March, 2012

The Super Bowl clock ticked down last Sunday with my home team, the New England Patriots, nursing a 17-15 lead over the New York Giants. Forced to punt with less than four minutes left in the game, the Patriots turned it over to their defense to pass their final and most important test of the year — to get the ball back to the offense without letting the Giants score.

Maligned all season long for their shortcomings, particularly in pass defense, the Patriots’ defensive players had a chance to redeem themselves, to prove to the world (after all, the whole world was watching, wasn’t it?) that the Patriots were more than the single dimension of Tom Brady. On the first play of the series, the defense failed the test. The fact that the Giants’ Eli Manning made a perfect pass and Mario Manningham a miraculous catch was less significant to this Pats’ fan than the defensive line’s inability to pressure Manning and the defensive backs’ failure to cover Manningham adequately.

After that, it was only a matter of time. It was clear that the Giants would take the lead. Patriots’ coach Bill Belichick hung the defense’s failing grade out for all to see by conceding the Giants’ go-ahead touchdown in favor of saving the clock. The final question was whether or not the Patriots’ offense could pass their test before the clock wound down to zero.

Brady passed on the first two plays from scrimmage — two catchable balls which fell incomplete — and absent the momentum that those plays might have provided, the rest was largely desperation. The offense, too, had failed.

So it is with your accounting team. During the regular season — the first eleven months of the fiscal year — your team keeps the score and reports it every month, your company’s wins and losses. If you, the owner or senior manager, have a sharp eye for numbers, you may spot some incompletions along the way. But the fumbles, those potential game-changers, often don’t show up until the CPA arrives to administer the ultimate test: the tax return, the review, or the audit. The result is frequently a year-end score that’s different from what your team has been reporting at each checkpoint. Like the referee who’s only going by the book, the auditor’s job is to throw a flag, which more often than not results in a penalty to your bottom line.

For your team to pass the test, it has to minimize the CPA’s dreaded “adjusting journal entries (AJEs),” which seemingly result from the application of accounting arcana to your day-to-day bookkeeping. Except that most of it is not really arcane. Most of it is just basic, straight-forward accounting that anyone with a degree in accounting or five years of progressive learning in the field of accounting should know.

If you, as the small business owner, are going to get off the sidelines and into the game to impact not only the final score, but the tally at each monthly milepost, here are nine accounting issues that should concern you before the CPA comes on the field of play:

1. Revenue recognition: You can record it only as fast as you actually earn it. Avoid the temptation to book in Month One all of the income from a service that you’re providing over the full year. And definitely don’t book as revenue any of your favorite customer’s advance deposit until you have delivered, at least in part, against it.

2. Inventory: Beyond accurately counting it in and counting it out, the trick is accounting for it while it’s still work-in-process (WIP). Whether it’s a product or a service, if you started working on it before the end of the accounting period, you’re creating additional value which should be capitalized on your balance sheet if it’s not out the door by month-end.

3. Payroll: Accrual-basis accounting requires that you recognize your labor expense as it’s incurred. You may have issued payroll on January 6th for the week ending December 31st, but the expense relates to December, not January.

4. Depreciation: There’s no need to wait for the outside accountant to determine this number. Your team can ask for the standard GAAP guidelines, calculate the monthly charge on new equipment, and add it to the rolling write-off on your asset-tracking spreadsheet.

5. Receivables: In the absence of special factors (e.g. retainage or other unique terms), you should take an uncollectible reserve for any invoices more than 120 days old. Better to be realistic and do it as you go along than have to package it all in a year-end surprise.

6. Payables: Get those invoices in! Outside contractors, in particular, are notorious for sloppy billing, as are some of your employees with their late expense reports. In the absence of a physical bill, book an accrual for the estimated expense to reduce the bad news that the accountant uncovers.

7. Unapplied credits: Look for negative numbers on your accounts payable aging statement. They’re often an indication that your team made a duplicate payment on a vendor invoice.

8. Misclassification: You and your CPA should agree from the start about the types of expenses that get charged to each account, and you should be rigorously consistent. An inordinate number of AJEs result from the simple reclassification of expenses.

9. Reconciliations: Most of us learned how to do math proofs back in middle school (remember?). Reconciling your balance sheet is nothing more than that, yet a lot of valuable CPA time (and your money) is spent on tying out the general ledger balance sheet accounts to the appropriate back-up ledgers for bank and credit card balances, debt and equity, receivables and payables.

The Patriots had a terrific regular season, which had a lot of their True Believers (yours truly included) willing to overlook some fundamental flaws to a point at which they expected the best during the playoffs. So it is with your financial statements. Lack of rigor in closing the books during the first eleven months can lead to a better won-loss record on your bottom line than you have actually earned. When the truth comes out in the twelfth month, don’t blame the auditors. Like the Giants, they’re only exposing your weaknesses in their drive for the final score.

February, 2012

The Syndicate was ready for action. Six neighbors and I assembled in the “Gathering Room” of the condo complex before the first of the NFL playoff games last Saturday to consider our collective wagers on the four contests. To varying degrees we had researched the subject — seasonal wins and losses, injuries, rushing and passing records — and we had ready access to the Web for the more arcane stats that would provide the definitive Eureka insight. We were primed.

The issue, of course, was not just which team might win or lose but how to deal with the Spread, the determination by the Las Vegas betting house of the number of handicap points the perceived underdog would need in order to equalize the betting interest between the two teams. Without the Spread, there’s no action: the favorites do win the majority of the games. In fact, the higher-seeded team won all four times last weekend (though higher-seeded Denver was not the favorite versus Pittsburgh). But the Syndicate likes to think that the collective wisdom of its members will more often than not beat the Spread. With relatively little debate we reached consensus and, brimming with confidence, placed our bets. [Results below.]

