What is an entrepreneur to do when the economic climate is weak, subject to further shocks from the Covid and can’t rely on forecasts of sales, revenue, profit and cash flow?

I’ve created 3 categories of businesses and explain what’s going on for each group and what they can do. The first includes those dealing with complete (or nearly) loss of business. The second includes those whose revenue has fallen more than 25%, and the third less than 25%.

Category 1: Complete Loss of Revenue Faced with no way to generate revenue the goal is survival, and my recommendation is hibernation in which they furlough all or nearly all employees and incur and spend virtually nothing. They will need to negotiate with the parties with whom they have commitments (banks, landlords, et al) to abate, defer and reduce expenses. I suggest taking the approach that these vendors and lenders are better off having the business re-open after the pandemic then to have them close for good.

These companies should also look to government programs to get them through the pandemic. These include PPP and EIDL loans as well as state and municipal programs.

Lastly, if they can find and make a pivot that will generate short term incremental profit to help pay bills and keep employees, they should act.

Category 2: Revenue losses greater than 25%. They need to focus on current sales, collections, expenses and cash flow while also looking for any indications that their revenues will start to decrease. They should take a cautious approach and assume that because everything is fine today it will be fine tomorrow.

Because cash is king and some business customers may continue to order products and services, companies need to make sure their customers are continuing to pay., If receivables or past due amounts are increasing, they need to be prepared for these customers to go out of business.

These companies should develop leading indicators to alert them to future reductions in revenue. Once a sign of negative future activity arises, management must respond and avoid the hopeful tendency to say it’s an anomaly and ignore it. Waiting too long to address reductions in a business could itself spell trouble for that company.

On a more positive note, they should look for ways to capitalize on the current economic environment including pivoting to new products and services and opportunities to acquire weaker competitors.

Category #3: Revenue loss less than 25%.  If the companies are still generating positive Operating Income and Cash Flow, reducing expenses should be limited to fat which may not have been seen before the pandemic. Where possible, they should look for ways to improve operations and margins to come out of the recession as a “lean mean fighting machine.” They can also use their strong position to look for opportunities to acquire weaker competitors at bargain prices.

If you would like to discuss how CFO Options can help your business strategize and build financial models, please contact Larry at llevy@CFOoptionsinc.com

 

 

Do you know your company’s Gross Profit margin? What about my major product lines? Or by major customers?

 

Whether you are a manufacturer, a distributor, reseller or service company, knowing how much money you make on each product, product line, revenue stream, channel, contract or customer is critical to maximizing your profitability. Simply put, if you don’t know the Gross Profit margin for one or more of these views (and which of those views is most important varies by industry and company), you are driving blind on your path to profitability and/or maximum profitability.

Let’s start with an explanation of what gross profit is using an example of a reseller/distributor/wholesaler with two major product lines.

If it sells Product line A for $100 per unit and if it buys each unit for $65, its gross profit, on direct costs, is 35%. We get that by subtracting the cost of $65 from the sales price of $100 and then dividing by the sales price of $100.

For Product Line B, it sells for $250 per unit and buy for $225. Using the same math, the company’s gross margin on Product Line B is 10%.

Would you rather sell one unit of Product A at $100 or one unit of Product B at $250? If you’re focused on growing sales, the answer is B, but the sale of one unit of Product Line B only generates $25 in gross profit while the sale of one unit of Product Line A generates $35 in profit.

So, I ask again, would you rather sell one unit of A or one unit of B?

With a focus on gross profit (and ultimately total profit,) I would choose to sell one unit of A and make $10 more than selling one unit of the higher priced Product B.

If this company were currently selling 1000 units of Product A each month and 1000 units of Product B each month, its revenue would be 1000 x $100 = $100,000 plus 1000 x $250 = $250,000 for a grand total of $350,000 in sales. How can we use what we learned about Gross Profit to help this company increase its Gross Profit (and ultimately net profit)?

Assuming the same amount of sales effort (salespeople, marketing, etc.) is required to sell the same number of units of each of A and B, what if they changed their sales and marketing efforts to sell more of A? Let’s say that they set a goal to sell 1500 units of A and 500 units of B (the same total number of units.) The revenue at that goal would be 1500 x $100 + 500 x $250 = $275,000. That’s a decrease of $75,000, but let’s look at how Gross Profit changes.

In the original scenario selling 1000 of each, the company generates gross profit of 1000 x $35 + 1000 x $25 = $60,000. Looking at the second scenario where revenue decreases by $75,000, gross profit would be 1500 x $35 + 500 x $25 = $65,000. Thus, with a $75,000 decrease in revenue they’ve increased gross profit by $5000 or about 10%.

There is much more than can be done with gross profit/margin analyses from looking at it by customer, revenue channel or specific contract. One can also incorporate indirect costs (e.g. people who help provide or support the product) as well as look at the impact on commissions which are not normally considered part of gross profit but are variable cost.

If you have any questions or need any help looking at gross margin for your company, please do get in touch with me a llevy@CFOoptionsinc.com

 

 

How Do You Judge Productivity for Employees Who Do More than Repetitive Tasks? 

Business owners often push for productivity, and in a company where there are 10 or 1000 people doing the same task over and over again, it’s easy to set a goal and measure whether it’s being achieved by each individual, a department or a production line. But what can you do in a smaller office-based environment where you have one to several employees that wear multiple hats that include data entry, updating spreadsheets, analyzing, thinking critically and making recommendations and/or decisions?

Throughout my career, from my first job that included mostly data entry to my more managerial and thinking roles, I’ve always been one who gets things done quickly (and accurately). Because of my own abilities, which in large part I drove myself to because of the expectations and coaching of those I worked for, I’ve set high expectations for all who’ve worked for me—ask any of them. Many were great at their jobs—quick and accurate on the task side and intelligent and insightful on the critical thinking aspects of their jobs.

