisions of the QC department in order to rack up more sales. In turn, when product is shipped that doesn’t meet the needs of the client, it’s much like a Hail Mary pass downfield. In this case, the hope is that they will need the product badly enough that they will skip some of their own inbound QC checking and just accept the shipment. The result is disaster. The customer loses confidence in the ability of the manufacturer to meet their needs, which might be the trigger to start looking for an alternate source.

The situation also presents a financial problem—when the customer returns the product as unsatisfactory. This results in:

  • Additional freight costs to return the product
  • Wasted manpower and raw materials
  • Rejected invoices for the shipped items
  • Raw material invoices that still must be paid—without incoming cash to cover
  • Cash flow shortage and income statement losses

Lack of care in manufacturing results in potential problems with quality control. The decision to ship inadequate product, scrap defective merchandise, or rework inventory attempting to meet standards creates problems with customers, generates waste and/or additional costs. Remember, proper planning prevents poor performance. Effective quality control should be a key component of your production processes.

Retail Store Revamp

Every company depends on cash to survive. Whether you borrow it or earn it, you need cash to pay your employees and your suppliers, cover overhead and buy inventory. Often companies have a limited amount of cash, so they need to make some critical decisions on how they use it. Every business owner knows that cash is THE critical element for success in any business. The challenge is figuring out where to employ your cash to the greatest advantage.

Many business owners are concerned about having enough cash to satisfy the regular overhead expenses that sustain their company. Two critical needs of any business operation are employees to do the work and a place for the business to operate. But, in addition to employees and offices, companies need product to sell. Some companies end up being inventory rich and cash poor because they have either overstocked their warehouses or stocked the wrong items. Inventory turns provide a measuring stick to manage inventory levels.

  • Business – Industrial Hardware Store
  • Location –Chicago, Illinois
  • Sales – $5 million
  • Ownership – Single owner

Initial Contact –

The hardware store was located in an industrial park. Its business depended on the manufacturing businesses near the store. The owner had finished his MBA, and acquired the business using a government loan. Performance of the store had declined prior to his purchase, and the new owner decided to reduce inventory as a means of increasing inventory turns and improving cash flow – his operational interpretation of what he learned while in school. Unfortunately, this resulted in less inventory to sell, and traffic in the store continued to drop over time as the shelves became more barren. His decision to retain cash rather than serving his customer base laid bare the true course of his business. In a retail environment, even where the consumer appetite has waned, a retailer needs to put his money visibly on the shelves, rather than hiding his cash in his mattress.

Significant Findings and Recommendations

Inventory Management

Being inexperienced in a retail environment, the owner felt he would supply out of stock items within 24 hours from a nearby distributor. But this eliminated the primary reason why customers came to the store, which was to buy items to fill an immediate need. Although some customers started placing orders over the phone, this dramatically reduced complementary purchases, further reducing sales, and eliminating the high margin impulse buys at the counter.

Recommendations

  • Evaluate historical data on product sales, ranking items by gross margin percent, sales per square foot, inventory turns and adjacency sales impact. Use that information to determine which products to keep and which to eliminate.
  • Establish a plan-o-gram physical layout for the store, making sure that different physical areas of the store are set aside for bulk product, racked product, impulse and seasonal products, and a service area location. Reset the customer flow to lead customers to either quick buys, or seasonal and impulse items.
  • Take a physical inventory of all items in the store and warehouse. Establish a plan to use clearance to quickly reduce stock of items that are being eliminated, so they don’t take up valuable floor space.
  • Bring in inventory to establish proper stocking levels for existing and new products.
  • Cycle count and evaluate sales/GM of new layout weekly to allow for changes to the floorplan.

Personnel

With years of declining sales, the existing staff had lost their enthusiasm for maintaining the store and serving customers. The result was that changes to the store layout weren’t implemented, and even staffing was erratic with workers coming and going at all times during the day.

Recommendations

  • Establish a new vision for the company that is based on urgency in both serving the customer and fulfilling day to day operational responsibilities. Each employee needs to be evaluated to assure that they will adopt the new operational imperative for the company.
  • A new focus of each staff person must be customer service. All staff should be familiar with the store layout and inventory locations. Place one person at the door to greet customers and guide them to the store location that is their immediate focus.
  • Develop a Service Department location in the store that is staffed by a skilled technician that can help customers with unique technical problems. Provide a connection to local factory repair centers to provide the service for repair of equipment that is brought into the store.
  • Provide staff with plans for a regular reset of the seasonal and impulse buying area of the store near the front door to provide continued interest to new and repeat customers.