So it is with financial analysts. Usually right, but never in doubt. However, while reliance on the numbers is fine for citing history, it’s much less certain for predictions or projections. I thought of the parallel as I read through the last three years of annual financial reports of a new client company which I signed up last week. The bound statements were the product of a CPA’s review and were supplemented by a spreadsheet which arrayed the three years of income statements and balance sheets side by side for ease of analysis. Not exactly bedtime reading, even for a numbers guy, but useful background, especially for a numbers guy.

However, having discussed the Company’s recent history for a couple of hours with the Owner, my goal in analyzing the statements was to determine not only if his story was confirmed, but if it was well-represented by the numbers. In a quick overview, I was looking for the following:

• The Opinion: Were there any concerns expressed by the CPA in the cover letter which related to the integrity of the presentation?

• The Content: Beyond the income statement, balance sheet, and statement of cash flow, was there a capitalization table reflecting investors’ interests? Were there notes explaining accounting policies, status of loans and leases, and unusual financial events?

• The Format: Was the expense detail simply arrayed alphabetically by account, or was the analysis at a more sophisticated level, perhaps with the expenses grouped by type (e.g., Cost of Goods Sold, R & D, Sales and Marketing, General and Administrative)?

• The Trends: What was the three-year Revenue history — up or down, by what percentage? To what extent did other income statement line items reflect the same percentage change? Was annual overhead expense increasing at the same rate as sales (usually not a good sign)?

• Balance Sheet Trends: How has the cash position changed compared with short-term debt balances? Did accounts receivable and inventory balances track the changes in revenue? Are payables and accrued expenses showing disproportionate increases?

• Cash Flow Insights: What’s been the source of the Company’s funding — internally from Operating Income, or from Debt or Equity infusions, or from Asset Sales? Has there been adequate renewal of the plant and equipment via Capital Asset purchases? What does a quick calculation of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) as a percentage of revenue reveal?

• Additional Analysis: What does the calculator on my Smartphone (the 21st-century equivalent of the back of the envelope) provide in the way of a Current Ratio (current assets over current liabilities), a Debt-Equity Ratio, and a Debt Service Coverage Ratio (total annual debt service divided by EBITDA), and how do these compare with nominal industry standards? What does the interest rate being charged on the bank loans indicate about the company’s creditworthiness?

Fortunately, the Owner’s story was fully confirmed by the financial reports. The Company, a significant player in the local construction industry, has taken some heavy hits in recent years but has managed its retrenchment well with the continuing support of its financing sources. It is set to ride out the downturn and to come back strongly with lessons learned about effective management in the face of adversity.

Unfortunately, effective management in the face of adversity is now the challenge for the Syndicate. Had we been wagering on credit last weekend, we’d have been underwater. Despite a collective experience of 50+ years of professional football history and a full appreciation of the need to read between the lines (a/k/a the Spread) in understanding the story before placing our bets, we came out on the short end all four times. We were left wondering what kind of odds we might have been quoted on that happening (?!).

January, 2012

(Jingle, jingle, jingle) – “You better watch out, you better not cry, better not pout, I’m tellin’ you why – Santa Claus is coming to town.”

Man, did we get mileage out of that when our five kids were little! From Thanksgiving right through Christmas Eve, if they weren’t always angels, they usually tried. Even when they got into their teens, they retained some sense that their behavior could impact the quality or the quantity of their Christmas experience.

Beth, Dave, Katie, Will, and Chuck, now that most of you are parents, let me share a secret with you – it didn’t make any difference! But it sure improved the four-week, pre-Christmas experience for your mother and me, just as it likely has for generations of parents. In fact, if I were to go back far enough (!), that jingle probably represents my first conscious experience with behavior modification (mine!).

I thought of this last week in an extended conversation with the senior managers of one of my clients around the subject of a Christmas (year-end) bonus. For the first time in a decade, last year (2010) the company recorded a loss in the face of a tough year for the industry. Everyone knew it, so there was no sense trying to paper it over with even a token gift while people (a few) were being laid off.

This year was better than last – modestly profitable, but not exciting. The management team agreed that most of the employees hadn’t really been challenged, nor had they challenged themselves. Thus, any kind of after-the-fact, incremental compensation would have rewarded behavior that needs to change if the company is to achieve its higher 2012 goals.

But what of the employees’ expectations? “I’ve done everything they’ve asked of me and never given them any trouble,” one might say. “Wouldn’t you think they could at least show some appreciation?”

In fact, the management team decided that in addition to the holiday party, some recognition was appropriate, in this case a gift certificate. However, in responding this way, the managers agreed as well that they were not making a statement about company incentives or rewards. It was simply a nice gesture to avoid Scrooge-like references.

In planning for 2012, on the other hand, they decided to take a new approach. In an economic environment of persistently high unemployment, they recognized that a primary concern for many employees is job security. And the counter to insecurity is job training and education within the company’s day-to-day operations. For next year, in addition to requiring that everyone develop personal goals that are meaningful, measureable, specific, realistic, and achievable, the managers also mandated that the staff members each come up with a set of objectives for individual learning. This professional development will include internal and external training, project team work, job shadowing across functions, and agreed-on enhancement of job skills.

With an empowered work force expected to exercise independent judgment and initiative, my client has determined that it no longer seems appropriate to tell employees day after day what to do. In fact, the greater challenge for both managers and staff is to encourage people to manage themselves and to expand their individual skills and knowledge, acquiring marketable talents even after multiple years on the job.

Wrapping this new approach around the company’s revised and purposeful vision statement going into the New Year, it was thus resolved by the management team:

1. To incorporate individual goal-setting in the performance appraisal process and to provide for self-reporting of progress by each employee.

2. To eliminate the flat, across-the-board pay raise in favor of budgeting for increased compensation based on the Company’s profitability, with allocations based on individual achievement of goals.

3. To provide multiple opportunities for employees to acquire new skills and to cross-train in other functional specialties.

4. To communicate the new strategy before the old year is out, setting expectations that personal output and attitude will make a financial difference, to the company and the individual.

