How to Identify and
Monitor the Key
Financial Elements
of Your Company
DURING MY PROFESSIONAL CAREER I have seen companies in various industries some with considerable sales volume operating with systems that failed to provide their owners or managers enough financial data to make effective business decisions.
Some responsible small business studies have demonstrated that a lack of adequate record keeping and financial management is a major cause of business failure. With the software that is available today poor record keeping should never occur. Nevertheless, I have seen and continue to see entrepreneurs show little or no regard for the financial information necessary to manage their companies.
I have heard accountants referred to as a "necessary only to help solve potential tax problems. I have seen people sell products without knowing what their costs are, and I've seen people bid on jobs not based on whether they can make a profit for their company, but on the basis of what their competition is selling it for.
I have often wondered why these attitudes and practices are so prevalent. I have concluded that many business owners simply disliked math in school and they shied away from anything that had to do with numbers. These behaviors started at a very young age and continue to this day.
In addition, owners and managers of entrepreneurial companies find themselves in the position of leadership by accident rather than by design. They often lack the necessary knowledge and/or training to understand and utilize financial data.
WHAT ARE FINANCIAL STATEMENTS FOR?
Over the last several years I have trained accountants and entrepreneurs in various aspects of business financial planning. My favorite question that I love to ask my audience is What are financial statements for?
I get the following answer from entrepreneurs and even accountants:
To secure a bank loan.
To complete a tax return.
To impress investors.
After they tell me those three items there is usually silence.
The purpose of a financial statement is to help the business make a profit. It is so rare that I hear that answer. Why is it that financial statement data is rarely viewed as a tool for making a profit?
The answer? Most entrepreneurs and accountants don' know how to use financial statements to help them make a profit. They use them for the three reasons I indicated above,
Yet, as the owner-manager of your company, you are responsible for monitoring, managing, and evaluating the results of all that activity. The buck stops with you.
WHAT'S THE BOTTOM LINE?
Does any of the following sound familiar?
It was 9:00 a.m. on Thursday the 28th. The lights in our conference room beamed a warm glow over the table. Across the table from me was John Sloan. I handed John a copy of his quarterly report. His first words came quickly: "What's the bottom line?"
"A small profit," I reported.
"How much tax will I have to pay?"
"At this rate, not much," I answered.
"Good," John snapped back.
Today was going to be quite a day. Four meetings were scheduled, and all of them were for reviewing financial statements.
At 10:30 a.m., I met with Ron Agnew, the owner of a small design company. Ron's opening words were, "How did we do tax-wise?"
Three hours later, I met with Sharon Samuelson, who had just started in business the previous year. A tall, rather slender woman, impeccably dressed, Sharon has great taste in clothes. Her taste has made her boutique quite successful.
When I handed Sharon her annual report, she looked at it and said, "Could you help me interpret this?"
I smiled and proceeded to walk Sharon through the accounting data. She was a good student, but it was going to take more than one session to teach her how to use the information I had presented.
My last meeting of the day was with Eric Brown. His partner, Joe Scott, managed to take their company for an extra $250,000. When Joe left the company, all financial decisions fell to Eric. He was a fast learner. I presented him with his year-end report, but before he opened it, he fired a barrage of questions.
"What's the bottom line? Will my banker be happy? How much tax do I have to pay? What I want is large profits to show the bank and no profits to show Uncle Sam!"
Yes, Eric had learned fast. He knew the creed well. "Large profits for the bank, no profits for the Feds!"
Sounds familiar, doesn't it? The meetings were typical management not schooled in financial matters, always in a hurry, never taking the time to digest the results of operations, and only interested in the bottom line.
Yet, today's economic conditions demand that management of all companies, large or small, learn as much as possible about using and understanding financial accounting. Not too many years ago, we could solve our financial problems by passing on price increases to our customers. That was accepted as part of the times. Inflation helped hide mistakes.
Today, however, inflation is gone, competition is tougher than ever, business is more complex, and money is harder to come by. It is far more important to master the skills necessary to keep our business alive. We must run our business in a businesslike manner.
WHERE DO WE BEGIN?
First, we must learn to understand financial accounting. There are three ways to go about this.
Review the sample financial statement in this book and follow the step-by-step comments.
Enroll in an accounting course for owners and managers of small businesses offered at your local university or college. This is the most time-consuming and will take some real dedication on your part.
The third method is the easiest and the least time consuming. Every time financial statements are prepared, have your accountant explain them in detail.
Begin with this simple question, "Now that you've prepared this data, how is the information going to help me and my business?" At this point, they will either panic because they don't understand the statements, or they will proceed to explain their meaning.
Don't be embarrassed. If you don't understand, ask questions; let your accountant know you don't understand. They are schooled and trained in the meaning of financial statements; you're not! So don't be embarrassed to ask questions. If they're good, they will take the time to explain the statements in a manner you can understand. If they can't explain them in a meaningful manner, seek help from someone who can.
HOW OFTEN?
Every business owner should review financial accounting once each month. This data should be compared to your forecast (yes, I said forecast, not budget; more later) on a line-by-line basis. If there is a problem getting the data monthly, get it done at least quarterly.
In every case where I have seen a business person receiving monthly statements, the first comment has always been the same: "I don't know how I operated in the past without this information."