Unfortunately, I’ve also had a few employees that weren’t so productive. What made me think so? Essentially, I said to myself, “how long would it take me to do that job?” And to the extent that my quickness was/is an aberration, I’d give the person the benefit of the doubt by taking some discount for my quickness. And to be fairer, if not also accurate, I would think about other employees (current or past) that did similar tasks with similar complexities and available tools, and ask myself, how long did/would this have taken that person.

In a recent situation, a client had a full-time controller who had been with the company in that role for several years. As their outsourced and part-time CFO, I didn’t see what this controller did all day each day, but I was convinced that it shouldn’t take him as long as it seemed to take him to do his job. A few months ago, when he resigned without notice, I was asked to step in to his role until we found and started a replacement. Despite not knowing all the systems, where he got all the information to do commissions and journal entries and such, I completed his job for that month in just 20 hours.

How could this be I asked myself? There are two possible answers. Let me describe them both and then I’ll tell you which one applied here. First, the employee genuinely works hard but just can’t get very much completed. Second, the employee’s work ethic and, in turn, productivity, expands or contracts like a balloon. The more work there is to do, the more productively they work, and the more work gets done. The less work there it to do, the slower they do it so that they appear busy but they really could handle a lot more.

In the situation described above, the employee was genuinely working hard but just wasn’t productive. Interestingly, I unknowingly hired someone who fit the other description years ago. This employee joined at a time of great expansion within the company, did a great job and took on more and more work till I agreed that more staff were needed. It wasn’t till several years later when the company was shrinking due to divestiture and I was working in the same office but in a different division, that I recognized what was happening. This employee was now working slower, I believe intentionally, to make it look like he/she was busy all day yet the amount of work he/she had was not nearly as great as several years before when he/she got it all done in a normal workday.

So, what should you do if you have an employee that says they can’t get it all done and you either don’t agree or aren’t sure? If you have someone to compare their workload to, do it. If you don’t, reach out to me or someone in your network to see if they can provide a comparison.

And if you find they are not being nearly productive as they should be? Then what? There are three paths: 1) you talk to them about your expectations and, in short, ask them to step up their game; 2) you start looking for a replacement and 3) you grin and bear it. Before I conclude, a few thoughts on each.

If you ask them to step up their game and do it in the best possible way, many employees will either not be able to step up their game or will give lip service to it but not really change. While I err on the side of giving the employee an opportunity to improve to your expectations, don’t be overly optimistic and potentially blind yourself to things not actually changing.

If you start to look for a replacement, how do you prevent someone that is not any more productive than the person they replaced? Many candidates can say all the right things in an interview and then not live up to the hype. However, if you know that productivity is a concern going in, then ask them open-ended questions on the topic. Ask them for examples where their work output exceeded a predecessor or co-worker. Where possible, ask them to tell you how many of something (e.g. entering invoices into an A/P system or entering actual sales amounts into a sales report) they could do in an hour. Or conversely, how long it would take them to input 50 of this or 100 of that. And since they can talk a good game, ask their references about their productivity and quickness.

If you grin and bear it, you will likely continue to be frustrated. Moreover, they may help establish a pattern of less than stellar productivity among others in their department or across the company.

I do realize my views and perspective on this are tough, and maybe overly tough, and thus I greatly welcome your feedback. You can email me at:  llevy@CFOoptionsinc.com

 

What is a strategic plan and how can it help me and my business?

If you run a company and you’re thinking about where you want that company to go, developing a strategic plan can help you crystalize your goal(s) and, even more importantly, how you’re going to achieve them. In short, it’s about setting a goal and a plan to make it a reality.

You may ask “why bother to create a strategic plan?” when you already know your goal and just need to keep doing the same thing you’ve been doing. If you have no doubts about your goal or that doing what you’re doing is working, then you probably don’t need to do strategic planning at that point. However, a year from now you may look back and realize the plan isn’t working or that you’ve achieved your goal and now you want to set a new one for which just doing the same thing may not be enough.

If you’ve thought about developing a strategic plan or if this article is getting those thoughts started, then please read on as I pose and answer a few key questions:

How will a strategic plan help my company?

Upon the completion of a strategic plan, you will not only have a well-thought-out goal that’s been discussed and agreed to by your leadership team and other key employees, you will have a plan to make it a reality. If your goal is doubling revenue, the strategic plan will address the number, type and quality of salespeople, the types and amount of marketing you need to do, the products you are going to offer and develop, your pricing strategy and customer retention.

Further, all these ideas should be put into a financial model to tell you whether your assumptions, fully executed, will get you to your revenue goal. If not, your team needs to keep working on the plan so that it does—without just changing the assumptions to make the numbers work in a spreadsheet but coming up short in reality.

That same financial model should also show you how much cash you will burn executing the plan before the revenue and gross profits start bringing in more cash than is going out. This is really important to know before you start executing the plan. If the plan will put you in a negative cash position, you’ve either got to get access to additional cash or slow down your plan so that you don’t go into a negative cash position.

Who should participate in the creation of a strategic plan?

I always include the leadership team of the company. You can also include certain key employees who you think are a) interested in the growth of the company, b) will have ideas to help you get there and c) whose buy in will be helpful in executing the plan. It’s often a really good idea to have someone from the outside help your team develop the plan with a key role being challenging assumptions (particularly of the owner/CEO) whom others may be hesitant to challenge. It’s also important to have a leader who keeps the discussions on track. Bringing up issues that will be obstacles to success is important; complaining without solutions is not helpful or a good use of time.

What do we do after we’ve completed a strategic plan?

Typically, you want to let your entire organization know where the company is going and how you plan to get there. Everybody that took place in the creation of the plan should be 100% behind it and help champion it amongst the rest of the company.

Set quarterly and annual goals for each manager, department and in many cases individuals. This will help in two ways. First, achievement of each sub-goal will get you closer to achievement of the larger goal. Second, you will have measuring points each quarter and year to stay on track.