In the meantime, I don’t have to rummage for that original Bing Crosby on 78 rpm, or even the Supremes on 33s, in order to pass the “Better not shout…” lesson on to our next generation of Andrew, Noah, Jack, Emma, Abby, and Brooke. Turns out that the latest to record it is Justin Bieber, and I’ll bet you kids didn’t think that I even knew the name!

November, 2011

“If I was him,” the taller guy was saying, “I might be doin’ the same thing.” He leaned over the tailgate of his pick-up, the one with the Maine plates, “…especially for a million bucks.”

As I approached the Bailey Island General Store in pursuit of my newspapers last Sunday (reading the Sunday papers on-line is an idea whose time has not yet come for me), I picked up the conversation. I knew what the two Islanders were talking about.

“Yup,” said the other. “Read it in the Anchor. He’s puttin’ the place up for sale.”

I had read the same article in the local newspaper. Charles Abrahamson, whose shorefront property includes the only sandy beach for miles around, had closed off access to the beach at the middle of last summer for the only time in anyone’s memory, raising temperatures all over the Island. In return for a permanent easement through the edge of his property down to the beach, he had asked the Town (pop: 5,300) for $950,000 and been turned down. Now, fourteen months later, his motivation was clear to all — selling his property with an easement (by contract or by common law) might conceivably reduce the value by that amount.

After years of facilitating access to the beach, Abrahamson was cast as a greedy Highlander (summer resident) by many native Islanders and by other summer folk. In a broader, more generous context, he and his wife Sally are essentially trying to monetize their real estate asset at its highest value, which includes either providing their successor with a private sandy beach in perpetuity (at a premium price) or being compensated for allowing it to “go public.”

I have no interest in buying the property or even helping to fund the easement to a beach which we have enjoyed access to for more than 40 years with kids, grandkids, and others, just a 10-minute stroll down the road from our summer house. But as I walked back from B.I.G.S. last Sunday, I began to think about how a bank loan officer would value something as intangible as private access in considering a mortgage application from a prospective purchaser of the Abrahamson property. That, in turn, got me thinking about how anyone assigns value to any kind of collateral in lending money. And, even though it was Sunday, and even though it was just a short walk back from the Store to my sunny deck chair, that got me thinking about a question that one of my clients had posed to me a couple of days earlier: “Is there a way to consolidate all [our] term debt into one note at a better interest rate? Do banks entertain that?”

Not only do they entertain it, they do it all the time, I responded. It’s called “blend and extend.” Of course, they’re generally not enthusiastic about renegotiating a long-term loan agreement simply to lower the interest rate that you have contracted to pay, but unless there’s a prepayment penalty, they have to respond to the market. In particular, if you are expanding your borrowing base (e.g., by purchasing more equipment) and at the same time trying to improve your cash flow by stretching out the payment period, you may have a good case for refinancing. Here’s how it works:

1. The Matching Principle — Banks and other lenders typically want to match the loan to the collateral that supports it: revolving loans are for revolving assets like inventory and accounts receivable (“working capital” loans); term loans are for long-term assets like machinery and equipment. Real estate has its own category.

2. The Easier Way to Valuation — In most cases, what you pay for a piece of equipment establishes its market value, so borrow as you purchase, most conveniently by opening an equipment line which may include all equipment acquired during a 12- to 18-month period. Banks will usually lend up to 80% of the purchase price, higher with SBA underwriting.

3. The Harder Way to Valuation — The problem in consolidating existing long-term loans is that both the “encumbered” (already pledged as collateral) and any unencumbered equipment will need to be appraised (could be $5,000 and up). Even if the same lender is doing the bundling, he or she wants to make sure that the market for the particular equipment has not gone south since its purchase date.

4. The Leasing Trap — It may come as a surprise, but you don’t actually own any equipment that you have on lease — the leasing company does, and it’s usually getting a premium rate of interest. They’ll relinquish it so that you may use the equipment as collateral elsewhere only if you meet their full prepayment penalty — you’re in for the sum of the remaining payments, which includes interest to the end of the loan. (…which is not to say that leases aren’t useful financing options.)

5. The Analysis — Estimate your weighted average cost of long-term capital by figuring how much interest you will pay on each loan during the next twelve months (the lender should have provided you with a monthly principal and interest schedule), then taking the total and dividing it by the sum of the outstanding balances of all your term loans at the end of last month. Just as with a home mortgage, compare that with the lender’s current offer, factoring closing costs into the equation.

6. Avoiding Paralysis — Because banks like to be able to track how you’re doing at any time and get first dibs on your cash in the event of default, they almost always want all of your business (deposits plus debt financing). When you contemplate shifting all of your accounts to a new lender, inertia is your current loan officer’s best friend. But whether you move or not, you should reassess your bank relationship at least every two years — competition among lenders for good loans is intense.

Whether the Abrahamsons move or not, they’ve had to reassess all of their relationships on our little island, in particular those with their abutters, some of whom want in on any deal. For the sake of a single easement, it’s for sure that traffic flow will increase on glorious summer weekends, affecting the value of every home in the neighborhood.

You can bank on it, but you may not be able to borrow on it, unless you’re operating a lemonade stand.

Draining the Swamp

From the Robert Half (“Accountemps”) 2012 Salary Guide:

Note: Salaries indicated are the national mean for companies up to $50 million in sales, except General Accountant, which is up to $25 million. Adjust by applying the following geographic factors: Boston +32%; Springfield +4%; Manchester/Nashua +10%; Providence -3%; New York City +41%; Chicago +22.7%; San Francisco +35.5%.

October, 2011

In her unending effort to catalogue the best retail resources in New England, my wife Anne several years ago chanced upon an unobtrusive store in mid-coastal Maine, about five miles north of Moody’s Diner (itself well-known to value-seeking eaters).