I've heard that time and time again.
Do not have an outside accounting firm prepare monthly statements; it is too expensive. Have your accountants train your bookkeeping personnel on how to prepare the company financial statements. With the book-keeping software available today, getting regular financial statements is a piece of cake.
Let your accountants confine their activity to a cursory review after the bookkeeper has completed the major portion of the work. This should reduce professional fees substantially and provide you with much-needed data.
If you do not have bookkeeping personnel, have your accountants recommend a competent freelance bookkeeper. This service is consid-erably less expensive than using professional accountants to do your bookkeeping.
Remember, you are trying to develop a system to provide financial data regularly and to develop your skills to interpret this data.
Understanding financial statements is not enough. You must have a management information system that monitors financial statements, cash balances, future cash needs, accounts receivable, and inventories.
CASH IS KING, ALWAYS HAS BEEN AND ALWAYS WILL BE
Not too long ago, I met Bill Hall and Frieda Gunter. Bill started in the glass business many years ago. At that time, Frieda was his bookkeeper. Today, Frieda earns about $250,000 per year and owns 25 percent of the company. Overpaid? Yes.
Our first meeting went something like this: I entered the reception area of their business and waited for about five minutes. A young lady asked me to follow her. We proceeded to walk through a maze of hallways, making turns, entering offices, then returning to more hallways and more offices. We finally ended our journey in a conference room.
There sat Bill and Frieda, both in their mid-fifties. Bill had a dark complexion, was gray at the temples, and was a little on the pudgy side. Frieda was also in her mid-fifties, but looked close to sixty-five. We started our conversation with small talk and ultimately got around to the financial condition of their glass company. The company was a highly successful business generating large profits and very large amounts of cash. A cash cow!
Bill and Frieda's banker had referred us to them. "What a fine gentleman Dave Reese [the banker] is," commented Frieda. "He takes us out to lunch at least once every other month and pays."
"What balances do you maintain in your accounts?" was my first question.
"We keep about eight hundred in the checking account at all times."
"How do you manage to keep such a small float in the account?" I was obviously impressed with their cash management.
Frieda quickly corrected me. "Eight hundred thousand."
"Eight hundred thousand dollars in your checking account?" I quickly asked.
"Yes," Frieda beamed.
After I regained my composure, I managed to squeak out an "oh" without being too emotional. I clearly understood why the banker took them to lunch so often and paid. He was a real sport. The bank was making a small fortune on their balances.
"Frieda, do you know you could be earning an extra $40,000 to $50,000 per year on your money if you moved it to some kind of money market instrument?" I asked. She smiled but said nothing.
Ultimately, they became clients of our firm. The first thing we did was to fill out the forms for a money market account. It took Frieda almost six weeks to sign them and transfer the funds.
I was annoyed not only with Frieda's attitude, throwing away $40,000 to $50,000 per year, but I was also angry with her banker who was doing absolutely nothing to help his customer.
Why they never changed to another bank is beyond me. Incidentally, Frieda left the company when Bill concluded that $250,000 a year was too much to pay for a bookkeeper.
CASH COSTS MONEY!
Cash is one of the most expensive commodities we use in running our businesses. Think about it for a moment. In many businesses, other than cost of sales and hopefully your salary the cost of cash (interest) is one of the largest expense items a company has.
MAKE YOUR CHECKING ACCOUNT OBSOLETE
Try to deposit all daily receipts directly to a money market account rather than into your checking account. Transfer funds from the money market account to a checking account only when you anticipate writing checks. Confine check writing to once or twice per month to allow the float in the money market account to build and earn additional interest.
Don't get caught up by the notion that your banker will treat you better if you keep high balances in a checking account. He may like you better, but you should earn as much as you can on your money. Today, the banking business is far more competitive than it's ever been. If you are a good customer of your bank, you can have a lot of influence with your banker. But always keep another bank in reserve, just in case.
REDUCE THE RENT ON YOUR CASH
Sounds silly doesn't it? Yet, we do rent money. Therefore, our goal should be to reduce the rent.
The banking industry is extremely competitive, which means more favorable credit terms. Ask your accountant to help you select a bank and banker. Accountants and bankers have mutual referral networks which can be of value to you.
BANKERS HAVE PROBLEMS TOO!
Jane Cole started our phone conversation with an angry comment. "The financial statement you sent us was wrong."
"Jane, we never sent you a financial statement, and we haven't even done any work on your account," I responded.
"Well, I sent what you gave me to the bank, and we got our loan, but the statement was wrong," Jane claimed.
"I don't know what you sent, but it obviously worked. Why don't you get a copy of the statement and read it to me, and let's see if I can figure out what you did?" I said.
Ten minutes later Jane called back.
"The name of the company is XYZ, Inc., and all the dates have 19XX" she said.
"Jane, you sent the bank a sample promotional statement we provide new clients. It is meaningless. It's a nonexistent company. The bank gave you money off of a sample financial statement? Wow! It doesn't say a lot about your banker." We both laughed.
If you're not bankable and using a lender other than a bank, you're more than likely paying interest in excess of what a bank would charge. I refer to these lenders as second-level financing companies. They usually base their loans on underlying collateral you've supplied as security for the loan, and they charge handsomely for the money. They are referred to as asset based lenders.
