“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tip every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … then No Cash? Can we borrow what we need?, What if our loan collateral doesn’t cut it? and the need for outside investors.

Last week, we began our conversation about business valuation. We continue that discussion today with a valuable chart that will help you understand some of the key valuation principles.

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“Can anybody remember when the times were not hard and money not scarce?”

~ Ralph Waldo Emerson

What’s the difference between a Strategic & Financial Buyer

John Wilson, CEO of Ace Business Stuff, has been working diligently with his controller, Tom Sampson, to assess his financing needs. They may require an equity investor as he suspects that his controller’s right that bank financing may be insufficient.

“Hi Lary,” John said when he got Lary Blogger on the phone again.

“We’re almost finished with our forecast, but it still looks like we’ll need some equity. I’d like to explore what you said about strategic buyers and financial buyers and see the diagram you mentioned.”

Different Buyers have Different Perspectives

“John, this diagram is only meant as a general overview of some key valuation concepts,” I said when I visited with John at his office a few days later. “It should help you better understand certain key concepts which underlie the valuation of an ownership interest in your company.

The Strategic Buyer will pay the highest premium

“At the top is the Strategic Buyer. In short, he’s looking for more than a simple financial return. He or she is looking to share a distribution network, like Google’s acquisition of YouTube, for example, or to expand an existing product line, like Mars buying Wrigley’s. These acquisitions are often about the “white space”, filling in gaps in the acquirer’s product line as we’ve seen happening in the wine industry, say with the sale several years ago of Rosenblum Cellars to Diageo. The expectation is that the Strategic Buyer will pay a “Special Premium” to obtain some of these strategic advantages.

The Financial Buyer has a different perspective

“Contrarily, the financial buyer is looking solely for a return on investment. That buyer is usually unwilling to pay a premium beyond his target rate of return. In the second horizontal bar, you’ll note the term “Control Value”. Keep in mind that when most people talk about “valuation”, they’re talking about value for the whole company, or at least a controlling interest of 51%.”

“But that’s not what I’m looking for,” John said. “I have no intention of selling my company. I’m just looking for a minority investor.”

What if you need a minority investor rather than a buyer?

“I understand, John, and that’s why I want to make sure you understand these concepts and how buyers and investors alike may look at your company. Since you’re considering a sale of a minority interestA significant but non-controlling ownership of less than 50% of a company's voting shares by either an investor or another company. in your company, the valuation is not the same as if you were selling a controlling interest.”

“I don’t see why not? They’re getting a piece of the same company I own and it should be worth to them what it’s worth to me.”

What kind of a discount is there for minority ownership?

“From a valuation perspective, John, it’s going to be worth more to you because you have a controlling interest. You’re the boss, you can elect a majority of your Board of Directors and you call the shots. Your potential partner has limited courses of action if he doesn’t like the direction in which the company is going.”

“Then he shouldn’t invest, Lary. It’s really that simple, isn’t it?”

“Absolutely, he must believe in the company as well as your leadership, but that doesn’t mean he has much influence over things if they don’t go well. So, let’s review the two primary discounts that occur from the valuation of a controlling interest in a company.

What is a Minority Discount?

“First, there is a control premiumAn amount paid to gain enough ownership to set policies, direct operations, and make decisions for a business. Contrast with Minority Discount., or a minority discountA reduction from the Market Value of an asset because the Minority Interest owner(s) cannot direct the business operations. Contrast with Control Premium. because, as I’ve said, the minority shareholders must depend on the majority shareholders to make wise decisions. Since they don’t control the company, their ownership piece is worth less, and therefore, they’ll expect to pay less to buy it.”

How is the Minority Discount applied?

“What you’re saying, Lary, is that if my company is worth, say $2 million, and I need to raise $400,000, I’m going to have to give up more than the 20% that I would get by multiplying $2 million by 20%. Is that right?”

“Generally speaking, that’s right, John. But in a negotiated situation like you’re thinking about, it might play out differently. If an investor agrees that the company is worth $2 million, he might conclude that it’s a fair proposition and pay $400K for a 20% interest.”