Alongside Route 1, just beyond The Well-Tempered Kitchen, behind a relic of a cash register in a dimly-lit shop sits Bob Havenstein, an octogenarian who presides over the largest collection of jigsaw puzzles in New England, right there in Nobleboro. His business, appropriately enough, is called I’m Puzzled.

Annie’s summer Down East isn’t complete without a visit with Bob, and she invariably ends up supplementing our puzzle stock, which appears now to be sufficient to absorb a house full of guests for forty days and forty nights of steady rain. Fortunately, this summer the guests and the rain never overlapped, so the puzzles sit on the closet shelves, waiting.

Anyway, there I was in the narrow aisles of Bob’s store, surrounded by puzzles of all vintages, trying to calculate whether a 1,000-piece puzzle takes twice as long (or more?) to complete as a 500-piecer, when it dawned on me that I could never do 1,000 pieces in one sitting. Which is why I never buy these things — I hate to start something that I won’t have time to finish the same day.

“But,” Annie reminded me, “you do like puzzles. It’s just that yours come in the form of spreadsheets.”

There it was. Harsh reality. I had admitted to her not too long ago that, for me, completing a financial spreadsheet projection was like solving a multi-layered puzzle. While it’s not to be confused with completing the Big Dig or the Burj El-Arab, a well-considered, well-documented spreadsheet that integrates a projected income statement, balance sheet, and cash flow forecast for twelve months is the sine qua non (that means it’s the Holy Grail) of financial management.

In addition to the fact that you can complete it in one sitting (once you have arrayed all of the pieces) consider these additional benefits:

1. Comprehensiveness — There, in a single document, is your total strategy for the year, summarized in dollars — marketing, sales, compensation, product development, supply chain. This is your game plan.

2. Documentation — With every assumption annotated, you’ll never have to scratch your head in mid-year wondering what you could possibly have been thinking as you gazed into your crystal ball.

3. Integration — That 20% revenue growth target is no more than a dream unless it results from an exercise that brings together well-supported assumptions about lead generation, individual sales targets, product development schedules, incentive compensation, customer persistency, and so on — all of these elements arrayed in separate schedules in the spreadsheet file.

4. Resource allocation — What are the key drivers of growth and profitability, and what will be spent on new people, new equipment, new incentives, new products, new markets?

5. Expense control — You’ll know you’ve achieved it when your managers, instead of asking “Do we have the cash to pay for it?” say “Is it in the budget?”

6. Direction — No one has to ask “Where’s this company going?” Line up the projection for the next twelve months with the results for the past twelve months and compare line by line to get the answer. If there’s no year-to-year change, then the answer is probably “Nowhere.”

7. Goal-setting — The big metrics in the financial statements are comprised of a bunch of little metrics produced by individual contributors. Employees who understand how their results flow into the group product are usually more productive, especially in the presence of a group incentive.

8. The answer to “How Much?” — It’s right there on the top line of the balance sheet. If the cash numbers are all positive once you’ve incorporated your current financing package, your cash requirements are covered. If, on the other hand, those cash numbers are surrounded by brackets, the largest of them (in a negative sense) is your cash shortfall.

As this indicates, the budgeting process doesn’t start and end with the income statement.

You may be producing a solid “bottom line” of profitability, but if you grow faster than your profitability allows, you can easily drain all of your cash in funding inventory, receivables and equipment. The three-part spreadsheet, by integrating a balance sheet forecast and a statement of cash flows, solves the puzzle, answers the cash question, and provides the array of other benefits.

The jigsaw puzzle, on the other hand, provides just a single benefit to me. At the risk of sharing a secret with the rest of the family, I will say that if someone else wants to clear the dining room table, dump out the 1,000 pieces, and take ownership of the exercise, I will probably jump in. I can then be as socially involved as the next person, without any need for completion. After all, the answer to the jigsaw puzzle is right there on the front of the box.

Alligator Bites

“In Toronto last week one Fred Shipley did a jigsaw puzzle while his apartment burned. Forcibly ejected by firemen. Puzzler Shipley finished his puzzle under a blanket on the sidewalk.”

“In Chicago the Century of Progress (World’s Fair) was about to issue an official jigsaw puzzle, picturing a panorama of the fair grounds, for 25¢.

“In a Manhattan speakeasy patrons worked feverishly over pictures showing cinemactresses in circumstantial bedroom scenes.

“Eddie Cantor sat up nights writing a jigsaw song.

“And a Mr. Morris M. Einson of Long Island City, L. I., went vacationing in the West Indies, leaving behind him a business which had increased its payroll 250% since last summer, was making 3,000,000 jigsaw puzzles a week, and had become so prosperous that it could retain smart Lawyer Mabel Walker Willebrandt to fight the Government’s contention…

“…that a puzzle of over 50 pieces is no child’s game, should pay the 10% wholesale tax on adult amusements. Most puzzles are 150–500 pieces. Her argument: no matter who plays with them, or how many pieces they contain, jigsaw puzzles are childish, picayune, taxfree.”

— Time magazine, February 20, 1933

September, 2011

Radon test. Check.

Utility bills. Check.

Smoke and carbon monoxide detectors. Check.

On went the list, like seven-card stud — condo docs, insurance coverage, chimney inspection — check, check, and check.

We were all over it. Each time they raised the bet, we covered. The result? There were no contingencies last month when the high bidder signed the Purchase & Sale agreement to buy our Waltham condo. We had everything lined up and threw it all into the deal — washer, dryer, refrigerator — including the kitchen sink, to make sure it would happen.

We knew the drill — anticipate their questions, respond to the Buyer immediately, and lay your cards on the table. They got their mortgage, and we got our deal, which has subsequently closed.

It’s no different with a small business these days. Banks and private investors are scrambling to put their money to work. Yes, they’ll kill a lot of trees to paper the deal, and they’ll securitize themselves six ways to Sunday with collateral. Yet for a well-run company in this environment, it’s a buyer’s market for funding.