Your goal is to improve the financial position of your company, not theirs. You need to become bankable as quickly as possible. To do this, you have to become more profitable, improve your cash flow, and operate your business in a businesslike manner.
GET MORE MONEY BY BEING PREPARED
Here are some tips on how to be prepared:
Do you know where your cash is? If it's not in your pocket, it's more than likely in accounts receivable (amounts people owe you) and/or inventory two items that sop up your cash like a slice of rye in a bowl of chicken soup.
THEY JUST GET LARGER AND LARGER
Do you remember the old joke about "The Three Famous Lies"? One of the lies was: The check is in the mail.
Now when you call a customer for payment they never say the check is in the mail. They say, "The check is being cut, but first we need a copy of the invoice. We seem to have misplaced it."
Does that sound familiar? (You wouldn't be doing that now by any chance, would you?) They have just borrowed your money for twenty-five additional days, interest-free. Five days to send the invoice copy, five days in their accounting department for approval, five days for cutting the check, five days for signature, then five more days back in the mail.
Always send invoices by e-mail. The mail should be obsolete.
Accounts receivable is probably the fastest growing asset in your company. The balance just seems to get larger and larger and larger. Remember, cash is king, and we have to get our hands on as much as possible. Therefore, monitoring and collecting accounts receivable is one of our most important functions.
BE SYSTEMATIC IN YOUR APPROACH TO COLLECTIONS
Here are some tips on speeding up the collection of your accounts receivable.
THE FANTASY ASSET
I like to refer to inventory as the fantasy asset. More games are played and guesses are made on the value shown as inventory on financial statements than any other item in the statement. This occurs so often that many times management loses sight of the importance of proper control and evaluation of inventory the single most important asset in deter-mining company profitability. Yet the fantasy goes on. Need more profit? Up the inventory. Pay lower taxes? Lower the inventory. Take an inventory? Too much trouble. Price it right? Too much detail. What's the inventory? Nobody knows. Plug in a number, so the saying goes.
If you use an incorrect inventory for your financial statement, your profit or loss statement will be incorrect by the exact same amount. It's a dollar-for-dollar ratio. Yet guesses are made, and the fantasy goes on and on and on.
A RULE TO REMEMBER
The profit and loss statement is absolutely worthless unless an accurately counted and priced (valued) inventory is used in the financial statements. You'll never know the true profit if the fantasy prevails; you're only fooling yourself.
FANTASY STORIES
Dave, Glenda, and Al sat quietly as I handed them their company's year-end statement. They were running a family business that was growing by leaps and bounds. Cash balances were running lower than their expectations, and they were concerned as to whether or not they were making a profit.
Dave began, "Are we on the right track? Are we making a profit?"
"Dave, I must be frank with you. The statement shows a profit, but as you know, much of the inventory was what you called an educated guess. If the number you gave us is right, then yes, there is a profit. However, there are no cost records of your work-in-process inventory and no material and labor costs for work completed. So, to answer your question directly, I don't know. What you need is a cost system that will tell you the material, labor, and overhead on each job and reflect accurate inventory value. This is a must for your business."
Dave responded quickly, "Maybe later."
Jim Williams is a man in his late fifties. He and his son were running a company that manufactured toilets.
"Jim what does it cost you to manufacture a toilet?" I asked.
"I don't know" was his response.
"How do you know what to sell it for?" I asked.
"We've been selling it at that price for years" was his last comment.
Bill Bennett and his partner Harold Mahler thought they were very clever. They got into the business of manufacturing wood household products: items such as breadboxes, saltshakers, canisters, etc. Sales were almost $12 million. You may have purchased one yourself; their products were well made, and they were everywhere.
One day in a meeting we were discussing the financial statement of the company. I urged them to hire a controller. Harold's father, Sam, was doing the books, and he was incompetent. You couldn't rely on any of his numbers.
I also was bugging them to get a cost accounting system installed to ascertain proper inventory and product costs. They were manufacturing a multitude of different products, but there wasn't one piece of paper available to indicate what this product cost.
"Harold, you've got to get rid of Sam and bring in a controller and a cost accountant. The business is growing; you can no longer operate as a mom and pop organization."
"I know, but how can I fire my Dad?" Harold asked.
"That's a tough one, but you need a better controller," I said.
"Maybe later," was Harold's cool reply. "By the way, I've installed a cost accounting system."
"Huh? When did you do that?"
"Not too long ago. We measure the trash in the barrels."
"What?"
"Every night we go to the waste bins and measure our scrap lumber. This gives us a method of measuring costs. Too much scrap, too much cost."
Needless to say, I was amazed. I had never heard of such a thing.
Steve Jenkins was great with the fantasy asset. His company was losing its shirt, yet the financial statements indicated a profit. He was in the underwear business. Obviously, the company was losing its undershirt.
Anyway after he left the company, we found out the games he was playing. At the end of every year he would change his computer to up the value of his inventory so that he would show a profit.
Eventually, Steve sold out to one of his employees. This has always puzzled me. The employees knew what Steve was doing, yet bought the business based on this fantasy inventory and phony financial statements.