Even though it is important to have cash in a business to cover ongoing expenses, nothing happens unless and until customers buy something. It is the exchange of cash for merchandise –sales – that grows a business. This obvious tenet is sometimes lost if the business owner is focused on one narrow aspect of their business – in this case, conserving cash. Many businesses hold onto old inventory, because it cost too much to discard, actually lose money by keeping it on the shelf. Selling it – at any price – provides working capital for the business by enabling the purchase of new, vibrant product.

If employees aren’t interested in serving their customers, and the store shelves are empty, there is little reason for customers to return. Every business needs to understand their unique value proposition. Why do customers come to them? Serving an immediate need and getting customers in and out quickly would keep customers coming back. The store needed readily available inventory; with employees whose sole purpose was to put it in the hands of time pressured customers. Convenience and customer service are sometimes more important than competitive pricing. Understand your customer and revise your business practices to meet their needs. In the end, they will make sure that you have sufficient cash to pay your bills.

Simple Inventory Control

The Income Statement certainly gets most business owners’ attention. The connection between your company’s operations and the balance sheet is just as important. Remember, the Balance Sheet shows the value of your business at a point in time. Here it’s not an overall picture that tells the tale, it’s the amount in each individual account that shows the difference between a growing, thriving business, and one that has lost control over its major assets.

Bringing Value Through CFO Insights

Two accounts on the Balance Sheet that hold large value for many companies are Inventory and Accounts Receivable. But it’s not just the size of these accounts that’s important, it’s the measure of control that is exerted on the underlying operations in those areas. Every business owner knows that these are important. If they don’t apply solid business practices to controlling and managing those areas, the resulting business risk results in additional cost to the company.

  • Business – Manufacturer of consumer products for big boxes
  • Location – West side of Chicago
  • Sales – $32.5 million
  • Ownership – Single owner (60%) and ESOP (40%)

Initial contact –

After selling a significant portion of the company to an ESOP, the long-time owner suddenly had someone looking over his shoulder – the ESOP Trustees. Issues that never concerned him before were brought to the surface, since they affected company value. Bank reporting included a monthly borrowing base, in which Inventory and Accounts Receivable played a significant role in credit line availability. So, increased interest was focused on those two topics.

Significant Findings and Recommendations:

Inventory Control

The company had over $5 million in inventory and had never done an annual physical count. When their bank finally required a physical as part of their borrowing base reporting, a 10% variance was uncovered. That $500,000 hit to the bottom line needed to be corrected to assure that it was never going to happen again. Controls on inventory movement needed to be put in place, and a program of mutual responsibility among the warehouse staff needed to be instituted. Accurate inventory had to be everyone’s goal.

Recommendations

  • Fix the cause, not the symptom. Verification of inventory isn’t an end in itself. There needs to be a commitment to find the root cause of the problem. Losses discovered in the counts are the symptom of an operational problem. Each time missing product is discovered, there needs to be a commitment to uncover the reason the inventory is missing. Then procedures need to be changed to keep it from happening again.
  • Cycle Counting is more efficient. Yearend physical inventories are the norm in many companies, but they take a lot of time and staff. Some companies literally close their operations for several days to perform that once a year physical. But, how do you discover the cause of the problem that’s been a year in the making? Dividing the inventory into A B and C categories based on value or movement provides a basis for weekly cycle counts. This allows inventory to be verified multiple times a year, providing an opportunity to correct procedural problems. Result – cycle counts took 1.5 hours each week for two people. Time spent – 156 hours annually, less than half the time spent on an annual count. Annual physicals were eliminated. Plus, there was no break in company operations during the counts.
  • Provide incentives for warehouse workers. Although a physical with a 10% variance is daunting, provide a free lunch for the entire company each time there’s a perfect cycle count. Providing a lunch for each person in the company creates a team reward for warehouse accuracy. When everyone is rewarded, then everyone is concerned that their little part is done perfectly. Result – variances dropped to less than 0.02% on the weekly cycle counts, and a free lunch was provided every 4 to 6 weeks, when they hit those perfect counts.
  • Verify master pack quantities. If the UOM (unit of measure) is wrong in the computer system, then the quantities shipped can be a multiple of the quantities you expected to ship. A systematic review of the UOM for every product will verify that the stocking unit is the same as the shipping unit.
  • Provide for a double check at the dock. Have someone double check each skid for the proper quantities before it gets loaded on the truck. If errors are found, then they can be easily corrected before leaving the dock. This eliminates not only inventory control issues, but customer problems as well.