BUT (ahh, you knew there was a but coming, didn’t you?)…

…you have to be ready. A year’s worth of rising sales, a solid pipeline of prospects, new products on the drawing board, and an experienced management team add up to very little if you can’t bring your cards (in the form of credible documentation) to the table in short order.

When the bankers or the investors come calling, here’s what you need to have readily accessible with a few clicks of the mouse:

1. Three years of CPA-reviewed financial statements. Producing just a tax return doesn’t do the job. The notes to an accountant’s review summarize your historical financial strategy. They’re an important point of departure for discussing where you’re going.

2. Year-to-date financial statements compared to budget and to same months last year. The critical component of the narrative is your explanation of the key variances, year over year, and budget vs. actual. Special props go to those who have it all arrayed in an Excel file, with cellular comments documenting the monthly variances.

3. A projection of revenues and expenses, balance sheet and cash flows for the rest of the year. To the extent that this has been regularly updated, incorporating your latest financial tactics and strategy and detailing your assumptions, you win early credibility with potential financing sources.

4. The “cap table,” detailing the capitalization of the company. Who invested how much, when, and on what terms? Coupled with the Shareholders’ Agreement, this sets the stage for constructive dialogue about the next equity financing deal.

5. The receivables and payables aging statements and the list of fixed assets. In addition to providing an excellent barometer of your day-to-day financial management capability, this information for a banker helps to answer the early question, “What am I lending against?”

Of course, being a good poker player, you can leave these five cards face down until you know the game and the stakes. Your simple acknowledgment that these documents are readily available will move the conversation in your favor, as will showing your “cards” in turn as you tell your company’s story. And because there’s no substitute for experience, inviting a banker or two in for a trial run will help you determine whether or not you’re holding a winning hand.

My wife and I had a strong hand when — out of the blue — a prospective condo buyer came knocking at our door, but we were still sorting our cards when he folded. A week later, our cards were aligned. Check, check, check, check: four bidders, one at our asking price. Not bad for a couple who a few months ago hadn’t even considered jumping into the market. With a saleable asset, you’re never that far away… from Showtime.

Alligator Bites

When it comes to forecasting, the alligator has for decades relied on The Kiplinger Letter to provide a meaty digest of political and economic perspectives from Washington. Last week’s Letter signed off with a paragraph that predates even our first foray into the Swamp, but is fully applicable in the current muck and mire…

Note the following Kiplinger Letter analysis from 1957. Sound familiar?

“People ask why government won’t cut taxes and spending. OK, here’s why:

“The whole system is geared to spending more…on practically every front.

“Every government administrator, big or little, wants more for his functions…and is backed by like-minded lobbies in Washington, lobbying for more.

“Every member of Congress tries to get more for his district, his voters.

“Even the average citizen, perhaps even you, has some special interest, and wants government to spend more for that, and economize on other things.

“Almost no one dares stick his neck out for cuts… on any specified front.

“The total forces for spending exceed the total of forces for cutting.

“And, mind you, this applies to the general public as well as to government.”

August, 2011

“I think it’s getting just a little whiffy around here,” I said to my daughter Katie as I extended my arms toward her. Five-month-old Brooke, my youngest grandchild, just a few seconds ago had been cradled against my chest. Now she was at arms’ length, my hands tight around her chest.

“She’s all yours,” I reminded Katie. Not that she needed reminding.

A generation makes all the difference. Thirty-four years ago, when Katie was that age, if the first whiff happened on my watch, I was the one trudging off to the changing table, babe in arms. Now, except during my rare service as DCCP (Designated Child Care Provider), that’s no longer in my job description. Having met the prerequisites as Dad to produce prolific progeny, I’ve been promoted to Grandpa.

Other benefits accrue to this title. Grandson Noah, age 16, visited Princeton for the first time last weekend. According to my daughter Beth, he loved the place and immediately decided that’s where he would go to college in two years. As Dad, my first reaction would have been “Good grief — $50K+ per year!” My second, “Noah, to get admitted here, you’re going to have to… [fill in the blanks with future high school attainments].”

But as Grandpa, all I had to say was “That’s terrific. What a great goal. I’d love to see him at Princeton,” my competitive juices for my own alma mater notwithstanding.

Surrounded by multiple generations of family last weekend, I had job descriptions — or at least roles — on my mind when I accessed an email message from a former client. Having downsized his small consumer-goods company significantly during the past two years, he is finally on the way back. He asked me to review the resumes of seven candidates for the position of Controller of his company in Portsmouth, NH. Unfortunately, the job description that he furnished to the candidates, and then to me, was for the role of a Staff Accountant.

The difference is more than generational. The title said “Controller,” but the description talked mainly about keeping an accurate set of books. The need is for management, but the verbiage said “handle a wide range of accounting duties.” There was a brief reference to corporate strategy, but the six “included responsibilities” were all focused on recording financial history.

When we met in person a couple of days later, he acknowledged that the ad was misleading, but he’d wanted to convey the sense that this was “a hands-on job.” My response: in companies of his size, and on up to at least $20MM, there are very few jobs in any functional area that are not hands-on. In Finance, whether your title is CFO, VP Finance, Treasurer, Controller or Accounting Manager, you are responsible for the numbers. You may not be doing the data entry, but you have to be involved enough to identify results that don’t make sense.

Facility with, and accountability for, the numbers may be the common denominator, but the emphases of the Staff Accountant and the Controller diverge from there. In my 30-year experience with smaller companies, the major differences include the following:

• Perspective —
• Accountant: Historical; maintaining the financial records of what happened in the past.
• Controller: Future; anticipating the financial implication of the range of events that could happen in the next twelve months.

• Size of firm —
• Accountant: Provides adequate coverage until there’s need for ongoing budgeting and financial planning, often the point at which the founder/owner gets too busy to handle it.
• Controller: Critical to companies with complex transactions, including debt financings, major capital equipment purchases, multiple business units, international issues, outside reporting.