Steve was last heard from somewhere in Arizona. The company, after forty-two years in business, went into bankruptcy. It was one of the oldest private companies in California.
By the way, Jim Williams' toilet business died a slow death. Dave Marcus' company is installing a cost system and doing well, and Harold fired his father just prior to a major creditor closing them down.
THERE ARE NO EASY SOLUTIONS
Inventory control is the most difficult area in running a business, yet also the most vital. There are no easy solutions to inventory control, but I do have some practical suggestions:
Don't be foolish when working with your inventory in determining costs and/or systems. If you are in doubt about what you are doing, seek professional advice.
Good housekeeping is an important factor in taking a physical inventory. Your inventory can be taken more quickly and more accurately if you begin with the following steps:
INVENTORY INSTRUCTIONS
Management should prepare detailed instructions for taking the inventory. These instructions should include cut-off procedures for shipping and receiving departments, complete procedures for counting the inventory, and the name of the individual to contact if there are questions.
All participants should attend a meeting to review the instructions.
ESTABLISHING THE CUT-OFF
A proper cut-off involves identifying the arrival and shipment dates of your inventory. This is essential, because it defines the items to be included in your inventory. Under ideal circumstances, all activities in the shipping and receiving departments would be stopped; however, many times this is not possible.
Goods received after the cut-off date should be physically segregated and counted separately. The receiving documents should indicate the date the shipment was received. This will facilitate the accounting of the related invoices. If the items are shipped during the inventory, the shipment date should be noted on the shipping records. This will identify the last invoices to be included in the current accounting period.
COUNTING THE INVENTORY
Thorough planning will help eliminate problems that can occur in counting inventory. Your planning should cover topics such as inventory counting teams, the layout of the warehouse, per-numbered inventory count tags, and supervision.
Monitor the Key
Financial Elements
of Your Company
DURING MY PROFESSIONAL CAREER I have seen companies in various industries some with considerable sales volume operating with systems that failed to provide their owners or managers enough financial data to make effective business decisions.
Some responsible small business studies have demonstrated that a lack of adequate record keeping and financial management is a major cause of business failure. With the software that is available today poor record keeping should never occur. Nevertheless, I have seen and continue to see entrepreneurs show little or no regard for the financial information necessary to manage their companies.
I have heard accountants referred to as a "necessary only to help solve potential tax problems. I have seen people sell products without knowing what their costs are, and I've seen people bid on jobs not based on whether they can make a profit for their company, but on the basis of what their competition is selling it for.
I have often wondered why these attitudes and practices are so prevalent. I have concluded that many business owners simply disliked math in school and they shied away from anything that had to do with numbers. These behaviors started at a very young age and continue to this day.
In addition, owners and managers of entrepreneurial companies find themselves in the position of leadership by accident rather than by design. They often lack the necessary knowledge and/or training to understand and utilize financial data.
WHAT ARE FINANCIAL STATEMENTS FOR?
Over the last several years I have trained accountants and entrepreneurs in various aspects of business financial planning. My favorite question that I love to ask my audience is What are financial statements for?
I get the following answer from entrepreneurs and even accountants:
To secure a bank loan.
To complete a tax return.
To impress investors.
After they tell me those three items there is usually silence.
The purpose of a financial statement is to help the business make a profit. It is so rare that I hear that answer. Why is it that financial statement data is rarely viewed as a tool for making a profit?
The answer? Most entrepreneurs and accountants don' know how to use financial statements to help them make a profit. They use them for the three reasons I indicated above,
Yet, as the owner-manager of your company, you are responsible for monitoring, managing, and evaluating the results of all that activity. The buck stops with you.
WHAT'S THE BOTTOM LINE?
Does any of the following sound familiar?
It was 9:00 a.m. on Thursday the 28th. The lights in our conference room beamed a warm glow over the table. Across the table from me was John Sloan. I handed John a copy of his quarterly report. His first words came quickly: "What's the bottom line?"
"A small profit," I reported.
"How much tax will I have to pay?"
"At this rate, not much," I answered.
"Good," John snapped back.
Today was going to be quite a day. Four meetings were scheduled, and all of them were for reviewing financial statements.
At 10:30 a.m., I met with Ron Agnew, the owner of a small design company. Ron's opening words were, "How did we do tax-wise?"
Three hours later, I met with Sharon Samuelson, who had just started in business the previous year. A tall, rather slender woman, impeccably dressed, Sharon has great taste in clothes. Her taste has made her boutique quite successful.
When I handed Sharon her annual report, she looked at it and said, "Could you help me interpret this?"
I smiled and proceeded to walk Sharon through the accounting data. She was a good student, but it was going to take more than one session to teach her how to use the information I had presented.
My last meeting of the day was with Eric Brown. His partner, Joe Scott, managed to take their company for an extra $250,000. When Joe left the company, all financial decisions fell to Eric. He was a fast learner. I presented him with his year-end report, but before he opened it, he fired a barrage of questions.
"What's the bottom line? Will my banker be happy? How much tax do I have to pay? What I want is large profits to show the bank and no profits to show Uncle Sam!"
Yes, Eric had learned fast. He knew the creed well. "Large profits for the bank, no profits for the Feds!"