Accounts Receivable Chargebacks

Increasingly, it seems that large retailers find new ways of making the lives of their suppliers difficult. Unusually detailed shipping restrictions, hard to meet packaging considerations, specific instructions on timely shipments. Some of these may be necessary for smooth stock operations at the receiving dock. But often, it seems to be just another way of building revenue on the back of the supplier. Care needs to be taken with each shipment to assure compliance. In the accounting department, chargebacks need to be carefully handled to minimize lost profits.

Recommendations

  • Create a logbook for chargebacks. It’s important to track the reasons for the chargebacks. This way chargebacks that keep recurring are identified and can be corrected. Result – the logbook identified individuals that needed retraining to eliminate packing and labeling errors. Chargebacks were reduced by 60%.
  • Follow-up on the chargeback. Some accounting people don’t want to take the time to research the chargeback and may just stick it in a drawer to be “dealt with later.” A response to the chargeback in 48 hours will send a message to the supplier that this is a concern to you. Result – the pushback resulted in a reduction of chargebacks for miscellaneous problems by over 75%. Was this the result of our work to train staff or refusal to accept charges from the customer? Unsure, but the reduction was noteworthy.
  • Look for small open amounts in the AR Aging. If a customer pays an invoice except for some small dollar differences, it might be because of a fine or penalty. Identifying those items, and not just writing them off, can identify some issues in the Accounts Receivable department.

Company profitability is best set on a solid foundation and built brick by brick. Each error, whether it be in Inventory Control or in Accounts Receivable, eats at profitability one small bite at a time. When they are left uncorrected, net income is reduced on a daily and weekly basis. As time passes, more errors and problems get added to the top of the pile. Finally, it’s impossible to see any of those little, inconsequential errors that have reduced the profits of the company so dramatically.

It’s more than good procedures that help maintain profitability. The work of each individual is key to the success of any company. Employee engagement, which is necessary to fixing any problem in any company, is dependent on their feeling that they are part of the solution. Without that, they are just part of the problem. Consider the many things listed in this newsletter. How many of them would make a difference in your company? Little changes add up to big results.

Specialized Inventory Is A Problem

Inventory is an asset on your balance sheet. Finished goods can be converted to cash relatively easily. Raw materials end up becoming finished goods, thereby completing that part of the cash cycle. But excess raw materials may be difficult to dispose of if no longer needed. Not only that, but raw materials need to be available in the proper proportions or the money invested just sits there, waiting on the shelf.

Bringing Value Through CFO Insights

Not all manufacturing uses stock materials. Sometimes specialized raw materials are purchased to produce product for one individual customer. Even though this is common practice for some companies, it can create additional risk for the manufacturer, because it can only be used for one customer, one product. As long as the delivery follows in due course, it’s not a problem. But it can become a major issue if things change. Then, who is left holding the bag?

  • Business – Manufacturer of restaurant seating
  • Location – Western Illinois
  • Sales – $30,250,000
  • Ownership – Single Owner

Initial Contact –

The bank insisted that the company get some help. They were bumping up against the top of their credit line constantly. Their inventory control was manual and therefore questionable. Plus, specialized inventory raised questions on their borrowing base. They had been profitable until recently, but their record keeping was inconsistent. The bank had already determined they would not allow an over-advance of the company’s line of credit, and the company had to get expenditures approved daily.

Significant Findings and Recommendations:

Inventory Management

Because the company produces custom seating for franchises, particular components could only be used for that individual brand. As a result, significant inventory just sits, waiting for the next order. The company maintains a manual inventory system, which is updated monthly by full inventory counts. The concern about running out of components results in more inventory on the floor than is needed.