• Skills —
• Accountant: Thorough knowledge of account recording evidenced by complete and timely accrual-based financial statements and by expert capability with employer’s accounting software.
• Controller: Ability to accumulate, assimilate, and analyze data from multiple sources in order to identify variances, to hold managers accountable, and to initiate discussion of appropriate changes in tactics or strategies going forward.
• Accountant: Tracking and ensuring the reporting of those aspects of the firm’s business that might result in income and/or expense. Accurately recording the assets of the organization.
• Controller: Establishing policies and procedures to ensure the control of and accountability for revenues and expenses. Responsible for safeguarding the assets.

• Behavioral tendencies —
• Accountant: Precise, meticulous, thorough, follows precedents, responsive, conscientious, steady, concrete.
• Controller: Active, initiator and coordinator, inquiring, analytical, logical, judgmental, conceptual.

• Keys to career progression —
• Accountant: Having mastered accounting, has to demonstrate depth of cross-functional understanding by providing useful and unique analyses to departmental leaders.
• Controller: Has to move beyond income statement to take leadership in balance sheet management, understanding financial analysis and being able to convey knowledge effectively to the rest of the management team.

Which brings me back to my career progression as Grandpa. Even with two sons still enjoying bachelorhood, I am blessed (always!) with six (count ‘em) grandchildren. As the conversation last weekend ranged from day care costs (accounting) to projected college expenses (controllership), however, I reverted to type, and all agreed — it takes constant financial planning. For the Senior Financial Manager, that’s what really counts.

Draining the Swamp

“Do you ever wonder what people in other industries make? Below, you’ll find median compensation levels for 10 positions at companies with 250 or fewer employees in eight industry sectors…” [Click here for the other seven positions, plus geographic and company size data.]

— Inc. Magazine, July/August 2011 Compensation Guide

July, 2011

Almost every year for the past 20+ years, my wife, Anne, and I have spent the last week of July with various members of our family sitting on a rock known as Star Island ten miles off the coast of Portsmouth, NH in the Isles of Shoals. As rocks go, it’s a pretty big one — 240 acres — but as islands go, it’s pretty small. If you can avoid the predatory seagulls, you can circumnavigate it by foot in just over an hour.

We return annually for The International Affairs Conference, an experience that more than a few have characterized as “summer camp for adults.” Offered under the umbrella of the Star Island Corporation, “I.A.” grapples each year with a different major international issue: this year it’s the role of Water in the global climate system. Theme speakers drawn from government agencies and NGOs as well as academia and the media will address the topic from geographic, political, social, economic, and historical perspectives, which probably takes care of the full range of presentable perspectives.

But none of those is really the perspective that most interests me. I love the perspective of sitting in a rocking chair on the broad front porch of the Oceanic, the old frame hotel building, looking out over Gosport Harbor while watching the sun set and the moon rise, listening to the wind, the waves, the gulls, and the occasional foghorn. It’s the one time of year that I am forced to slow down — no phones, no Internet, no TV, and when newspapers do arrive, they’re often a day late. The world goes on, and I stop. And I have discovered that my stopping doesn’t make any difference to the world.

What does make a difference to me, however, is that my brain cycles into a different realm. Instead of confronting the week-to-week challenges of my clients, I am encouraged by the plenary sessions and break-out groups of I.A. to think much more broadly, often about matters that confront us as a species. And when you’re ten miles out, amidst the elements of nature, you’re not far from existential issues.

I invariably come back from Star Island recharged, though sleep-deprived — those gulls wake up early! For a few weeks thereafter, I view my client companies through a different lens: one that’s longer term, perhaps more existential. Where is this company going? Are they really making progress?

Post-vacation is the time to take a fresh look at things, to begin what my home improvement client Moonworks (Woonsocket, RI) started on a pre-vacation basis last week by gathering its senior management team to initiate a strategic planning process. This 18-year-old reseller and installer of Andersen Windows, Gutter Helmet, roofing, siding, and insulation developed an agenda (thanks to COO Matt Weiner) which seems appropriate as a place to begin for a lot of smaller companies. What follows are the key discussion elements of this first meeting:

The Objective: To build the foundation of a plan to maximize company value within five years. Translate into Annual Operating plans to drive management activity.

The Process: Exchange perspectives on each of the major topics below leading to a statement of consensus (or differences). Identify areas requiring additional research and inquiry. Assign work items and time frame for completion. Follow up.

1. Market conditions — What’s viewable in the five-year crystal ball, considering both the global economy and our market segment?

2. Trends and opportunities — Can we identify and take advantage of them before our competition does?

3. State of the Company — What’s our candid assessment in terms of (a.) leadership; (b.) middle management effectiveness; (c.) financial condition; (d.) product positioning; (e.) outside partners and vendors?

4. Revenue forecasts — Considering product life cycles, what are the assumptions leading to best estimate, best case, and worst case sales projections for each of our existing products and services for the next five years?

5. The Vision thing — What will be the profile of the Company in 2016 as described by (a.) revenues and profit; (b.) markets and geography served; (c.) market position and brand development; (d.) core capabilities; and (e.) organizational structure?

6. Reinvention — What new products and services will help to close the gap between the revenue vision in 5a and the best case in 4? What’s the bottom line potential of each?

7. Opportunism with focus — How do we move these beyond the concept stage? Who takes ownership?

8. Do we have what it takes — in terms of product sourcing, management talent, personnel resources, financing, and just plain creative problem-solving — to build a premium value company?

We got many of these issues out on the table in our session last week. A lot of them resulted in follow-up assignments, some of which need some broad and deep thinking. At the risk of losing momentum (see Alligator Bites below), we’ll be scheduling most of our coming meetings after vacation plans in July. Hopefully, the results in early September will reinforce Lesson #1: First You Take a Vacation.