Sounds familiar, doesn't it? The meetings were typical management not schooled in financial matters, always in a hurry, never taking the time to digest the results of operations, and only interested in the bottom line.
Yet, today's economic conditions demand that management of all companies, large or small, learn as much as possible about using and understanding financial accounting. Not too many years ago, we could solve our financial problems by passing on price increases to our customers. That was accepted as part of the times. Inflation helped hide mistakes.
Today, however, inflation is gone, competition is tougher than ever, business is more complex, and money is harder to come by. It is far more important to master the skills necessary to keep our business alive. We must run our business in a businesslike manner.
WHERE DO WE BEGIN?
First, we must learn to understand financial accounting. There are three ways to go about this.
Review the sample financial statement in this book and follow the step-by-step comments.
Enroll in an accounting course for owners and managers of small businesses offered at your local university or college. This is the most time-consuming and will take some real dedication on your part.
The third method is the easiest and the least time consuming. Every time financial statements are prepared, have your accountant explain them in detail.
Begin with this simple question, "Now that you've prepared this data, how is the information going to help me and my business?" At this point, they will either panic because they don't understand the statements, or they will proceed to explain their meaning.
Don't be embarrassed. If you don't understand, ask questions; let your accountant know you don't understand. They are schooled and trained in the meaning of financial statements; you're not! So don't be embarrassed to ask questions. If they're good, they will take the time to explain the statements in a manner you can understand. If they can't explain them in a meaningful manner, seek help from someone who can.
HOW OFTEN?
Every business owner should review financial accounting once each month. This data should be compared to your forecast (yes, I said forecast, not budget; more later) on a line-by-line basis. If there is a problem getting the data monthly, get it done at least quarterly.
In every case where I have seen a business person receiving monthly statements, the first comment has always been the same: "I don't know how I operated in the past without this information."
I've heard that time and time again.
Do not have an outside accounting firm prepare monthly statements; it is too expensive. Have your accountants train your bookkeeping personnel on how to prepare the company financial statements. With the book-keeping software available today, getting regular financial statements is a piece of cake.
Let your accountants confine their activity to a cursory review after the bookkeeper has completed the major portion of the work. This should reduce professional fees substantially and provide you with much-needed data.
If you do not have bookkeeping personnel, have your accountants recommend a competent freelance bookkeeper. This service is consid-erably less expensive than using professional accountants to do your bookkeeping.
Remember, you are trying to develop a system to provide financial data regularly and to develop your skills to interpret this data.
Understanding financial statements is not enough. You must have a management information system that monitors financial statements, cash balances, future cash needs, accounts receivable, and inventories.
CASH IS KING, ALWAYS HAS BEEN AND ALWAYS WILL BE
Not too long ago, I met Bill Hall and Frieda Gunter. Bill started in the glass business many years ago. At that time, Frieda was his bookkeeper. Today, Frieda earns about $250,000 per year and owns 25 percent of the company. Overpaid? Yes.
Our first meeting went something like this: I entered the reception area of their business and waited for about five minutes. A young lady asked me to follow her. We proceeded to walk through a maze of hallways, making turns, entering offices, then returning to more hallways and more offices. We finally ended our journey in a conference room.
There sat Bill and Frieda, both in their mid-fifties. Bill had a dark complexion, was gray at the temples, and was a little on the pudgy side. Frieda was also in her mid-fifties, but looked close to sixty-five. We started our conversation with small talk and ultimately got around to the financial condition of their glass company. The company was a highly successful business generating large profits and very large amounts of cash. A cash cow!
Bill and Frieda's banker had referred us to them. "What a fine gentleman Dave Reese [the banker] is," commented Frieda. "He takes us out to lunch at least once every other month and pays."
"What balances do you maintain in your accounts?" was my first question.
"We keep about eight hundred in the checking account at all times."
"How do you manage to keep such a small float in the account?" I was obviously impressed with their cash management.
Frieda quickly corrected me. "Eight hundred thousand."
"Eight hundred thousand dollars in your checking account?" I quickly asked.
"Yes," Frieda beamed.
After I regained my composure, I managed to squeak out an "oh" without being too emotional. I clearly understood why the banker took them to lunch so often and paid. He was a real sport. The bank was making a small fortune on their balances.
"Frieda, do you know you could be earning an extra $40,000 to $50,000 per year on your money if you moved it to some kind of money market instrument?" I asked. She smiled but said nothing.
Ultimately, they became clients of our firm. The first thing we did was to fill out the forms for a money market account. It took Frieda almost six weeks to sign them and transfer the funds.
I was annoyed not only with Frieda's attitude, throwing away $40,000 to $50,000 per year, but I was also angry with her banker who was doing absolutely nothing to help his customer.
Why they never changed to another bank is beyond me. Incidentally, Frieda left the company when Bill concluded that $250,000 a year was too much to pay for a bookkeeper.
CASH COSTS MONEY!
Cash is one of the most expensive commodities we use in running our businesses. Think about it for a moment. In many businesses, other than cost of sales and hopefully your salary the cost of cash (interest) is one of the largest expense items a company has.
MAKE YOUR CHECKING ACCOUNT OBSOLETE
Try to deposit all daily receipts directly to a money market account rather than into your checking account. Transfer funds from the money market account to a checking account only when you anticipate writing checks. Confine check writing to once or twice per month to allow the float in the money market account to build and earn additional interest.
