Bridging the gap between entrepreneurs and bankers

CLASSROOM RULES • Please ask your questions when you have them! – If they are too specific and the entire class will not benefit from the discussion, then we can discuss it individually after class. But PLEASE ASK!Copyright 2009 CFOwise® 2

Agenda• Introduction of the Entrepreneur• Accurate and Timely Internally-Prepared Monthly Financials• Internal Staff• Projections – the Three-Statement Way• Fixed vs. Variable Costs and Break-Even• Enterprise ValueCopyright 2009 CFOwise® 3

ENTREPRENEURS• DEFINED: Individuals who effectively combine factors of production(land, labor, capital, intelligence, kn owledge, capacity) into a product or service that can be commercialized; undertake and take responsibility for the outcome of a business venture; risk-takers• NOT INCLUDED IN THE DEFINTION: – Banking experience – Accounting experience – Finance experienceCopyright 2009 CFOwise® 4

ENTREPRENEUR ATTRIBUTES• They are eternally optimistic about their business• They do not know their key liquidity and debt ratios – many of them do not know what their balance sheet says• They often do not understand their cash flow and how it differs from their net income• They rely on their gut and what we call “entrepreneur math”• They do not understand bankers• Any others?Copyright 2009 CFOwise® 5

ENTREPRENEUR’S CHALLENGES• Most do not receive accurate AND timely monthly internally prepared financial statements• They lack internal staff that can analyze and explain the firm’s performance AND drive improvement in cash flow and profitability• Most do not project cash flow• Most do not know their break-even point• Most do not understand the value of their business, and, more importantly, how to improve itCopyright 2009 CFOwise® 6

Agenda• Introduction of the Entrepreneur• Accurate and Timely Internally-Prepared Monthly Financials• Internal Staff• Projections – the Three-Statement Way• Fixed vs. Variable Costs and Break-EvenCopyright 2009 CFOwise® 7

ACCURATE & TIMELY FINANCIALS• Why does and entrepreneur need accurate and timely financials every month? – They need to understand their profit and cash flow drivers or they will fail – To build a relationship with outside professionals• At a minimum, accrual-based financials. At a maximum, GAAP-compliant financials• 15th or 20th of the month, no laterCopyright 2009 CFOwise® 8

ACCURATE & TIMELY FINANCIALS• Overall Issues – – Most entrepreneurs have been conditioned to not trust what their financial statements say – Without formal monthly closing procedures, we often get very inaccurate financials – QuickBooks lets you print for any time period – just because it lets you print anytime you want does not mean the reports are accurate – Internal controls are often disregarded and compromisedCopyright 2009 CFOwise® 9

P&L ISSUES• Revenue Recognition• Matching Principle disregarded• Gross Margin all over the board• Period costs not in the right period• Payroll accruals ignored• Discounts and Bad Debt mis-handled.• Failure to break-out divisions for profitability reporting• Failure to job-costCopyright 2009 CFOwise® 10

BALANCE SHEET ISSUES• Monthly Reconciliation of all balance sheet accounts ignored• No one validates AR balances• Pre-Paid insurance and other items are not booked• Failure to do a physical inventory count• Depreciation incorrectly booked• Payroll Liabilities not handled correctlyCopyright 2009 CFOwise® 11

BALANCE SHEET ISSUES• Current portion of long-term debt not broken- out• Mis-handling inter-company transactions• Principle and Interest not correctly booked• Shareholder/Member loans are missed• Retained Earnings do not tie• Schedule L of tax return does not match the financial statementsCopyright 2009 CFOwise® 12

OVERCOME THE ISSUES• Properly staff the accounting and finance function• View accounting/finance as a critical component of the firm’s strategy and success• Maximize accounting software capabilities• Incent timely and accurate monthly “closes”• Incent behavior that improves cash flow, like collectionsCopyright 2009 CFOwise® 14

ACCURATE & TIMELY FINANCIALS• Monthly Reporting Package – Balance Sheet Comparison – P&L Month and YTD with % of Sales – P&L Prior Year Month and YTD with % of Sales – Statement of Cash Flow – Budget vs. Actual – Balance Sheet and P&L – Key Ratio Analysis – DSO, working capital, Current and Quick Ratio, Inventory Turnover, Payable Days,Copyright 2009 CFOwise® 15

Monthly Exec Team Meeting• Review financial performance and hold team accountable to budgets and goals• Discuss strategic initiatives and make plans for implementation• Companies who do this consistently out- perform their competitorsCopyright 2009 CFOwise® 19

INTERNAL STAFF• Bookkeeper, Office Manager, Controller – They often lack the education and/or experience to correctly complete the monthly financial statement package and closing procedures – They often do not speak “entrepreneur” – Their focus is seldom on helping the entire enterprise grow and improve – May have “shortcuts” that hinder financial reporting – They usually do not analyze the financials from a tax, accounting, business, and industry perspectiveCopyright 2009 CFOwise® 21

SHORT-TERM PROJECTIONS• Net Income almost never equals cash flow• Projecting just the P&L will never give you enough information about your cash flow• A simple spreadsheet can be put together to forecast all inflows and outflows for at least the next 90 days – this allows us to understand surpluses and shortages and how we should handle themCopyright 2009 CFOwise® 24

LONG-TERM PROJECTIONS• One of the major reasons to complete long- term projections should be to determine your cash needs and your wherewithal to re-pay your lenders• This is sometimes also called financial modelingCopyright 2009 CFOwise® 25

PROJECTIONS• Good LONG-TERM projections always include the following – P&L projections with well-thought out and documented revenue and COGS model – Realistic balance sheet account projections with changes directly correlated to the P&L projection – Statement of cash flow projections to portray the firm’s sources and uses of cashCopyright 2009 CFOwise® 26

PROJECTIONS• Timeline – Always have two years of month-by-month projections for all three statements – Always have at least five years of annual projection for all three statementsCopyright 2009 CFOwise® 27

PROJECTIONS• Track Your Progress – Compare your performance monthly to your projections – If you do this for 12 months consecutively, I can guarantee you will know more about your company’s profit drivers, financial health, and cash flow than your competitorsCopyright 2009 CFOwise® 28

BREAK-EVEN• Entrepreneurs need to be sure they can hit their break-even sales volume in the near future without increasing fixed costs• Entrepreneurs also need to understand the capacity that their current fixed cost structure will maximally allow• Entrepreneurs need to operate their business between these two levels, or else they will need financingCopyright 2009 CFOwise® 36

BREAK-EVEN$250,000 Operations Above Max Capacity = Increase Fixed Costs and Need Capital$200,000 Operations Between Break-$150,000 Even & Max Capacity = Profit Break-Even Max Capacity$100,000 Operations Below Break-Even = Losses $50,000 $0 Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8Copyright 2009 CFOwise® 37

Bridging the gap between entrepreneurs and bankers

by Ken Kaufman

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