“What kind of discount are we talking about, Lary? How big is that so-called “minority discount?”

“I know you’ll love this answer, John … but it depends . . . on a number of factors that a qualified valuation specialist will assess. Why don’t we get into those details another time?”

“Okay, but I don’t like the direction this is going, Lary. The value of the minority interest I’m selling keeps going lower.”

The value of a minority interest can get reduced even further

“I understand your point, John, but there is yet another, bigger factor to consider – a lack of marketability discountA method used to help calculate the value of closely held and restricted shares. The theory is that a discount exists between the value of a company's stock that is and is not marketable. Various methods have been used to quantify the discount that can be applied. The consensus of some studies suggests that this lack of marketability discount can range from 30-50%.. A minority investment in a private company is also an illiquid investment, and the lack of liquidity makes it less desirable, say, than a comparable investment in a public company. The minority investor in a private company is not usually able to ‘cash out’ until you do.”

“So, Lary, what are we up to, in total discounts I mean? Is there anything left for me?”

What do all these discounts amount to?

“First, John, these discounts don’t get added together. The ‘Marketable Minority Interest Value’ you see on the diagram gets calculated first by applying the minority discount. That term is roughly equivalent to share of stock of a publicly traded company; you’ve probably noted in your own experience that public company shareholders almost always receive a “control premium” when the entire company is purchased.

“At the same time, it’s quite different to own a share of publicly traded company that you can sell any time you’d like and a share in a privately help company where there is no ready market to sell it.”

What is the Lack of Marketability Discount?

“Sure, I guess so, Lary. That is an advantage with a public company, but I didn’t think about the fact that a share in our company isn’t very liquid. I can’t even sell my own shares back to the company with any expectation that they could afford to buy them from me.”

“That’s right, John. So lets look at how this “lack of marketability discount” works. It’s actually applied to the remaining net number, which is the “Marketable Minority Interest Value” to arrive at the Non-Marketable Minority Interest Value, which is at the bottom of the diagram. This generally represents the minority investment in a private company. All in? It wouldn’t be unusual for those discounts to equal a 30-45% discount from the value of a controlling interest in the same corporation.”

“So, in my little $2 million example, the value of my company to a minority investor might be more like $1.1 – $1.4 million or so. That’s a big difference.”

A Minority Investor has a unique perspective

“Yes it is, John. Remember, though, that in your case, this is a negotiated process and the potential investor won’t know all of this. I want you to be aware of these concepts, though, because minority investors are not easy to find for these two key reasons – they don’t have much control and they can’t get their money back easily.

“John, this is all the more reason you need to carefully prepare your forecast and be certain you’ve captured all of the unique attributes and capabilities of your company so you can justify a fulsome value and only raise the equity capital that you absolutely need.

“Let’s get together again next week when you have the forecast finished and we’ll talk further about this process.”

Business Finance | Valuation | What kind of investor do I need? is a post from: Sword Tips – the Exkalibur blog

Nothing in life travels in a neat formation accompanied by bugles and cavalry. A lot of it shows up filthy and unkempt, prominent in the mess we’ve made around our foxhole. These lessons are typically the offspring of hubris, naivete and ignorance … or from overlooking the land mines hidden beneath our feet.

Every Tuesday, we’ll share valuable and practical leadership tips and tools to help you BE a better leader so you can BECOME a better leader. Remember … you won’t BECOME a better leader until you start BEING a better leader  … implementing NOW the changes necessary to adopt the proven strategies of successful leaders. You might start by building on the communication matrix and making sure you’re defending the castle to get done what only you can do. Make some time so you’re thinking past today.

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It’s Almost Midnight. Do you know where your cash is?

Okay, I admit it, I’m cheating a little this week … but I’ve got a few good reasons. Well, I’m calling them reasons anyway.

For one, I’m working hard to get ready for our Cash Flow Workshop, “It’s Almost Midnight. Do You Know Where Your Cash Is?” scheduled for May 25th. If you live in the San Francisco bay area, are not a financial executive and want to advance your business finance knowledge, our workshop is tailored for you.