Alligator Bites

Based on years of experience,here’s what we see the typical small or midsized business go through when they’re considering a strategic planning off-site retreat:

Scenario:  The CEO wants to get his/her team working together to build a plan for the coming year or two.  The senior leadership team is buzzing about the excitement.  Everyone is looking forward to having some input on the plan.

The planning retreat is held off-site during a two-day session, which everyone finds rewarding and exhausting. They come out of the session with a clear set of goals and an action plan. Everyone has talked about what they are going to do differently to make sure it does. The team feels energized and looks forward to getting back to work.

Then what happens?

The senior leadership team goes back to work and they face the same chaos that attacks their everyday lives and business once again:

The strategies, goals and action plan you just put in place — seem to fade into the background.

You keep an eye on the financial statements occasionally, and hope it works out. At some point, the financial statements take a turn for the worse, and you jump back in, trying to figure out what’s going on and what you need to change.

The point is, most strategic planning retreats don’t work.

Before you commit to conducting one more strategic planning retreat, ask yourself:

• Does your senior leadership team know how to make a real commitment, not just a “yes I’m on board” commitment, but a “yes I will get this done and I will stake my bonus on it” commitment?

• Does your organization have the skills it needs to execute?

• Can you focus?

• Can you communicate the mission, vision, values and strategic direction of the company?

• Can you drive active accountability — with everyone in the organization?

• Are you willing to dedicate time — not only to the strategic planning process, but communicating it so your team members are able to execute your strategy?

BOTTOM LINE:  Execution is hard work. It requires a relentless focus, commitment and discipline. Before you invest a lot in developing strategy, invest in the skills and resources required to execute strategy. If you’re not ready for change — real change — a strategic planning retreat offsite is most likely another waste of time and money. Don’t let this happen to you.

— Skip Reardon, The Six Disciplines Blog, July 8, 2010

June, 2011

“The role of the CEO is to sit on the side of the hill eating pizza, drinking beer, and having people bring him reports.”

This was said to me a number of years ago, only half in jest, by Chip Johns, Co-Founder, President and CEO of Vanguard Sailboat Company in Portsmouth, RI. He contended that until you were able to separate yourself from the daily fire-fights of operations, you wouldn’t have the space to focus on the critical strategic issues that would lead to a successful exit.

After 15 years of building his company into the largest small boat manufacturer in the U.S. – in part by an acquisition of the Sunfish and Laser brands – Chip achieved separation. But he wasn’t ready to sell. He left Vanguard in the hands of his managers and took off. Together with his young family, he spent six months sailing in the Caribbean, searching for the best pizza and cerveza (not!), and receiving periodic reports from the Company at his various ports of call. The Company did well in his absence.

On his return, Chip resisted the temptation to dive back into operations. Problems that had been solved by his managers during the previous six months could still be solved by the managers. Short-term opportunities could be pursued by the newly-empowered staff. Chip still had the separation – the space – to be an effective CEO, focusing on developing a long-term strategy for selling the Company. With monthly input from a three-person advisory board, Chip set about moving toward the exit by…

1. Articulating a realistic Vision: What does my company have to achieve in five years to make it an attractive acquisition candidate at a premium price? What’s the goal for revenue and EBITDA?

1. Creating the destination org chart: What does this company look like organizationally in five years with 2x revenues? In what slots will we need new people with new talents? Where will we find them?

1. Developing and nurturing the management team: Who are those who will be inspired to build a great company? Who will fall by the wayside?

1. Determining the right product offerings: What will be our major money-makers in five years? How can we determine this? What will be the competitive landscape? How do we identify and develop winners?

1. Discovering and integrating two complementary acquisitions: How do we accelerate the growth of both the top and bottom lines? What is involved in melding corporate cultures?

1. Providing the financial resource: How fast can we grow on internally-generated cash? How else can we fund our growth?

1. Accessing the market: How will we figure out and get ahead of the sales and marketing curve in our industry? What trends are just surfacing today that will be commonplace in five years?

1. Ensuring excellent execution: Do we have policies and procedures in place to provide a solid basis for managerial accountability? What additional measurements will promote top performance?

1. Developing a compensation strategy: Who deserves the biggest rewards? What’s the right balance between salaries, incentives, and stock? What will it take to keep key people on board?

1. Identifying the likely acquirers: Who’s buying? Who’s expanding? Who’s on the outside of our industry, looking to get in? How do we establish and maintain connections with the likely players?

Five years to the month after his return from the Caribbean, Chip successfully negotiated the sale of Vanguard at the top of the market in 2007. So is he now sitting on the side of the hill, eating pizza and drinking beer, and wondering why no one is bringing him reports? Far from it: he’s in the due diligence phase of the acquisition of another manufacturing company, planning to build that company in the same way he built Vanguard – though presumably with a strategic plan that involves neither the Caribbean nor drinking beer.

Alligator Bites

In 1983, Professor Neil C. Churchill with Virginia L. Lewis wrote a seminal article in the Harvard Business Review, The Five Stages of Small Business Growth, stages which he identified as Existence, Survival, Success, Take-off, and Resource Maturity. Despite the passage of 28 years, many of his observations of Stage IV, the Take-off, still apply. To wit:

“In this stage the key problems are how to grow rapidly and how to finance that growth. The most important questions, then, are in the following areas:

“Delegation. Can the owner delegate responsibility to others to improve the managerial effectiveness of a fast growing and increasingly complex enterprise? Further, will the action be true delegation with controls on performance and a willingness to see mistakes made, or will it be abdication, as is so often the case?

“Cash. Will there be enough to satisfy the great demands growth brings (often requiring a willingness on the owner’s part to tolerate a high debt-equity ratio) and a cash flow that is not eroded by inadequate expense controls or ill-advised investments brought about by owner impatience?

“The organization is decentralized and, at least in part, divisionalized – usually in either sales or production. The key managers must be very competent to handle a growing and complex business environment. The systems, strained by growth, are becoming more refined and extensive. Both operational and strategic planning are being done and involve specific managers. The owner and the business have become reasonably separate, yet the company is still dominated by both the owner’s presence and stock control.