Meet at least annually with the same people that created the goal to review progress to date, new and/or unanticipated obstacles that have come up and make adjustments to the plan, even if just tactics, to keep you on the path to full success.

 

If you’re interested in exploring the development of a strategic plan and the accompanying financial model I mentioned, please reach out to me at  llevy@CFOoptionsinc.com

 

Can You Make It Up In Volume?

Watching a colorized version of an episode of the I Love Lucy show, I ignored the colorization and kept thinking about Lucy’s get rich quick scheme.  In this case, the Mertz’s (their neighbors and best friends) convince her that she should sell her homemade salad dressing.

After she and Ethel Mertz go on TV to advertise it, they start getting lots of orders, and Lucy goes to the supermarket (Were they called that in the 1950s? Were they even super then?) and starts making jars of salad dressing. In walks Ricky (her husband, for those of you who may not know the show.) He asks what’s going on, and she explains. That’s when the future Marcus Lemonis (of current day TV show The Profit) invades the body and brain of Ricky and asks how much it costs to make one bottle and how much she is charging. She recites the numbers, does some calculations and determines that it costs her $0.22 to make each bottle which she is selling for $0.25. Ethel reminds her that 3 cents of every sale goes to the person who got them on TV to advertise for no cost.

Lucy and Ethel realize that all their hard work will make them no money. And Marcus/Ricky points out that they haven’t even factored in the cost to ship to the customers.  At this point Lucy says: “I’ll make it up in volume.” Ricky scoffs.

While Lucy should have known about what her costs would be before she priced her salad dressing and started marketing it, I’d like to explore her idea that she can make it up in volume. Having a gross margin of 0% is not a recipe (pun intended) for a profitable company. Nor is selling more and more of a product or service that produces no gross margin will not yield profits for any company. Yet, is it possible that she can make it up in volume? I say she could.

Since Lucy was buying the ingredients and jars from a grocery store at retail, her costs would go down considerably with higher volume as she is able to buy from a wholesaler and negotiate better and better pricing. Then there’s that labor issue. She and Ethel were making and bottling the salad dressing and were not factoring their cost of labor into their gross profit/margin analysis. Because their time is valuable and, moreover, because they can’t personally handle ever increasing volume of production, they will need to factor the cost of making the salad dressing as well as packaging it and preparing it for shipping. The good news is that there are efficiencies of scale available here too.

In sum, visionaries and entrepreneurs who are going to create a product or service need to think about their costs to make and deliver that product/service before they start making and selling the product or service. And if the profits at low margins are insufficient or negative, they also need to look the profit margins at higher volume levels and ask themselves is it worth the investment to cover the losses until they get to profitability. This is true whether you’re investing your money, your friends’ and family’s money or that of other investors. If the market won’t sustain a price that generates a sufficient gross profit margin after efficiencies of scale have been achieved, then they might find themselves chasing their tail and throwing good money after bad. And, if there are no efficiencies of scale available, no that going in.

 

You’ve finished your budget. Now what?

Companies big and small develop an annual budget and spend a lot of management time discussing, creating and finalizing it. Much of that time and effort is wasted if you don’t spend even more time working to execute the plan in the budget and hit your financial goals. Here are five tips for achieving the financial goals in your budget:

  1. Make sure everybody on your management team, if not everybody in the company, knows what your financial goals are for the year and what your plan is to attain those goals. Your budget is a detailed numerical outline of your goals and plan so that means you’ve completed your goals and plans for the next year. To attain those objectives, get your people familiar with your goals and how you plan to achieve them. Whether your company has an open book philosophy or keeps its financial performance limited to a select few people, you can inform everybody of your goals and plans; the more you lean towards open books, the more details you’re willing to share. In sum, the more your team knows what you’re trying to achieve and how you plan to achieve it, the better your chance of success.
  2. Get each of your managers to demonstrate both buy in and responsibility for achieving their section of the budget as well as doing everything possible to help the company achieve its overall financial goals for the year. For example, the VP of Sales should be positive and optimistic when sharing the sales departments sales and revenue goals for the year. There should be no second-guessing the plan after it’s been finalized. The time for that was during the development and finalization of the budget. Another example, the VP of Engineering should not join the naysayers if they say “but we can’t achieve these goals without more resources.” Your team needs to see and hear that their leaders have confidence in the plan and the company’s ability to achieve the financial goals.
  3. Manage to your budget. You and each of your budget-responsible managers must refer to the budget when making spending decisions to make sure each department’s budget stays within budget. This is particularly true when you’re about to spend a large amount of money (relative to the size of your budget) and/or that he/she knows the expenses are not included in the budget. The first step is to see if that expenditure is included in your budget. If so, you can proceed, but if not, your next step should be to figure out what you can cut out of your budget (either in full or in part) so that you can go forward with the current spending decision and still hit your expense budget for the year. While it’s best to start looking at your budget for that line item (for example, Advertising,) there is generally nothing wrong with reducing one type of marketing expense for another type of marketing expense. The manager in charge of marketing, for instance, could reduce advertising expense to help pay for an additional employee so long as he/she is still focused on achieving the marketing, revenue and profit goals of the company.

But what should a manager do when he/she believes it is very important to incur an unbudgeted expense and can’t find or is unwilling to reduce other line items in the his/her budget to keep within the budget for the year? First, it is part of the manager’s job to make tough decisions, and spending less on some things to get something else they want can be a tough decision. Their goal should be to find the needed money within their own budget. If they don’t, can’t or won’t, then the decision should be discussed by that manager with his direct supervisor or peers. That manager should come to such a meeting prepared to make the argument that the company is more likely to hit its current year financial goals (typically at the EBITDA or Net Income level) if they spend the money on his/her unbudgeted item and give up something in another department’s budget. In the absence of an agreement among those people, a VP or CXO could request a decision by the CEO or COO. Decisions made at that level should also look first to reduce expenses elsewhere in the budget which would keep total expenses for the company within budget for the year.