Every successful business executive needs a solid grounding in the principles of cash flow … not artificial placeholders like EBITDA, but the hard, cold cash that Warren Buffett calls the “lifeblood of business”. This is an Extended Learning Workshop that is different than anything you’ve ever attended. There are special conference calls before and after the workshop, a financial literacy test, an E-book … and a private 1/1 consultation with a senior member of Moss Adams LLP, a senior banker from Exchange Bank and me. We’d love to see you there.

Alright, so maybe that sounded a little self-serving but it really isn’t. We’ve got a great group of North Bay sponsors who share my belief that helping small and middle market business owners and executives become better equipped to measure, manage and increase cash flow is the greatest service we can provide to that community.

Join us and we’ll teach you how to increase cash flow. It’s that simple.

New L.E.A.D.E.R.S.H.I.P. Series

I’ve also been planning a new program, the Top Ten Attributes of L.E.A.D.E.R.S.H.I.P., which is directly related to our weekly Leadership Series. Next Tuesday, and for the following 11 weeks, we’ll tackle this fascinating subject and get a dialogue started about the most important attributes of great leaders. The North Bay Business Journal, a San Francisco affiliate of the New York Times, will also be carrying these articles every week during the 12 week series.

What does it take to be a good leader? How much is inherited, and is that all we’re going to get? Where can we get what’s missing? What if we apply the best practices that others have learned and shared? Does that get us there?

Yes, it’s possible that we’re not quite the leaders we think we are. How do we measure our capability and success as leaders? If our company is making money, does that cover it? If our company is growing, have we arrived? Do we just need to look around to see if anyone is following us?

Join the Conversation

Please join us as we engage in a vibrant conversation about L.E.A.D.E.R.S.H.I.P. Maybe there are attributes you think I overlooked, or maybe you disagree with my choices, so feel free to share your thoughts along the way.

What do you think are the most important characteristics of leadership? Which ones do you cherish as critical to your success? Are there some that you think are overrated?

Leadership Lessons | Are you only a legend in your own mind? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … then No Cash? Can we borrow what we need? and What if our loan collateral doesn’t cut it? Last week, we talked about the need for outside investors.

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“All intelligent investing is value investing — acquiring more than you are paying for. You must value the business in order to value the stock.”

~ Charlie Munger

How important is valuation?

John Wilson, CEO of Ace Business Stuff, spent the last few weeks preparing for his meeting with Lary Blogger. He called a few days ago to follow up on his recent conversation with his attorney, Frank Lee Documents, when they spoke about investors, DilutionA reduction in earning per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities and ValuationThe process of determining the current worth of a company. An analyst valuing a company may look at the company's management, the composition of its capital structure, prospect of future earnings, and market value of assets. Judging the contributions of a company's management would be more subjective, while calculating intrinsic value based on future earnings would be an objective technique..

Valuation is the bedrock for investors

“Hi, Lary. I appreciate your coming by to meet in person to talk further about some of the issues we discussed a few weeks ago. Can we talk about valuation first, since that seems to be the foundation for conversations with prospective investors?

“Sure, John. I think you’ll find from our conversation that while valuation is one of the cornerstones for such discussions, your company’s performance, as well as its promise, is what really underlies any discussion about valuation.”

What you WILL do may be more important that what you’ve DONE

“I’m not sure I follow you, Lary. I understand the performance part – what we’ve done historically will have a lot to do with what the company’s worth, but what does the future have to do with our valuation now?”

“John, let me give you a brief overview of the valuation process, which I hope will make it clearer. As you’ve already figured out, valuation is as much an art as a science, and there are many subjective factors to consider. Certain judgments about future conditions in your industry, for example, and in the economy, can be thought of as ‘subjective’ information since nothing in the future is really ‘objective’.

There are also other factors relevant to the final valuation outcome like the purpose of the valuation, the calculation of “invested capital” and the various discounts that often apply. If we don’t get to those today, we’ll talk about them another time.

How is a company valued?