“This is a pivotal period in a company’s life. If the owner rises to the challenges of a growing company, both financially and managerially, it can become a big business. If not, it can usually be sold – at a profit – provided the owner recognizes his or her limitations soon enough. Too often, those who bring the business to the Success Stage are unsuccessful in Stage IV, either because they try to grow too fast and run out of cash (the owner falls victim to the omnipotence syndrome), or are unable to delegate effectively enough to make the company work (the omniscience syndrome).”

Draining the Swamp

“If they choose to do so, most of the top small business credit card issuers can still subject customers to rate hikes on existing balances, double-cycle billing, and other practices barred from personal credit card agreements under the two-year-old [CARD] reform law. That’s according to a recent survey by Card Hub, a credit card comparison website.

“Of the nine largest card issuers surveyed, only Bank of America gives small business cardholders the same protections now required for consumer cards under the CARD Act. Even though most small business cards are personally guaranteed, affect borrowers’ personal credit scores, and function like consumer credit cards, the law does not apply to business credit cards.”

Source: Bloomberg.com, The New Entrepreneur, May 4, 2011

May, 2011

Guess what?

I’m 70 – that’s seven-zero – or at least I will be five days after this newsletter is distributed.

It’s probably jinxing myself to write this, but I feel very good about being 70, even apart from a consideration of the alternative. I’m in excellent health, I feel great, I have lots of energy to spend on my full house of clients (which has gradually replaced my house full of kids), with plenty left over for family, for traveling, for working out, for volunteering, for keeping up with friends. In short, life is good, and I have no plans to change any of it…

Or at least I didn’t until I began to consider the what-ifs. Turning 70 increases the urgency to do that and to provide specifically, rather than just generally, for downside scenarios. After lots of input from many sources, my wife Anne and I realized that the options and opportunities are best presented in an updated family financial plan. Despite my years of developing spreadsheets, Boolean algorithms, and small business financial strategy, we discovered that there’s no substitute for objectivity and broad-gauged experience. Like the shoemaker going to Nike for his children’s footwear, we engaged a personal financial planner.

The five kids, the six grandchildren, and the seven clients are all keepers, but everything else is up for grabs as Annie and I consider what we want our lives to look like in three to five years.

More importantly for planning purposes, in light of the downs and ups in our investment portfolio in the past three years we need to play out some revised income scenarios with varying “what-if” assumptions. The fact that some of the revenue drivers (interest rates, the stock market, real estate prices) are out of our control won’t deter us from constructing alternative strategies to address the risk-reward balance.

In similar fashion, my longest-running (seventh year) client is in the process of extending its planning horizon through 2014. Having recently hired a new COO in response to the President’s vision to build a $25MM business from what is currently a $10MM footprint, we’re creating the blueprint for significant revenue growth. No longer can the company simply be an order-taker for its four major customers (which together comprise 80% of the business). No longer can the sales reps simply chum the trade shows in hopes of reeling in new big fish.

Sustained growth for this company requires the development of a long-range plan with detailed assumptions in four major areas: Revenue, Staffing, Sales/Marketing, and Capital Expense, with R & D becoming a fifth factor in a year or two. The rest of the financial plan is largely a function of decisions in these areas, and among them the dominant issue is revenue generation. So that’s where we have started, by asking the following questions:

1. What’s the five-year sales history of all of our currently-active accounts? What does this tell us about their prospects for the next three years?

1. What do we know about the market position of each of them that will help us to forecast their future requirements for the products that we provide to them?

1. How much penetration do we have as a vendor to each of them?

1. What new products are they developing that we can manufacture for them?

1. To what extent are they likely to provide their additional manufacturing capability in house vs. outsourcing?

1. How good is our connection to them in terms of our historical performance, personal relationships, unique expertise, and competitive position?

1. With respect to new customers, where do we find the best prospects? Should we stay within our defined industry or branch out?

1. Do we target established companies ahead of start-ups?

1. Is there any mileage to be realized from “rehashing” (in an organized way) prospects that we have connected with at any time in the past three years, to requalify them?

1. What’s the prospective revenue from each of the existing accounts vs. the potential among new customers?

Addressing all of these questions points the discussion toward related areas: marketing tactics, sales compensation and incentives, product mix, pricing, our own production capacity (with staffing and equipment/facilities considerations), targeted profit margins, etc. And the net of it all is…

How do we pay for this growth? Will internally-generated funds be adequate? Will we have the collateral to support bank financing? Will we need to go to the equity market? If so – when, where, and how?

…All of which brings us back to life at (st)age 70. When you’re growing or declining as an individual or as a business, running out of cash is more than a theoretical prospect. While you can’t plan for all contingencies, planning for none of them and assuming that tomorrow will be pretty much like today is seldom a winning long-term strategy. A single finger in the breeze is not a barometer. Who’s your weatherman?

Alligator Bites

“Bad planning on your part does not constitute an emergency on my part.” - Proverb

“He who fails to plan, plans to fail.” - Proverb

“Planning is bringing the future into the present so that you can do something about it now.” Alan Lakein

“A good plan violently executed now is better than a perfect plan next week.” - General George S. Patton

“Let our advance worrying become advance thinking and planning.” - Winston Churchill

“Organizing is what you do before you do something, so that when you do it, it is not all mixed up.” - A.A. Milne

“When planning for a year, plant corn. When planning for a decade, plant trees. When planning for life, train and educate people.” - Chinese Proverb

“It pays to plan ahead. It wasn’t raining when Noah built the ark.” - Unattributed

“Unless commitment is made, there are only promises and hope, but no plans.” - Peter Drucker

“Good fortune is what happens when opportunity meets with planning.” - Thomas Edison

Source: - ThinkExist.com

Draining the Swamp

For planning purposes:

Source: The Kiplinger Letter, April 1, 2011