  1. The CFO, whether full-time or part-time or in the absence of either the Controller, should produce and share departmental income statements with comparisons to budget that also show how much money is left in each line of the budget for the year. Before continuing, let’s be clear on what a departmental income statement compared to budget is. It shows the actual expenses and budget expenses for each line item in each respective manager’s budget. It should be produced showing the current month (i.e. the one most recently completed) along with year-to-date figures for each of actual and budget. For all periods, it should show the variance between actual and budget meaning how much over (a negative variance for expenses) or under (a favorable variance for expenses) that department was for that line item for the period.

Certain accounting software programs including Quickbooks Online offer an option to produce a column that shows the amount remaining in the budget for the year for each line item. Please be aware, however, that when you call this report from Quickbooks, it includes all actual expenses that have it the QBs general ledger for the year—not just year-to-date for the closed accounting periods. Thus, if your accounting team has closed the books through April and then produces and distributes the departmental income statements showing the remaining amounts for the year, it will include those expenses that have already hit the general ledger for May (and possibly beyond if you have recurring journal entries.) There is a positive to this in that your manager will see what they’ve incurred for the whole year not just through the end of the last closed accounting period, but the total spend will differ from the amount on their year-to-date departmental income statement. If you want your managers to see what’s remaining as of the end of the last closed month, you can export the report to Excel and change any actual numbers after the closed month to zero.

  1. In the absence of a board which approves budgets and/or spending plans, the CEO may decide that the company should spend money on an unbudgeted item to either help improve the likelihood of attaining its current year goal or investing in the growth of income in future years. Typically, such decisions involve input from the leadership team, and the company CFO, again either full-time or part-time, should be advising the CEO as to the impact on cash, financial covenants with lenders, and commitments to the board if not also playing the more conservative devil’s advocate.

Annual budgets are great planning tools. To make them great execution tools and help you reach your annual financial goals, I strongly urge you to take the steps described above. If you have any questions or need help with this, please reach out to me at llevy@CFOoptionsinc.com

 

WHEN GROWING YOUR TOP LINE, HOW DO YOU ENSURE YOUR BOTTOM LINE ALSO INCREASES?

Most business owners and CEOs want to grow their top line, and many do something about it (launching new products, hiring more salespeople, investing in marketing and driving more revenue from their existing customers.) As their Chief Financial Officer, I put a focus on growing profitably.

There are two ways to make sure your grow your bottom line while putting an emphasis on increasing revenue. The first is to make sure that you are selling more of your most profitable products and services, and the best way to do that is to understand your costs of goods sold and your gross profit margin. For those not familiar with those terms or how to determine them, here’s a recap using an example of a company with two products.

Product A                                          Product B

Retail Price                                                                     100.00                                                100.00

Costs of Goods Sold

Direct Costs*                                                                    40.00                                                   80.00

Shared Costs**                                                                  10.00                                                   10.00

Total Costs of Goods Sold                                             50.00                                                   90.00

Gross Profit (Retail Price less CGS)                             50.00                                                   10.00

Gross Profit Margin (GP divided by Retail Price)     50%                                                     10%

*Direct costs are those that are incurred each time a new product is produced or provided. If your product is tangible, this would include your raw materials and manufacturing costs per unit.

**Shared costs are incurred to produce or provide your service but do not increase a certain amount each time a new product or service is provided. Instead, your company might incur a cost that is shared amongst many customers but is not limitless. To distinguish a shared cost from overhead, ask yourself whether you would have any cost if you had no customers or revenue.

In the example above, the gross profit margin of Product A is 50% while the gross profit margin of Product B is 10%. For every $100 of Product A sold, $50 of gross profit is generated, but for the same amount of sales Product B, your company would only make $10 of gross profit. What becomes obvious at this point is that growing sales of Product A will lead to higher profits and higher enterprise value than growing sales of Product B.

Continuing our analysis of the growth in sales among these two products, we also need to consider the sales and marketing costs related to the sale of each product. If you have a 20% cost of sales and marketing for both products, then selling more of Product B will actually cause a decrease in your profitability. While reaching this conclusion is obvious once you know your gross profit margin per product/service and your cost of sales (or acquisition cost), it’s vitally important that you pay attention to these things before you embark upon your growth initiative.

The last piece of the equation is your overhead. After focusing on sales of products and services that produce a strong gross profit that more than covers the costs of sales, you need to keep your overhead as stable and as low as possible. The math is obvious, so I won’t bore you with an example. Restricting the growth in overhead is the challenge. As more customers are sold and onboarded, there is likely to be pressure from front-line workers and their managers to increase headcount. While some growth in headcount may be necessary to support the increase in revenue, there should also be significant synergies from volume. To the extent your business and products truly require X number of people to support Y dollars in revenue or number of customers, then it’s important that you factor those costs into your gross profit analyses as shared costs. While accounting rules may not allow your accounting department to put the costs for these people in Costs of Goods Sold, you must determine ahead of your growth whether there is sufficient revenue to cover all of the variable costs of delivering that product or service.

In conclusion, growing your top line is typically a means to an end—more cash flow and/or higher enterprise value. If your goal is greater cash flow, look at how your costs will increase as you grow your revenue and determine if the revenue growth will make you more profitable. If your goal is higher enterprise value, know that while some companies are valued at a multiple of operating income (or EBITDA in accounting-speak) and some at a multiple of revenue, higher gross margins and higher total profitability will have a positive impact on your value.

If you or someone you know would benefit from a discussion about how to drive higher profits while growing your topline, please contact me at llevy@CFOoptionsinc.com

 

Top line growth is great, but don’t forget your bottom line.

Whether your company has been around for years or decades or if you’re a start up with revenue, you probably want to grow your business. For many entrepreneurial CEOs, growing their business is first and foremost about increasing revenue, but is growing your top line the only thing you should be concerned with? My answer is a definitive “NO.”