Recommendations

  • Minimize the purchase of specialized inventory. The bank has difficulty loaning on it because it has limited value in a distressed sale. Custom items should only be ordered when Sales Orders are received.
  • Work out arrangements with customers to “pre-purchase” the custom raw materials. This reduces the liability in case of an order cancellation.
  • If pre-purchasing is not acceptable, arrange for a “guarantee” that would require the customer to purchase the raw inventory in the event of an order cancellation.
  • Establish a perpetual inventory system, so that potential shortages can be identified and filled. This also reduces inventory adjustments at month-end.
  • Review Bills of Materials for accuracy. This allows for the standardization of hardware components, reducing the variety of items in the warehouse.

Cash Flow Modeling and Management

Because of lackluster company performance over the past two years, the bank has tightened borrowing availability. As a result, the company supplies daily information to the bank to release payments.

Recommendations

  • Build a short-term sales and operating forecast for the company. Concentrate on realistic expectations for shipments and cash collections.
  • Using the completed operating forecast, develop a 13-week cash flow forecast so that the company can plan for payments and payroll.
  • Track the impact of inventory shifts and shipments daily, so the impact on the company’s upcoming weekly borrowing base certificate is understood.
  • Limit all discretionary spending.
  • Contact all suppliers and negotiate longer payment terms. Then importantly, stick to agreed payment schedules.

Manufacturing and Financial Reporting

The company’s ERP system is only partially utilized. They receive the standard Income Statement, Balance Sheet and Statement of Cash Flows monthly, but there are no subsidiary reports. Those reports would help identify issues for management to address.

Recommendations

  • Develop several dashboards for management and staff to use weekly and monthly, including KPIs on variances in manufacturing, group profitability, returns.
  • Create metrics on labor productivity. Measure actual hours against the proposed setup and production times. Review significant variances, and if needed change pricing or improve operations.
  • The company has significant warranty issues. Identify the root causes of the issues and fix the problems, rather than considering it the normal course of business. Current warranty claims exceed $600,000.
  • Determine the level of reports that are available from the company ERP system, including inventory levels, comparisons to prior years and subsidiary reports detailing manufacturing costs, operating expenses and more. Other items like inventory turns, AR collections (DSO), payroll efficiency should be calculated as part of KPIs.

Any money a company spends should ultimately drive profitability. But when inventory is purchased specifically for an individual customer, cash commitments and risks are increased. Not only are you dependent on sales of your products for your company to survive, but now you’re dependent on a customer to complete their sales order, so you can use the raw materials you purchased for them.

Being able to control your company’s assets is key to your independence. If you are totally dependent on the purchases, sales or payments from any single customer, you are beholden to them more than you may think. This is another aspect of customer concentration. Too often, specialized inventory can become a write-off when the customer goes out of business or makes changes in their business. And, if buying specialized inventory is for a large customer, rather than a general company practice, the risks – especially in an economic downturn – can spell danger for any company.

Staffing Issues – Should They Go?

As business owners work to get more done with less, they depend on their staff to work harder for the benefit of the business. Annual performance reviews don’t always provide a complete window into the work that staff is doing or motivate improved performance. Sometimes it just feels like “things aren’t getting done right.” And, the longer staff has been with the company, the more difficult they are to replace with every passing year.

Bringing Value Through CFO Insights

There is a dichotomy when we reach the C-Suite. In some companies, there is a revolving door for the CFO, as they get blamed for lackluster company performance. In other companies, where the CFO has long served as a trusted advisor, dissatisfaction at long term declining performance is glossed over because of past successes. The decision to make a change at that level is never easy. What procedures are buried in the head of the CFO rather than being written down? What important issues will fall by the wayside because of the change?

  • Business – Printing Company
  • Location – Joliet, Illinois
  • Sales – $37 million
  • Ownership – Single owner

Initial Contact –

The business owner had recently hired a Chief Operating Officer to take over day to day operations of the company. It became apparent that the CFO, a long-time trusted advisor, was getting behind in her work and providing less information about how the company was running. The owner was interested in taking a smaller role, but needed more information to help guide the new COO. She reached out for advice in restructuring her accounting and finance function, looking for a new approach, more transparency, and better results.