“In the meantime, let’s cover the two most prominent approaches to value a company’s shares. For each approach, a certified appraiser will select the appropriate method to apply based on the company’s characteristics. Once their work is complete, all of the findings will be taken into account to come up with a fair market value for the company.

The Market Approach looks at sales of comparable companies

“The ‘market approach’ looks for relevant information among public companies, or about the sale of comparable private companies. As you know, there is a gold mine of information available about public companies, but it is more limited for private companies. Appraisers are looking for public companies in your industry with characteristics similar to your company. They will then consider those stock prices and the relevant metrics that may apply to your business.”

“But there aren’t any public companies like ours, at least none we know about. So how is that going to help?”

“That’s only one method, John. An appraiser will also want to look at the sale of comparable private companies from the growing variety of databases available for this data.”

“Can you give me an example, Lary, to illustrate what you mean?”

Study the sale of comparable companies

“Sure. Let’s say that we find a few companies that were sold in the last 12 months or so, with about $20 million annual sales volume. Let’s further assume that they prices at which they were sold translate to something like 1.2 X revenues or 4.5 X EBITDA. We would then try to determine the comparability of your company to those examples.

• Do you use a similar distribution channel to sell comparable products?
• Are the general levels of profitability similar?
• Are the growth rates in the same ballpark?
• Etc.

Then you could apply similar metrics to get one estimate of value for your company.

The Income Method is another valuation approach

“The second approach is the “income approach”, which is usually the most important for private companies. That approach typically looks at the cash flow from future revenues and expenses based on a forecast that you provide, to arrive at a future value.

Then, that stream of cash flows is discounted at a rate that reflects the risk associated with achieving those cash flows. That’s why your company’s future ‘promise’ is so important.”

The importance of forecasting can’t be overlooked

“I see what you mean, now. I don’t think we’ve ever put together a real forecast, I mean we do some budgeting each year, but usually only to get some idea of our expenses. Is a complete forecast that essential?”

“In my experience, it is, John. For one thing, an investor is likely to ask ‘what are your plans for the future’ since they are rightfully looking at how their investment is going to be repaid … sometime in the future … with an appropriate rate of return. Responding ‘I don’t know’ isn’t going to work.”

“I see your point, Lary. Even though we can tell our story, without anything written that illustrates the revenue growth and profitability, it will seem like we haven’t done a very thorough job in evaluating our own future. I’ll sit down with Tom Sampson and hammer something out this afternoon.”

Where does the forecasting process begin?

“John, this is not something you’ll be able to cobble together in a few hours. You need to think carefully about your underlying assumptions for revenue and expenses, and make sure they’re well documented. You’ll also want to get some input from your leadership team about your plans, as well as the related cost structures and investments that might be required to support those plans.

The future investments that may be required to realize your plans will be critical to investors. Access to that funding will be important to the company’s future success and the likelihood that an investor will recoup her investment with an acceptable rate of return.

If you haven’t done it before, you’ll need to set aside some quality time to prepare a thoughtful and thorough forecast.”

Make sure you’re well prepared if you’re courting outside investors

“Getting investors isn’t as simple as I thought, Lary, but I think I understand why it’s important to get it right. I don’t want to give up more equity than absolutely necessary, but I see that the better job we do up front, the better result we’ll get. By the way, does all of this have anything to do with what my attorney mentioned about financial buyers vs. strategic buyers?”

“It all ties together, John. The next time we get together to review your forecast, I’ll show you a useful diagram to explain those principles. In the meantime, you’ve some work to do.”

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TO BE CONTINUED …

This is Part 5 of a 12 part series called the “Big River“. The Big River signifies the growth path that so many companies follow, or are seeking, and the dangers that lurk along the shoreline as the Big River races forward trying to consume everything in its path. Next week, an important valuation framework is included to help you understand the most important concepts that effect company valuation. Make sure you sign up now so you receive every update in this practical series.

Business Finance | What’s the value of my company? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … then No Cash? Can we borrow what we need? Last week, we faced What if our loan collateral doesn’t cut it?

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“The worst mistake is to have the best ladder and the wrong wall.”