Top line growth is a means to an end, and the end is some combination of greater profits and increased valuation. Let’s look at two scenarios.

In the first, we have a five-year old business that’s got between five and ten million in revenue, is reasonably profitable and wants to double its revenue in the next five years. The ultimate outcome of the goal to double revenue should either be to grow cash flow or increase the value of the company for a sale at the end of that five-year period. If the owner wants to grow the company and retain ownership for the long run, I expect they want to grow the company to make more money. Thus, it’s important to make sure that profits grow significantly over the five-year period and not just the revenue. If they want to exit the business at the end of those five years, will their company be more valuable with higher EBITDA? In most cases, the answer is yes. Even though some businesses are valued based on a multiple of revenue, the buyer’s financial team is also looking at how much cash flow and profits they will be adding to their company when they close on the acquisition. The more profitable the business, the higher multiple of revenue the buyer can justify internally and/or to their investors and lenders.

In the second scenario, we have a two-year old startup with one to two million in revenue that is targeting $10M in revenue within three years. Further, due to the sector they are in, they are seeing other companies sell for a multiple of annual revenue, monthly recurring revenue or number of subscribers. With access to capital from existing and new investors, should they be paying attention to their profitability in addition to just growing their top line? Again, my answer is YES for some of the same and some additional reasons as compared to the first scenario. In addition to the likelihood that greater profitability can drive a higher multiple of revenue or subscribers, the best reason for a startup to focus on profitability is that the more profitable you are (and in some cases that means smaller operating losses,) focusing on higher profitability allows the entrepreneur to conserve cash. The more cash he/she can generate means the less capital they have to raise and the less dilution for founders and early stage investors. Further, higher levels of profit allow for the reinvestment of more cash into producing higher revenues.

In the end, striving for the highest possible gross margins and highest possible operating income will help increase the value of your company and provide more cash for continued growth while limiting the dilution of the founders and early stage investors.

If you or someone you know would benefit from a discussion about how to drive higher profits while growing your topline, please contact me at llevy@CFOoptionsinc.com.

 

Are You Ready for the City of Chicago’s Proverbial Knock on the Door

If the City of Chicago hasn’t already approached your business looking for Sales & Use Tax returns and money, you should be prepared for their knock.

For years, State and Municipal governments have become more and more aggressive in collecting Sales & Use Tax from businesses within their boundaries on purchases where the vendor didn’t bill any or the correct amount of tax. In some cases, companies buy tangible goods from out of state, and the vendor doesn’t bill IL sales tax. In other cases, a vendor in a suburb might bill you the IL+suburban tax when the City of Chicago expects the higher City of Chicago tax to be billed and paid.

Further, the City of Chicago has decided to treat Software as a Service the same way it does the rental of personal property and is applying their personal property rental tax rate against SaaS services. While taxing a service doesn’t make sense, their argument is that each company that uses SaaS is essentially renting their vendors services which are tangible personal property.

To give you a sense of what might be coming down the pike:

  • A client of mine was contacted by the City of Chicago Dept of Revenue looking for tax returns going back to the inception of the company. To the best of our knowledge they found my client by looking at Illinois Secretary of State records for businesses with addresses in Chicago.
  • We had to determine the amount of purchases of tangible items that were not fully taxed for each year ending 6/30/XX and the amount of SaaS that were taxed by the vendors for each of the same years. Not an easy or fun process. Because my client had not filed the forms for either the Purchase of Tangible Personal Property or the Rental of Personal Property, we had to dig through old records to determine the numbers that applied for each year.
  • Because the City of Chicago has changed rates effective 1/1/XX but their returns are for the 12 months ended 6/30/xx, we had to file two returns for some one year periods.
  • Because the City of Chicago created its business small tax exemption effective 1/1/16, we had to file two returns for the year ended 6/30/16.
  • The rate on SaaS was 8% for a few years, increased to 9% and then went down to 5.25% on 1/1/16.
  • The 5.25% rate is only applicable to SaaS services where the user is putting their data on the vendor’s server. Thus some but not many SaaS services are still taxed at the 9% rate.
  • Because this client is a small business and was less than five years old for part of this period, we were able to take advantage of the “small business tax exemption” which went into effect 1/1/16 for businesses less than five years old and with revenue of less than $25M.

You may have heard references over the last few years to Chicago’s “Cloud Tax.” When it comes to Chicago charging taxes on SaaS, this is what they are talking about. If you are not remitting your taxes due monthly and filing the returns each year by 8/15/XX, I expect that some day you will get a letter asking you to complete the forms, pay the tax and interest. They seem to be lenient about penalties.

While each of you and every other business owner in Chicago will make their own decision as to whether to start filing returns and remitting payment for back years as well as current payments or to wait until they come knocking, you should know about these taxes and the fact that the City of Chicago is likely to find you and have you pay all the back taxes plus interest.

If you wish to discuss this with me, please let me know at  llevy@CFOoptionsinc.com

 

What’s the best way to increase your profitability?

Almost every business owner I know wants their business to make more money. It can allow them to reinvest, expand their product offerings and increase future sales or it can allow them to put more money in their own pockets. Further, more profitability and greater cash flow generally increase your ability to borrow money to grow as well as increase the value of the company should you look to sell or bring on an equity partner.

So, what’s the best way to increase your profitability?

You could focus on increasing sales and revenue, but that does not guarantee increased profits and profit margins. Why? First, your efforts to increase revenue will typically cost money and profits in the short term. If your investments in marketing or additional salespeople don’t have positive returns on investment, your profits and margin will go down. Second, even when those efforts succeed, you could sell more of low or unprofitable products and services. Third, you could increase expenses other than sales and marketing and find your company with less profit.

You can also reduce expenses. If there are expenses that can be reduced or eliminated without breaking your systems and/or impacting customer satisfaction, you should always be looking at those opportunities. However, if you’re trying to grow your revenue too, reducing expenses in the wrong places or in the wrong way could hurt your ability to onboard new customers and keep them happy along with your existing customers. In the long run, this path could lead to higher profits in the short term and lower profits in the long term as old and new customers leave.