Significant Findings and Recommendations:

Accounting and Finance

The company is in its second generation, and the owner had hired the CFO 15 years earlier, when she first became CEO. As the company grew, the CFO hired her own son as the Controller, even though he lacked a finance background. As a result, internal controls are lacking. The finance and accounting department operates behind a curtain of inside information. Reporting isn’t GAAP and was incomplete and slow in coming. The CFO brushed off complaints of inadequate reporting and was unwilling to establish a working relationship with the new COO.

Recommendations

  • Restructure accounting and finance, replacing the CFO and weak Controller with a part time CFO and a strong operationally based Controller, saving significant money and putting emphasis on operational finance improvement. Evaluate remaining staff for skill level and retrain where possible. Replace staff where needed with people having deep experience with the company’s specific software. This shortens integration time, and brings new knowledge and expertise to the team.
  • Immediately move the company to GAAP, accrual-based accounting. Establish regular month end account reviews, and simple spreadsheets to provide background for accrual entries. Review prepaids and accruals on a monthly basis.
  • Segregate roles of the CFO, Controller and accounting staff to provide for better internal controls and oversight. Formalize those in a written policy so that lines of review are well established.
  • Establish a formal monthly close process with definitive timelines and due dates to allow for proper reporting to CEO and Board on a timely basis. Reporting should include KPIs and dashboards to allow senior management to review progress of the company to best practices and better results.

Core Policies and Procedures

Like many entrepreneurial businesses, the company relies on the knowledge of its tenured staff to handle key processes on a consistent basis and pass those processes and procedures on to new employees. While this works for small companies, when companies grow to middle market size, the staff gets too large, and has too many layers to have a sustainable and consistent knowledge transfer.

Recommendations

  • Establish job descriptions for staff in all departments, making sure that everyone is in the best position for their background and skill and is cross trained to assist when needed.
  • Develop a formal credit and collections policy. This way, credit decisions can be processed by line staff rather than the CEO. Collections should be followed up regularly. Waiting till invoices are 30 days past due delays collections by an additional month, leading customers to wait till they get called before payment.
  • Put in place a formal purchasing and payment policy, which will provide better internal controls. There is risk in having one person do all levels of the purchasing and payment process. Assigning different people the responsibility for entering new vendors, issuing purchase orders, and making payments secures the company’s cash, and assures that it’s paid out properly.
  • Schedule regular company review meetings so that each department head can provide financial reports, sales reports, and reports on plant operations to the whole management team. This allows strategic decisions to be made by the whole team, and promotes accountability and ownership of the decisions that drive the company forward.

As companies grow, there is credit to be passed around to those who have helped build it. But nobody can sit on their laurels. The health of the company is based on the procedures and data that are provided by senior management, and especially the CFO. Within that office lies the primary operational data that is the result of the company’s efforts, and the financial information, KPIs and dashboards that provide answers to the ultimate question, “How are we doing?” Without a regular stream of accurate information, it’s difficult for line employees, managers and ultimately the company to move forward.

Just as any employee needs to contribute to the ongoing good of the company, the CFO and other C-Suite executives must contribute to the company on an ongoing basis. The age-old question, “what have you done for me today?” is just as relevant for senior management as the line employee. If they are not willing to pull their weight, it’s time to find someone else to do the job.

Startup Knowledge – Drink Deep

Entrepreneurs creating a start-up face an almost insurmountable task. Many have little or no understanding of the finance side of business, and their experience is often limited to one aspect of the product they’re developing. Their challenge is getting enough information to clearly understand not only the creation of the product or service that they’re selling, but the myriad costs involved in building a profitable company from scratch.

Bringing Value Through CFO Insights

One incredible challenge for a business owner is how much capacity to commit to while the company is still in its infancy. Each move to a larger platform, whether that be IT, manufacturing, marketing or delivery, requires not just the increased cost of the larger service offering. It also requires the cost of making the change, which can be significant in itself. And the impact of the change isn’t just monetary. It also impacts business operations and personnel as well. Do you risk spending too much money too soon, or delay making the changes till growth leaves no other option?

  • Business – Ready to eat food manufacturer
  • Location – Chicago
  • Sales – $475,000
  • Ownership – single owner

Initial Contact –

The owner had spent 2 years developing her product and had been careful about developing budgets and a rudimentary cash flow forecast. But with no historical results to compare to, she was nervous about whether her plans would match the reality she now faced. She was unsure how to keep up with the accounting and production issues she needed to address. She was referred by a business incubator.