~ Donald Rumsfeld

Do you need an outside investor?

John Wilson, CEO of Ace Business Stuff, was thinking about several of the issues that he discussed earlier that day with his controller, Tom Sampson, and what Tom told him:

“Giving our customers an additional 30 days to pay, relaxing collections and neglecting the sale of inventory already on hand, isn’t a very sound strategy.”

Instinctively, he knew that Tom was right and that whatever bank loan they could obtain, it wouldn’t be enough.

What if bank financing isn’t enough?

Ted Deepockets, his long-time friend, had periodically needled John about the pros and cons of outside investors. They had never discussed price, terms or amount, but Ted’s name kept coming to mind over the last several days. John decided to call his attorney first.

“Hi, Frank. What’s new in the legal world these days?” Frank Lee Documents was John’s long-time friend and the company attorney.

“Same-o, John. The legal work keeps piling up so I guess that’s good. How about with you?”

“Frank Lee,” John drew out the syllables to emphasize the double entendre, “business is great, if that’s what you mean. Too good, in fact, but a few sloppy decisions on my part has us with booming sales and no cash. I’m actually thinking about taking on an investor.”

“That’s quite a change, John. You’ve never been inclined to consider that in the past.”

Is it possible to run out of cash while sales are still growing?

“I know, Frank, and I’m still very skeptical about taking on a partner, but we’re really growing. I don’t think we can borrow enough to fund our growth. Even if we tighten up a few things, we’re going to run out of cash before we run out of sales.”

“So, how can I help, John? Do have any kind of proposal or plan in front of you yet?”

“No, but I’m thinking of calling Ted to talk about it.”

“Deepockets might be a good place to start. He always speaks highly of you and what you’re doing, and after that windfall sale of his Saratoga property, he can probably spare a few bucks.”

Equity Investors raise a lot of new issues

“Probably so, Frank. But I’m not sure how to approach him. We’re still figuring out how much money we’ll need and even then, I’m not sure how this works. You and I have chatted before about DilutionA reduction in earning per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities. … LeverageLeverage can mean several things. 1) The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment, or 2) The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.. … ValuationThe process of determining the current worth of a company. An analyst valuing a company may look at the company's management, the composition of its capital structure, prospect of future earnings, and market value of assets. Judging the contributions of a company's management would be more subjective, while calculating intrinsic value based on future earnings would be an objective technique. . . . a lot of concepts that remain pretty unfamiliar to me. I need to understand this stuff – and sooner than later.” John could hear Frank’s stubby pencil scribbling across the page of the dog-eared notebook he always had at hand.

Make sure you’re getting the right kind of advice

“Here’s what I think, John. Of course, we can help you with the documentation, and you certainly better make sure any transaction like this is well documented. But I think there is someone else who is better prepared to guide you from a business perspective.

He’s had a lot of experience with middle market companies, and has helped companies raise capital during some difficult times. Let’s try to get him on the phone.”

What is dilution … exactly”

After a brief introduction and a few pleasant exchanges, John briefly described his issue to Lary Blogger.”

“So, Lary, can you help me understand what this term “dilution” is all about?”

“Don’t be put off by the fancy term, John. In this context, it simply means that by issuing additional stock to a new partner, you’ll own a lesser share of the company than you own now. You’ll be ‘diluted’. The subject can get pretty complex because there are a lot of ways that dilution occurs, but we can deal with those issues if and when they come up.”

How much money do you need?

“So, Lary, how much dilution are we talking about? How can I make that as small as possible?

“The key question is how much money do you need and what will it cost, which quickly gets around to ’what’s the value of the company’ today? Here’s a simple example to make the point. Don’t get hung up on the math, though, because we can go back over it later.

Consider this dilution illustration

“For now, let’s assume your company is worth $1 million and you own 100% of the stock. The $1 million is known as the “pre-money valuation”, meaning that it’s the valuation before any investment is made.

If, for example, there are 10,000 shares, each share is worth $100/share ($1,000,000 value divided by 10,000 shares). Let’s say you need to raise $300,000 to meet your capital needs. To do that, you will have to issue 3,000 new shares (the $300,000 investment divided by $100/share price).