Don't get caught up by the notion that your banker will treat you better if you keep high balances in a checking account. He may like you better, but you should earn as much as you can on your money. Today, the banking business is far more competitive than it's ever been. If you are a good customer of your bank, you can have a lot of influence with your banker. But always keep another bank in reserve, just in case.
REDUCE THE RENT ON YOUR CASH
Sounds silly doesn't it? Yet, we do rent money. Therefore, our goal should be to reduce the rent.
The banking industry is extremely competitive, which means more favorable credit terms. Ask your accountant to help you select a bank and banker. Accountants and bankers have mutual referral networks which can be of value to you.
BANKERS HAVE PROBLEMS TOO!
Jane Cole started our phone conversation with an angry comment. "The financial statement you sent us was wrong."
"Jane, we never sent you a financial statement, and we haven't even done any work on your account," I responded.
"Well, I sent what you gave me to the bank, and we got our loan, but the statement was wrong," Jane claimed.
"I don't know what you sent, but it obviously worked. Why don't you get a copy of the statement and read it to me, and let's see if I can figure out what you did?" I said.
Ten minutes later Jane called back.
"The name of the company is XYZ, Inc., and all the dates have 19XX" she said.
"Jane, you sent the bank a sample promotional statement we provide new clients. It is meaningless. It's a nonexistent company. The bank gave you money off of a sample financial statement? Wow! It doesn't say a lot about your banker." We both laughed.
If you're not bankable and using a lender other than a bank, you're more than likely paying interest in excess of what a bank would charge. I refer to these lenders as second-level financing companies. They usually base their loans on underlying collateral you've supplied as security for the loan, and they charge handsomely for the money. They are referred to as asset based lenders.
Your goal is to improve the financial position of your company, not theirs. You need to become bankable as quickly as possible. To do this, you have to become more profitable, improve your cash flow, and operate your business in a businesslike manner.
GET MORE MONEY BY BEING PREPARED
Here are some tips on how to be prepared:
- Have your accountant introduce you to a banker. He/she will have access to high levels in the bank that you might not otherwise have. Don't just walk in off the street.
- Bring current financial statements consisting of a balance sheet, a profit and loss statement, a statement of cash flow, and footnote disclosures. The bank may require these statements to be reviewed or audited by a CPA.
- Bankers will want to review your history, so be prepared to present two or three years' prior financial statements and/or tax returns.
- Generally, you will personally guarantee the business loan, so have your personal financial statements and tax returns available.
- Bring financial forecasts. This will consist of forecasted profit and loss and cash-flow statements for at least one year in advance. It will also show the banker that you are sophisticated in your management approach.
- Provide a breakdown of what you're going to use the money for.
- Prepare a packet of additional information, which might consist of brochures, sales literature, contracts, history of the company, publicity, research projects, etc. Gather all the propaganda you can muster to show the banker that you are someone they must do business with.
- Watch your appearance. First impressions are lasting.
Do you know where your cash is? If it's not in your pocket, it's more than likely in accounts receivable (amounts people owe you) and/or inventory two items that sop up your cash like a slice of rye in a bowl of chicken soup.
THEY JUST GET LARGER AND LARGER
Do you remember the old joke about "The Three Famous Lies"? One of the lies was: The check is in the mail.
Now when you call a customer for payment they never say the check is in the mail. They say, "The check is being cut, but first we need a copy of the invoice. We seem to have misplaced it."
Does that sound familiar? (You wouldn't be doing that now by any chance, would you?) They have just borrowed your money for twenty-five additional days, interest-free. Five days to send the invoice copy, five days in their accounting department for approval, five days for cutting the check, five days for signature, then five more days back in the mail.
Always send invoices by e-mail. The mail should be obsolete.
Accounts receivable is probably the fastest growing asset in your company. The balance just seems to get larger and larger and larger. Remember, cash is king, and we have to get our hands on as much as possible. Therefore, monitoring and collecting accounts receivable is one of our most important functions.
BE SYSTEMATIC IN YOUR APPROACH TO COLLECTIONS
Here are some tips on speeding up the collection of your accounts receivable.
- Sit down with your bookkeeper or collector every two weeks and review a listing of the accounts receivable.
- Call delinquent customers immediately.
- Have nasty letters sent to slow pays. Three is sufficient, and they should generally follow this order: The first letter should ask for payment and give approximately twenty days for results. The second letter, which is sent out after the twenty days, should be a threat to turn the matter over to your attorney for collection. Give them about ten more days. The third letter, which goes out after the ten days, should say the account is going to be turned over for collection within forty-eight hours. If you don't get any results within the forty-eight hours, turn it over for collection.
- These letters should be computerized. If you send a letter to a long-time customer and he calls and says, "Listen you S.O.B., I've been dealing with you for years and now you send me one of those letters! I'm P.O.ed!" Your quick response should be, "Oh my god, our computer screwed up! It's a computer error I'm so sorry. " Then gently ask for payment.
- Monitor the total receivable balances daily.
- When you are instructing someone in your organization on the procedures for collecting the accounts receivable, be specific; give names and phone numbers to call and amounts you'd like to see collected.