Significant Findings and Recommendations:

Financial Reporting

The company’s accounting system provides monthly reports, with most expenses and revenues posted accurately. There are some entries that are clearly cash basis in an accrual-based accounting system. The month-end process is ill-defined, making each month-end a scavenger hunt to determine what else needs to be done. The General Ledger lacks a detailed account layout. There are many significant categories summarized, limiting the actionable detail needed for data analytics, benchmarking and decision making that would improve company performance.

Recommendations

  • Revise and expand the Chart of Accounts, so that information on Product Sales, Distribution Channels and Cost of Goods Sold are defined in sufficient detail. This provides information on product segmentation, profitability by sales outlets, and channel costs along the supply chain. It’s easier to summarize data for reporting than to create details from summary information.
  • Since the company lacks historical information, updating the budget monthly is critical to planning for the next six to twelve months. Each new month’s information provides more history on how the company is progressing, leading to a more accurate forecast.
  • Assure that all entries are consistent with accrual accounting. The system is either accrual or cash basis. Posting costs differently skews financial reporting.
  • Reconcile distributor remittances to company invoices, to catch unauthorized or unexpected chargebacks and payment of slotting fees. Unfortunately, not all costs were anticipated, and surprises need to be reflected in the upcoming months’ budget.

Financial Analysis

Although financial reports are completed monthly, there has been no development of a standard analytics package tracking performance of the company. Analytics are always key to any management decision making. Especially in a start-up, where there is little or no historical information on which to base decisions, any data collected during a month is critical to helping plan for the direction and slope of the company’s growth.

Recommendations

  • Develop detailed Income Statements by customer and by product SKU. This provides some clear visibility to margin improvement opportunities.
  • Critical KPIs need to be identified. Tracking accounts receivable collections, (DSO – Days Sales Outstanding) or inventory turns, (DIO – Days Inventory Outstanding) will provide good information on those two key factors.
  • Create trendline analysis for major KPI categories: track sales forecasts against actuals; margins against projections; identify incremental impact of changes in costs or additional fees being charged by channel partners. The trajectory of the tracked data allows visualization of possible future results.
  • Critically assess sales and marketing expenses as it relates to ROI. Every marketing expenditure needs to be measured against sales, how they affect profitability, and their Return on Investment. Especially in highly competitive food markets, each marketing expense, whether co-op advertising, slotting fees or added distribution costs, nibbles away at margins. A company short on cash needs to make sure that there is a direct payback for these added expenses.

In a start-up, where there are so many things that need doing, many entrepreneurs focus solely on product and operations. This relegates financial reporting and analytics to the back burner. It’s true that without a well-designed product that is priced competitively and accepted by consumers, the company has no future. But if sales forecasts aren’t managed, pricing isn’t properly calculated, and financial models aren’t used to consider all of the upcoming expenses, the business is in trouble long before it opens its doors. In a world where cash is tight, having a full financial plan that can be easily modified is critical for business owners in any business, not just in a start-up.

This is an oft-beaten drum. Financial reporting, well-defined data, easily adjusted models, well developed costing and a business plan that lays out how the business will get to the next stage are important. Strategic decisions on the next steps, and the ability to move quickly reflect the flexible approach that is critical for any successful start-up.

The key issue is good data as a basis for insightful planning. The more information an entrepreneur has, the better able he or she is to make the right decisions. It’s the rare start-up that has collected “too much” information. A clear understanding of costs – all costs – in addition to operational flows and a team of well-experienced advisors are critical to the steady growth of any company. Though finance is often put off till later, a fractional CFO can provide critical advice and counsel as a member of that Trusted Advisor Team. Just having a great idea for a business isn’t sufficient. A well-laid out plan is the key to planting your idea in a well fertilized marketplace, and tending it while it grows into the success you have dreamed for.

Succession Planning

Forbes reported that 90 percent of family-owned businesses fail in the third generation. It might be worthwhile to examine one such case and see what happened.

Bringing Value Through CFO Insights

When companies fail it is frequently a combination of factors. But mostly, it’s just lack of preparation.

  • Business – Machine shop – heavy equipment repair
  • Work – Long-term (six months to a year) repair and reconstruction projects
  • Sales – $9,700,000
  • Ownership – Single owner, second generation, passing it to his son

Initial Contact –

The bank was concerned about the business’ cash flow. The company had used its entire credit line and regularly wrote checks that exceeded its credit line availability.