My recommendation is an approach that focuses on profitable top line growth with carefully chosen expense reductions. What do I mean by “profitable top line growth”? It’s new revenue that brings in more revenue than the expense incurred to generate the revenue and provide the service or product. Whether you are a product or service business, I strongly urge the use of a Cost of Goods Sold section on your income statement resulting in a gross profit margin or the percentage of your revenue that’s available to cover overhead costs and yield a profit for the owners.

I’ve found that some businesses either don’t pay attention to their gross profit or, if they do, only look at it companywide and not by product or service.  Focusing on your gross profit margin in total and by product or service, understanding how it’s changed over time and finding ways to improve it in the future are keys to increasing your company’s profit. There are three ways to increase your gross profit margin. 1. Increase your price while holding your costs steady. While this sounds simple, market forces do no always allow businesses to increase their prices. 2. Find out which of your products have the highest profit margins and focus your sales efforts on those products. 3. Reduce your costs of goods sold. While certain costs may be hard to reduce, there are often unseen opportunities that just takes some effort. Tactics include switching vendors, re-negotiating with existing vendors, eliminating costs that are no longer needed.

In sum, efforts to increase your profit and profitability should look at all three areas: increasing revenue, reducing expenses and improving your gross margin. While increasing revenue is always a key strategy to grow a company, doing that in conjunction with improving your gross profit margin and holding overhead expenses in check is the best route to improving your bottom line. If you’d like to discuss how you can improve your company’s profits, reach out to me at llevy@CFOoptionsinc.com.

 

The Year is More than Half Over, Is Your Budget Still Relevant?

Has your company ever been in the position where the budget you put together in the fall seems less and less relevant as each month goes on? If so, read on.

Revenue-related variances:

If the products you sell are of a monthly recurring charge nature (MRCs), your monthly revenue on your accrual-based financial statements are more impacted by what you sold in the months to date than they are the current month. For example, if you planned to sell, turn up and recognize $10,000 of new MRCs each month of the year, you would have added $780,000 of additional revenue for the entire year. However, if you only sold $5000/mo in the first six months of the year, can you hit your annual budget by selling $15,000/mo July – December? Even though you would have still sold $120,000 of new MRCs in the year, you’re only going to see $600,000 on your year-end P&L leaving you $180,000 under budget.

Getting to your original goal of $10,000 of new MRCs per month may be possible—maybe even $15k/mo. But can you get to $24,000/mo of new MRCs July to Dec? That’s about what you need to do to hit your annual revenue goal of $780,000 new revenue on the P&L.

Let’s assume you can’t. Should you continue to use your original budget and continuously be way under (or over budget) or re-budget? I say keep comparing your actual performance on the P&L to your original monthly and YTD budget. To ignore the original budget is equivalent to ignoring your goal for the year, and ignoring one goal makes future goal-setting, for you and your team, less and less important and effective.

So, what should you do? In addition to continuing to compare your actual performance to your original budget, I recommend creating an updated plan or forecast for the balance of the year. Using the example above, if you’ve righted the sales ship and can establish $15,000/mo in new MRCs as the stretch goal, then create that goal and measure performance against it. When you do a monthly financial review, you will see that you’re $XX,XXX under budgeted revenue for the month and YTD but at revised goal for new sales.

The same concept works if you’re significantly over budget. Let’s say the company sold $15,000 in new MRCs each month during the first six months of the year. Those sales are going to add $855,000 to your P&L by the end of the year, but you certainly don’t want to stop selling. If you set a revised sales goal of $15k/mo for the rest of the year (or of course more if that’s appropriate), then measure sales performance against that new goal in addition to comparing actual P&L performance against the original budget.

Expense-related variances:

Whether your variances from budget are revenue- or expense-related, continuing to compare performance to your original budget is almost always the best thing to do. If your expenses have changed significantly and by design, I would also create an updated forecast of your whole P&L so that you can compare actual P&L performance to the planned changes you’ve made and captured in the forecast.

Here’s an example. Let’s say you start the year with 5 sales people and all the associated costs for each one (salaries, payroll taxes, benefits, memberships, travel and entertainment, etc,) and you decide to add five more to increase sales even further. Comparisons of actual to budget for sales expenses will always show you over budget. While it’s easy to say “it’s over budget because of the new salespeople,” it’s also easy to miss that sales expenses are also higher due to other non-planned reasons. A comparison of actual to forecasted sales expenses will highlight those items in excess of the designed changes.

The same also applies to planned reductions in expenses. You might see expenses under budget, but without a comparison to forecast, will you be able to see how much more is being spent then you planned?

One final thought: keep the significance of your changes to sales or expenses in perspective. You don’t need to reforecast or do additional analyses each month for small changes.

If you’d like to discuss this further, please reach out to me at llevy@CFOoptionsinc.com.

 

You’ve Completed Your Budget. Now What?

Companies big and small develop an annual budget and spend a lot of management time discussing, creating and finalizing it. Much of that time and effort is wasted if you don’t spend even more time working to execute the plan in the budget and hit your financial goals. Here are five tips for achieving the financial goals in your budget.

First, make sure everybody on your management team, if not everybody in the company, knows what your financial goals are for the year and what your plan is to attain those goals. Your budget is a detailed numerical representation of your goals and plan so that means you’ve completed your goals and plans for the next year. To attain those objectives, get your people familiar with your goals and how you plan to achieve them. Whether your company has an open book philosophy or keeps its financial performance limited to a select few people, you can inform everybody of your goals and plans; the more you lean towards open books, the more details you’re willing to share. In sum, the more your team knows what you’re trying to achieve and how you plan to achieve it, the better your chance of success.