After the investment, the share price won’t change – it will still be $100/share but there will now be 13,000 shares (the original 10,000 shares plus the 3,000 newly-issued shares). The value of the Company will also increase by the amount of the investment so that the total “post-money valuation” will be equal to $1.3 million (the original pre-money valuation of $1 million plus the $300,000 investment).

What does dilution do to my ownership?

“From this, you can see two things. First, as I said earlier, the share price doesn’t change. Secondly, although you still have the 10,000 shares you started with, the Company now has 13,000 shares outstanding, so your percentage ownership goes from 100%, when you owned all of the 10,000 shares, to around 77% (your 10,000 shares divided by the total number of outstanding shares of 13,000).”

“So, Lary, if I understand you correctly, the valuation of my company is pretty critical to this process. The higher it is, the less dilution I’ll experience. Is that right?”

What can I do to minimize dilution?

“That’s absolutely right. Let’s take our previous example and assume that the company is actually worth more, say $2 million as a pre-money valuation where each share is worth $200.

Now, with a new investor putting up $300K, they would only get 1,500 shares. In this example, there would be only 11,500 shares outstanding (the original 10,000 shares plus the newly-issued 1,500 shares), and you would own about 87% of the company, a full 10% more than the 77% in our earlier example.

Is Valuation an Art or a Science?

“I understand, but valuation is pretty subjective, isn’t it?”

“Yes, John, it can be as much art as it is science.”

“Thanks, Lary. Could we get together in person in a few weeks to talk more about some of this stuff? That would really help me and by that time, I’ll know more about our company situation.”

“Anytime will be fine, John. Just give me a call when you’re ready.”

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TO BE CONTINUED …

This is Part 4 of a 12 part series called the “Big River“. The Big River signifies the growth path that so many companies follow, or are seeking, and the dangers that lurk along the shoreline as the Big River races forward trying to consume everything in its path. Next week, we’ll begin to talk about valuation and how that is such an important consideration when evaluating the potential need for an equity investor. Make sure you sign up now so you receive every update in this practical series.

Business Finance | What happens if we need an outside investor? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … and continued last week with No Cash? Can we borrow what we need?

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“Anyone who lives within their means suffers from a lack of imagination.”

Oscar Wilde

Where do we start?

Tom Sampson, the controller for Ace Business Stuff, was in his office considering how to explain to John Wilson, the Company’s CEO, the issues related to the Company’s borrowing capacity and the weaknesses in the Company’s Balance Sheet.

Tom pulled together several schedules for his meeting with his CEO that afternoon, but was still struggling with how to get across some of the subtleties that he knew John would want to understand. Tom knew that his CEO was absolutely committed to the Company’s success, yet became very frustrated when his convictions about future performance collided with the bank’s concerns about current performance.

What factors will the bank consider?

Tom knew that the bank considered many factors when judging an asset-based loan. Having enough collateral to support the Company’s borrowing request was only part of it.

How do they measure the strength of the collateral?

One key ingredient is the quality of the collateral. Tom had often expressed concerns about the Company’s liberal return policy, as well as its lenient collection policy. He knew the bank would examine the Company’s historical product return rate and its collection policies and they might fall a little short.

What is the quality of our receivables?

It was likely that the generally-accepted 80% advance rate against receivables would be reduced by the bank given the Company’s product return rate of around 7%, meaning that the Company only netted about 93% out of every sales dollar. Tom knew that the return rate was unacceptably high and while they were working on it, they hadn’t made much progress.

Is there any bad debt expense?

Tom was pretty sure that the 8% margin over the target 80% advance rate would not give the bank a sufficient cushion. Most likely, the company would be unable to borrow at an 80% rate … more likely, something like 70%, which would be pretty tight.

What about our inventory value?

“Hi Frank,” Tom said when he reached the Company’s warehouse manager. “John and I will be visiting with our bank next week and I wanted to get an update from you on some of the older inventory we still have on hand. Any movement on any of that?”