Significant Findings and Recommendations:

Profitability

When a company is short on cash, the first place to look is at profitability, not just overall, but at the unit level. What is the profitability of each product family, even each product that is sold, or each project that’s completed?

Recommendations:

  • Do a detailed cost analysis of every completed project to determine if the actual cost of the project, and profitability, matched the estimate. Understand why the profit goal was not met. Use that finding to re-evaluate and manage current projects.
  • Be more realistic when doing future estimates, being especially careful about labor estimates.
  • Initial analysis showed that the biggest overrun of project expense was the labor component. Provide tighter supervision of line employees, so that they know the time expectations and their part of the cost of the project they were involved in.

Cash Management

The company regularly wrote checks without regard to the amount of money that was in their account, overdrawing their account regularly. This angered the bank and gave them little confidence in the company’s management.

Recommendations

  • Create a cash flow forecast to project how much money they would have in each of the coming weeks.
  • Issue a cash requirement report weekly to show the amount of money needed for payables, and only cut checks if there is sufficient money in the bank.
  • Reduce the amount of unnecessary expenditures for software, office supplies, and miscellaneous items. Small expenditures add up.

Quoting New Business

The son was interested in growing the business significantly. Being ambitious, he started quoting jobs with estimates between $10 million and $15 million, well in excess of the company’s annual revenue of $9.7 million. Despite the company’s technical expertise, it was impossible to show prospects that the company could complete projects of that scope. Preparing these estimates and pricing them took significant engineering staff time and yielded no business after a year of trying.

Recommendations:

  • Stick to what you know and do well. This might involve slower, but stable and consistent growth. The facility and staff weren’t sufficient to handle the bigger jobs, and the company didn’t win any of the new business, in spite of the effort put forth. The bread-and-butter jobs that were the company’s mainstay evaporated when the son stopped calling clients to seek additional work.

Mentoring the Next Generation

The son had an engineering degree, and was technically capable, but he didn’t understand the financial aspects of business, managing it on a daily basis, or managing staff. The father didn’t prepare his son for his role in running the business, because he felt that he could learn on the job. Unfortunately, he left town when he remarried, and left the company solely in his son’s hands.

Recommendations:

  • It is important for the leader of a company to be not only technically adept, but financially literate as well. Courses in business finance and accounting would have prepared the son with an understanding of business finance, giving him the tools to make changes to improve the company’s operations and its profitability.
  • Learning how to manage people is just as important in leading a company as understanding the financial reports. Some basic courses in supervision in addition to regular meetings with a business coach would have improved his skills as a manager.
  • Mentoring the next generation while giving them increasing responsibilities would have allowed the son to grow into his position, rather than being thrust into it suddenly, with nobody to guide him on how to manage the company day to day.

Even in the best of circumstances, taking over and running a business is difficult work. If the new leader is unprepared, they lack the knowledge of how to move the company forward. Business management is a learned skill. Whether it be operational, managerial, or financial, it takes years to learn how to run a business successfully.

An experienced CFO has the financial and managerial experience to help run a business. In many instances, they provide mentoring to management to help them succeed in areas where they lack experience.

The Upgrade Challenge

Making the right decisions is critical to any business’ success. Information comes from experienced staff and data gathered from operations. Management’s ability to interpret data is important to make the “right” decisions that guide the company. Often, the way the data is collected, sorted and stored is deferred to technologists that don’t understand how the company operates, and are therefore unable to integrate the capabilities of the software with the operational needs of the business.

The challenges are even greater when a company totally changes the way it is operating. Upgrading simple accounting software to an ERP (Enterprise Resource Planning) system that is going to manage every aspect of the company from operations to accounting and finance, and sometimes even sales and customer relations is no small task. There is a significant amount of planning that needs to take place. If the planning is incomplete, this huge expenditure of money and staff time is doomed. Global consultancy McKinsey estimates that more than 70% of ERP implementations fail, and Gartner says that failure rates can exceed 75%. With those failure rates, what are the steps that will assure success?