Second, get each of your managers to demonstrate both buy-in and responsibility for achieving their section of the budget as well as doing everything possible to help the company achieve its overall financial goals for the year. For example, the VP of Sales should be positive and optimistic when sharing the sales departments sales and revenue goals for the year. There should be no second-guessing the plan after it’s been finalized. The time for questioning the goals was during the development and finalization of the budget. Another example, the VP of Engineering should not join the naysayers if they say “but we can’t achieve these goals without more resources.” Your team needs to see and hear that their leaders have confidence in the plan and the company’s ability to achieve the financial goals.

Third, manage to your budget. You and each of your budget-responsible managers should refer to the budget when making spending decisions to make sure each department stays within its budget. This is particularly true when you’re about to spend a large amount of money (relative to the size of your budget) and/or that the manager knows the expenses are not included in the budget. The first step is to see if that expenditure is included in your budget. If so, you can proceed, but if not, your next step should be to figure out what you can cut out of your budget (either in full or in part) so that you can go forward with the current spending decision and still hit your expense budget for the year. While it’s best to start looking at your budget for that line item (for example, Advertising,) there is generally nothing wrong with reducing one type of marketing expense for another type of marketing expense. The manager in charge of marketing, for instance, could reduce advertising expense to help pay for an additional employee so long as he/she is still focused on achieving the marketing, revenue and profit goals of the company.

But what should a manager do when he/she believes it is very important to incur an unbudgeted expense and can’t find or is unwilling to reduce other line items in the his/her budget to keep within the budget for the year? First, it is part of the manager’s job to make tough decisions, and spending less on some things to get something else they want can be a tough decision. Their goal should be to find the needed money within their own budget. If they don’t, can’t or won’t, then the decision should be discussed by that manager with his direct supervisor or peers. That manager should come to such a meeting prepared to make the argument that the company is more likely to hit its current year financial goals (typically at the EBITDA or Net Income level) if they spend the money on his/her unbudgeted item and give up something in another department’s budget. In the absence of an agreement among those people, a VP or CXO could request a decision by the CEO or COO. Decisions made at that level should also look first to reduce expenses elsewhere in the budget which would keep total expenses for the company within budget for the year.

Fourth, the CFO, whether full-time or part-time or in the absence of either the Controller, should produce and share departmental income statements with comparisons to budget that also show how much money is left in each line of the budget for the year. Before continuing, let’s be clear on what a departmental income statement compared to budget is. It shows the actual expenses and budget expenses for each line item in each respective manager’s budget. It should be produced showing the current month (i.e. the one most recently completed) along with year-to-date figures for each of actual and budget. For all periods, it should show the variance between actual and budget meaning how much over (a negative variance for expenses) or under (a favorable variance for expenses) that department was for that line item for the period.

Certain accounting software programs including Quickbooks Online offer an option to produce a column that shows the amount remaining in the budget for the year for each line item. Please be aware, however, that when you call this report from Quickbooks, it includes all actual expenses that have hit the QBs general ledger for the year—not just year-to-date for the closed accounting periods. Thus, if your accounting team has closed the books through April and then produces and distributes the departmental income statements showing the remaining amounts for the year, it will include those expenses that have already hit the general ledger for May (and possibly beyond if you have recurring journal entries.) There is a positive to this in that your manager will see what they’ve incurred for the whole year not just through the end of the last closed accounting period, but the total spend will differ from the amount on their year-to-date departmental income statement. If you want your managers to see what’s remaining as of the end of the last closed month, you can export the report to Excel and change any actual numbers after the closed month to zero

Fifth, in the absence of a board which approves budgets and/or spending plans, the CEO may decide that the company should spend money on an unbudgeted item to either help improve the likelihood of attaining its current year goal or investing in the growth of income in future years. Typically, such decisions involve input from the leadership team, and the company CFO, again either full-time or part-time, should be advising the CEO as to the impact on cash, financial covenants with lenders, and commitments to the board if not also playing the more conservative devil’s advocate.

Annual budgets are great planning tools. To make them great execution tools and help you reach your annual financial goals, I strongly urge you to take the steps described above. If you have any questions or need help with this, please reach out to me at llevy@CFOoptionsinc.com

 

Your Balance Sheet, How It Can Help You

Whether you keep your books on a cash or accrual basis, don’t forget to pay attention to your balance sheet. While your income statement (or Profit & Loss or P&L) tells you how your business is performing, failure to look at your balance sheet at the same time can either inadvertently hide activity that belongs in your income statement and/or be a a good source of information.

In terms of inadvertently hiding information, sometimes the people keying information into your general ledger or accounting system aren’t quite sure what something is or where it should be coded. While it is important that they get answer to that question, the person that has the answer, often you, isn’t immediately available and so the item gets coded to a temporary account possibly a balance sheet account. When that happens and you only look at your income statement, you’re missing the impact–whether good or bad–of the item that was put into a balance sheet account. Looking at changes to the balance sheet as compared to the prior month and asking questions about those changes will help prevent this problem.

Even if that doesn’t happen, you should be looking at a comparative sheet each time you look at your income statement. While looking at your bank account online or in a check register will tell you the balance, a comparative balance sheet will show you whether your cash balance is growing or shrinking and by how much. The same goes for accounts receivable, and if it’s growing significantly, you want to make sure it’s in proportion to growing revenue and not to customers paying you later and later. Looking at your balance sheet can also uncover accounting activities being ignored such as failing to file and remit sales & use tax payments as required. You would see this if your Sales Tax Payable account kept growing out of proportion to your revenue.

For our typical clients, a review of a comparative balance sheet only takes a few minutes each month and can alert you to things that need to be addressed now before they take up hours or days of your time.

 

Zero-Based Budgeting, What is it?

What is Zero-Based Budgeting? While the answer is simple, the execution is hard. Zero-Based-Budgeting means you start with a completely blank slate. No dollar amounts or other numbers for revenues or expenses. You literally start with zero.