- Charge interest or service charges on old balances. If you can't get paid in full, ask for partial payment.
- If you are not being paid regularly, your invoice may be going through the bookkeeping department with little concern on their part to pay the bill. Send a copy of the invoice to your contact at the company with a note to "please take care of this." You may get faster results. Often times your contact may not realize your bill is not being paid.
- After your credit manager, bookkeeper or collector has called several times, the debtor knows exactly why they are calling and will ignore the call. Have the bookkeeper leave a new name; Bridget is a good one. There isn't a businessman alive who would not return a call from a Bridget. For those of you who are dealing with women customers, Lance might suffice. But if Bridget calls you, watch out! She may be dunning you.
- Here is a familiar scenario: You instruct your bookkeeper to call on all accounts past due. She starts at the top of the list at the letter A, gets interrupted, starts over at A. She gets interrupted again, and starts back at A. Another interruption and back to, you guessed it, A. Once in awhile have the bookkeeper work up the list starting with Z.
- Put past due accounts on a cash-and-carry basis.
- Check your customer's current financial condition. They may be having worse problems than you.
- Bug the hell out of them.
- If all else fails, sue.
THE FANTASY ASSET
I like to refer to inventory as the fantasy asset. More games are played and guesses are made on the value shown as inventory on financial statements than any other item in the statement. This occurs so often that many times management loses sight of the importance of proper control and evaluation of inventory the single most important asset in deter-mining company profitability. Yet the fantasy goes on. Need more profit? Up the inventory. Pay lower taxes? Lower the inventory. Take an inventory? Too much trouble. Price it right? Too much detail. What's the inventory? Nobody knows. Plug in a number, so the saying goes.
If you use an incorrect inventory for your financial statement, your profit or loss statement will be incorrect by the exact same amount. It's a dollar-for-dollar ratio. Yet guesses are made, and the fantasy goes on and on and on.
A RULE TO REMEMBER
The profit and loss statement is absolutely worthless unless an accurately counted and priced (valued) inventory is used in the financial statements. You'll never know the true profit if the fantasy prevails; you're only fooling yourself.
FANTASY STORIES
Dave, Glenda, and Al sat quietly as I handed them their company's year-end statement. They were running a family business that was growing by leaps and bounds. Cash balances were running lower than their expectations, and they were concerned as to whether or not they were making a profit.
Dave began, "Are we on the right track? Are we making a profit?"
"Dave, I must be frank with you. The statement shows a profit, but as you know, much of the inventory was what you called an educated guess. If the number you gave us is right, then yes, there is a profit. However, there are no cost records of your work-in-process inventory and no material and labor costs for work completed. So, to answer your question directly, I don't know. What you need is a cost system that will tell you the material, labor, and overhead on each job and reflect accurate inventory value. This is a must for your business."
Dave responded quickly, "Maybe later."
Jim Williams is a man in his late fifties. He and his son were running a company that manufactured toilets.
"Jim what does it cost you to manufacture a toilet?" I asked.
"I don't know" was his response.
"How do you know what to sell it for?" I asked.
"We've been selling it at that price for years" was his last comment.
Bill Bennett and his partner Harold Mahler thought they were very clever. They got into the business of manufacturing wood household products: items such as breadboxes, saltshakers, canisters, etc. Sales were almost $12 million. You may have purchased one yourself; their products were well made, and they were everywhere.
One day in a meeting we were discussing the financial statement of the company. I urged them to hire a controller. Harold's father, Sam, was doing the books, and he was incompetent. You couldn't rely on any of his numbers.
I also was bugging them to get a cost accounting system installed to ascertain proper inventory and product costs. They were manufacturing a multitude of different products, but there wasn't one piece of paper available to indicate what this product cost.
"Harold, you've got to get rid of Sam and bring in a controller and a cost accountant. The business is growing; you can no longer operate as a mom and pop organization."
"I know, but how can I fire my Dad?" Harold asked.
"That's a tough one, but you need a better controller," I said.
"Maybe later," was Harold's cool reply. "By the way, I've installed a cost accounting system."
"Huh? When did you do that?"
"Not too long ago. We measure the trash in the barrels."
"What?"
"Every night we go to the waste bins and measure our scrap lumber. This gives us a method of measuring costs. Too much scrap, too much cost."
Needless to say, I was amazed. I had never heard of such a thing.
Steve Jenkins was great with the fantasy asset. His company was losing its shirt, yet the financial statements indicated a profit. He was in the underwear business. Obviously, the company was losing its undershirt.
Anyway after he left the company, we found out the games he was playing. At the end of every year he would change his computer to up the value of his inventory so that he would show a profit.
Eventually, Steve sold out to one of his employees. This has always puzzled me. The employees knew what Steve was doing, yet bought the business based on this fantasy inventory and phony financial statements.
Steve was last heard from somewhere in Arizona. The company, after forty-two years in business, went into bankruptcy. It was one of the oldest private companies in California.
By the way, Jim Williams' toilet business died a slow death. Dave Marcus' company is installing a cost system and doing well, and Harold fired his father just prior to a major creditor closing them down.