  • Business – Industrial seating manufacturer
  • Location – St. Louis, Missouri
  • Sales – $15 million
  • Ownership – Single owner

Initial Contact –

The company had been working on their ERP implementation for over a year. Everyone was in place for the kick-off at the start of a new month. But in less than a week, management realized that the results weren’t meeting their expectations. Not only were the customizations not working properly, but staff was not fully trained in the new software. The financial reports were no better than with the old software. And, on top of that, even though the balance sheet totals matched the totals in their old system, the numbers didn’t match the subsidiary reports that supported it. They needed to start over, and needed a new approach to achieve the success they expected from their investment of time, money and manpower.

Significant Findings and Recommendations:

Any dramatic change in the way a company operates starts with the leader. It needs to be more than a commitment of dollars. It needs to be in time and energy, with the expectation that the monumental effort will yield significant changes and improvements for the employees and the company. That commitment shows in not just memos, but participation as well. The CEO knew that company operations needed to change, but in spite of the effort and cost, he was skeptical that the final product would meet expectations. As a result, that lack of confidence pervaded the organization, leaving the employees with a half-hearted effort to complete the task.

Recommendations

  • Staff commitment – Establish new teams with someone from Operations and Finance involved with a member of the outside implementation staff. Hierarchical meetings were established, starting with senior management for overall guidance and scheduling, middle management for operational planning and milestones, line employees with specific training and testing.
  • No customizations – Software is designed to work a particular way. Customizing the software creates challenges. Any programming changes may affect different sections of the software, with some effects not seen till it’s operational. Plus, upgrades must be tested and confirmed with the customizations, to assure that they would still work. Best practices are to use the software as delivered.
  • Operational workflow–The new ERP system must either work within the bounds of the way that the company functions, or the company operations must change to meet the flow of the new system. Workarounds are counterproductive. Build an operational plan based on the new paradigm created by the ERP. Think about what is the best way of accomplishing the operational task, and how does the ERP contribute to tracking, efficiency and reporting?
  • General Ledger Dimensions – ERP systems allow true slicing and dicing of information gathered. Take advantage of the new capabilities of GL Dimensions by redesigning the Chart of Accounts for added flexibility. If it isn’t designed into the GL now, you won’t be able to take advantage of its power to analyze information later.
  • Verify data conversion – Make sure that the detail brought from the old system matches exactly with what arrives in the new database. Verification of Inventory, Accounts Receivable, Accounts Payable, Bills of Materials must all be exact. Any conversion program must be run and re-run to verify the accuracy of the data brought. Otherwise, the true nemesis of any computer system – Garbage In/Garbage out – will become reality.
  • Ad Hoc reporting – No ERP system can provide stock reporting with every variation management desires. Implementation should have a report writer for quick design and capture of information.
  • Test Company – To assure that things are setting up correctly, build a test company with enough data to do sample runs of various operations. Billing, cash collections, inventory adjustments, manufacturing, calculating standard costs. Every operation should be tested by different people to assure it works as planned.
  • Training of staff– Every employee – every employee – should be trained in the test company so that they know how to do their daily activities in the new ERP system. Every software package works differently, and the first week will be slow going. But spending time in advance will save a lot of frustration when the system goes live.
  • Trial Run –Take a long weekend. Convert the data, verify the critical numbers and then have the lead person in each department do one test transaction in each functional area to assure that everything is working correctly.
  • Running Parallel – Even though this is considered the gold standard, it takes a huge amount of work. If all the other steps are taken, going live should be a cut-over activity, with everyone moving to the new system. No looking back.

RESULT

It was painful to “start over” again. But the effort paid off. After an intense three months of work, the company was ready for a new cut-over. During the first 48 hours there was a lot of nervous energy in the office. But by the end of the first week, the staff was humming along, pleased with the efficiency and capabilities of the new system. By the time month end rolled around, the speed of the close, and the ease of gathering data made even upper management smile.

Data is the backbone of any decision-making process in a company. Installing a new ERP system in any company, whether large or small, is a daunting task. It’s not just the expenditure of money and time that is at risk, it’s the confidence of the line staff that all of this work is going to be worth it. Making sure that the plan is complete and well executed is the key to success. Assuring that everyone has a part in the process makes the change a team effort.

Change is difficult. Leaving old processes behind, and embracing new ones adds stress to everyone. But if it’s done right, the benefits outweigh the time and energy spent. Planning is the key that assures success. Then everyone can take credit for the part that they played.

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