Why would a company create a Zero-Based Budget? By starting with zero, you force yourself to think about and make a choice about every expense the company will need in order to hit its objectives for the year and run the company. Every startup that creates a budget before the business begins is preparing a Zero-Based Budget because they have no choice; they don’t have any historical data to start with. The potential trap for all companies doing a Zero-Based Budget and especially so for brand new ventures is that you might not include an expense you actually will need to incur. For example, while you might think about and include the cost of business cards for the founders, will you remember to include the legal costs to start the company and keep it in good standing with the Secretary of State each year?

If your company has been running for 1 or more years, it’s likely starting point for your next budget (or for that matter long term forecast) is some combination of the previous year’s budget and actuals. The benefits of this are that it saves you time in building your next budget and makes it much less likely that you will forget to include an expense, like annual Secretary of State filing fees, that you will actually incur.

So why would a company that’s been around at least one year choose to do a Zero-Based Budget? If your company is either young and/or small, you need every dollar you can find to invest in generating sales, improving your product, keeping the lights on and having enough cash in the bank to meet payroll. If your company is more developed and/or more profitable, you still want to make as many dollars as possible available to generate even more sales, improve your product further or just have a higher Net Income and profit margin at the end of each month, quarter or year. Zero-Based Budgeting can help you accomplish this. Here’s one example of how:

Say your company has been spending $10,000 per month on a combination of Search Engine Optimization (SEO) and digital advertising. Without a Zero-Based Budget, you might simply budget $10,000 per month for digital marketing making the tacit assumption that it seemed to work last year so let’s keep doing it. However, with Zero-Based Budgeting, that thought process is not allowed. Whether you have a VP of Marketing proposing a marketing budget or you’re the CEO/CMO rolled into one, Zero-Based Budgeting forces you to think about what your marketing goals are and the most cost-effective way to accomplish them. Taking it a step further, you might say that your goal is to generate an additional $10,000 in monthly recurring revenue each month through digital marketing. You determine that the average sale is $2000/mo, that you close 30% of your sales opportunities and that your cost of acquisition of each true sales opportunity is $200. This data and a little math tells you that to generate $10,000 in new monthly recurring business each month, you actually need to spend $3,333 per month to achieve your $10,000 sales goal.

  • Sales Needed: $10,000 / $2,000 = 5
  • Leads Needed: 5 Sales / 30% close ratio = 16.67
  • Required Marketing: 67 Leads x $200 Cost of Acquisition = $3,333

With an expense that has a direct correlation to sales, you could choose to spend $10,000 for digital marketing and budget for $30,000 month in new recurring monthly revenue. Before you do this, you need to consider whether your operational team can handle that much at a time and whether you will have the working capital to support such a big increase.

Either way, the Zero-Based Budgeting method forces you to ask yourself the tough questions rather than just continuing what you’ve done before. When you’re considering overhead expenses that don’t generate additional revenue, such as Office Supplies or Postage expense, Zero-Based Budgeting can help you find line items where you can spend less which will provide more dollars for sales, product or current year profit.

 

Travel & Entertainment Reporting

What do people hate worse than filling out an expense report? Answer: being audited by the IRS. While reporting all of your company’s travel & entertainment (T&E) expenses correctly will help you if you are audited, it will not help you avoid that all painful IRS audit.

At worst, employees think signing off on a credit card statement and submitting it to their boss for approval and then submission to the accounting department is sufficient. While it might be satisfactory to their boss and/or the owner of the company, it’s not going to be sufficient if the IRS comes knocking. Here’s what each employee should be doing to report his/her T&E expenses in a way that will be satisfactory to both the company and the IRS:

  • As a general rule, attach a receipt for all expenses. However, for expenses under $25, if you have other documentation, such as a credit card statement or bank statements, a receipt is not absolutely necessary—although still recommended.
  • For all entertainment expenses,
    • Provide the full name of each person that was entertained on that charge
    • Provide the name of the company they represent
    • Provide a brief description of the business purpose
  • For all travel expenses,
    • Provide the name of the company or event that you were travelling to or from

The period between when the charge took place and when the credit card bill is paid or when you reimburse the employee is the best time to get this information from the employee. If you don’t get all of the information and are later audited by the IRS, they could disallow charges that are not fully and properly documented. Whether it’s having to pay additional income taxes or spending time collecting information that is years old, you can avoid those pains by getting it right the first time.

Revenue — billed, collected, earned

While not every business follows or, for that matter, needs to keep their books on an accrual basis or in accordance with Generally Accepted Accounting Principles (GAAP), I believe it’s very important for everybody running a business to know what the differences are. Let’s start with an example.

You sell a joke-writing service to accountants, CPAs and CFOs at a cost of $1,000 per month. You and your humorless clients agree to annual billing. On January 1, the beginning of the 12 month period, you bill your client $12,000, and your client pays you on February 1. When should the revenue appear on your Profit & Loss Statement?

Companies that record revenue based on billing show $12,000 of revenue in January. Companies that record revenue based on cash received show zero revenue in January and $12,000 in February, and companies that record their revenue on an accrual basis would show $1,000 of revenue in each month January through December. This is because only $1,000 is earned each month during the 12-month contract period.

Similarly, if your company does project work, your earned revenue on an accrual basis is based on hours worked that month multiplied by the applicable hourly rates or the percentage of the project completed if it’s a flat fee project.

While there are nuances to the recording of revenue under GAAP which I don’t go into here, the basics above apply to most situations. If you’re not recording your revenue in this manner, why does this matter?

  • While cash is king, bankers and investors (both current and potential) will likely want to know how the company is performing on an accrual basis.
  • If you’re looking to sell, potential buyers are likely to want to see or convert your revenue to the accrual basis so they can better analyze your business.
  • You should be looking at your business from both a cash and accrual perspective. While recording revenue based on billing or cash receipts is common among SMBs, you could be missing trends, skewing profit margins (both gross and net) and not paying enough attention to collecting receivables.