THERE ARE NO EASY SOLUTIONS
Inventory control is the most difficult area in running a business, yet also the most vital. There are no easy solutions to inventory control, but I do have some practical suggestions:
- Use perpetual inventory records for the large dollar amounts of inventory. You don't have to maintain records on the entire inventory. Usually, 20 percent of the inventory items accounts for 80 percent of the dollars. Maintain records on 20 percent of the items that account for the 80 percent of the dollars, and not on the 80 percent of the items that account for 20 percent of the dollars.
- Take physical inventories regularly, and compare the physical inventory with your perpetual records to test the perpetual records for accuracy.
- If taking a physical inventory is a large task, take counts on a cycle system. This may mean counting a fourth of the inventory every three months or a sixth every two months.
- The small and low value items should not be included in your routine inventory counts. Count them once or twice a year; use your judgment.
- If the physical inventories and the perpetual inventory are in agreement, the perpetual inventories can be used for financial accounting.
- All differences between the physical inventory and the perpetual inventory should be reconciled.
- As soon as an item in inventory appears to be slow moving, reduce the price and get rid of it. This will keep your inventory fresh at all times.
- If you manufacture a product, a cost accounting system that determines the cost of your product should be developed. This will aid in the determination of the price your product will be sold for.
- Sell your product by calculating the sales price in the following manner:
Don't be foolish when working with your inventory in determining costs and/or systems. If you are in doubt about what you are doing, seek professional advice.
- If you are in the construction business, whether you're building buildings or painting walls, develop job-cost accounting. This will allow you to keep track of materials and labor on all jobs, and it will be of great assistance in determining productivity, bidding procedures, and pinning down where you've made mistakes.
- Adopt and maintain written policies and procedures to implement all inventory procedures.
- Review inventory reports and procedures regularly.
- Stop fantasizing.
Good housekeeping is an important factor in taking a physical inventory. Your inventory can be taken more quickly and more accurately if you begin with the following steps:
- Move identical goods to the same location.
- Place inventory in order.
- Make all items readily identifiable.
- Clear aisles and passageways.
- Segregate scrap and worthless items.
INVENTORY INSTRUCTIONS
Management should prepare detailed instructions for taking the inventory. These instructions should include cut-off procedures for shipping and receiving departments, complete procedures for counting the inventory, and the name of the individual to contact if there are questions.
All participants should attend a meeting to review the instructions.
ESTABLISHING THE CUT-OFF
A proper cut-off involves identifying the arrival and shipment dates of your inventory. This is essential, because it defines the items to be included in your inventory. Under ideal circumstances, all activities in the shipping and receiving departments would be stopped; however, many times this is not possible.
Goods received after the cut-off date should be physically segregated and counted separately. The receiving documents should indicate the date the shipment was received. This will facilitate the accounting of the related invoices. If the items are shipped during the inventory, the shipment date should be noted on the shipping records. This will identify the last invoices to be included in the current accounting period.
COUNTING THE INVENTORY
Thorough planning will help eliminate problems that can occur in counting inventory. Your planning should cover topics such as inventory counting teams, the layout of the warehouse, per-numbered inventory count tags, and supervision.
- The counting teams should consist of two individuals: one as a counter and the other as a recorder. These individuals should be familiar with the items to be counted but, if possible, should not be employees who work in the warehouse. Employees who have regular access to the inventory may be able to hide any misappropriation by falsifying counts.
- Each counting team should be assigned an area of the warehouse. Those sections should be easily distinguishable from each other. For example, aisles may be used as boundaries. This will decrease the possibility of inventory being counted twice, thus creating false profits.
- Once the counting teams have been assigned their areas, pre-numbered inventory tags should be distributed to them. When filled in, the tags will contain a description of the item, the quantity of items counted, the units in which they were counted (for example, one dozen each), an identification of the inventory counting team, and test-count information.
- As the tags are issued, the supervisor should maintain a control sheet showing which tags were distributed to which teams. For example, tags 1 through 100 might be given to Counting Team A, and 101 to 150 to Team B.
- All items of inventory should be tagged. After the counts have been made, a tour of the areas to see that all items have been tagged is appropriate. After this is complete, then all tags should be pulled.
- The completed tags will be placed in the inventory areas in boxes or on shelves. The supervisor will subsequently collect the tags, place them in numerical sequence again, and tabulate the results.
- Unused tags will be returned to the supervisor to ensure all tags have been accounted for. If your inventory tags are not pre-numbered and some are misplaced, your final figures will be inaccurate. Pre-numbering the tags is designed to eliminate that possibility.
- To count large quantities more efficiently, consider the following shortcuts: You can use a scale to determine quantity. For example, if you know that 100 bolts weigh approximately four ounces, you can calculate the total number of bolts by weighing them.
- You can also pre-count portions of the material prior to the formal inventory. In this way, in the weeks preceding the actual inventory, employees can use their spare time to count some of the items.
- If pre-counting is used, be sure a pre-count slip is attached to each container, showing the quantity and description of the item, as well as the initials of the employee and the date of the count. The containers should then be sealed. If any of the units are removed from a pre-counted container, it must be indicated on the pre-count slip.
- Adequate supervision is a must. It provides the assurance that all procedures are being followed as prescribed by management. The supervisor can solve problems that arise, such as identifying unusual goods, and should conduct random checks of some of the sections that have been counted.