“Not really, Tom,” Frank replied. “I’ve reminded the sales guys every time they wander through here, and I know John has talked to David about it.” David is the company’s sales manager, a capable executive but one who, in Tom’s opinion, always looked forward to next season’s products without much accountability for inventory that remained unsold for the past season.

“Tom, you know John. Like the rest of us, he hates writing stuff off but some of this stuff, well, I don’t think the customers really want it anymore.”

What are you doing about slow-moving inventory?

“Thanks, Frank. I know I need to talk to John further about it. I’ll get back to you with whatever I learn.”

This is why their inventory turnover is declining, Tom thought. He knew that the sales department, with John’s tacit support, was unwilling to reduce prices on products that an outsider might consider obsolete, believing that they could be sold “if they could just find the right customer”.

They rarely did, so the inventory just sat there. Once the “salable inventory” was identified and examined by the bank, the common 50% advance rate for inventory might also be under attack.

Are you paying enough attention to your balance sheet?

Tom considered various ways to overcome these issues but also realized that the Company’s Balance Sheet was also working against him. He didn’t have a current schedule handy, but he knew he needed to update their various ratios so he could show John, in black and white, exactly what was going on.

What are some of the ratios the bank cares about?

Tom knew that their Current RatioA liquidity ratio that measures a company's ability to pay short-term obligations. It is a well-established measure of a company’s liquidity, which divides Current Assets by Current Liabilities to evaluate whether the current liabilities could be paid as current assets are converted to cash. A higher number demonstrates the Company’s superior ability to generate cash to pay its short-term obligations. The Current Ratio is also known as the 'liquidity ratio', 'cash asset ratio' or 'cash ratio'. was tolerable but not great. He also realized that a greater concern would be the Quick RatioAn indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company. The quick ratio is calculated by dividing the net amount of (Current Assets - Inventories) by the amount of Current Liabilities. This ratio is deemed a closer measure of liquidity, referring to how quickly the Company can generate cash. Since inventory has to be sold before a receivable is created, the Quick Ratio shows whether a Company is likely to struggle with its current obligations if its inventory is not sold on a timely basis. Also known as the 'acid-test ratio' or the 'quick assets ratio., which was not very strong, barely half the size of the current ratio.

To be forewarned is to be forearmed

A lot was on the line. They weren’t just asking for a collateral loan. It was a balance sheet loan, too, and Tom hadn’t even dealt with those issues yet.

“John,” Tom said when he called his CEO and got a voicemail recording. “I’ve got a few more things I’d like to prepare for our meeting, a few more schedules I’d like to put together. I’d like to push our meeting out by 24 hours so I can be better prepared and show you a more comprehensive picture.

“I’ll give you a call in the morning to reschedule our meeting.”

Do your homework

Have you carefully prepared for your meeting with the top executives in your company? Will you “bring it” when you meet with your bank or will they find you stumbling around for answers that you should know cold?

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What’s next?

This is Part 3 of a 12 part series called the “Big River“. For me, Big River signifies the growth path that so many companies follow, or are seeking, and the dangers that lurk along the shoreline as the Big River races forward trying to consume everything in its path. Next week you’ll learn how to begin to evaluate your bank borrowing capacity.

Business Finance | What if our loan collateral doesn’t cut it? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Last week we began our 12 part Big River series so you can pick up the story there.

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“Creditors have better memories than debtors.”

Benjamin Franklin

What happens if we run out of cash?

John, are you ready for our meeting? We said yesterday that we were going to meet to go over our financial projections and review a possible bank proposal.”

“I’ll be right there, Tom,” John Wilson, company CEO said to his controller. He reflected on their conversation last week about the Company’s expected negative cash flow and the need to borrow from their bank, most of which resulted from giving extended terms to their customers. John learned his lesson and wanted to avoid borrowing, but Tom had been pretty explicit about the need.

First, we need to review our short term cash needs

“John, I’ve gone over our short term cash needs again,” Tom said after they gathered in the conference room and were looking at some numbers on the overhead projector. “I’ve created a simple example on the screen with all the numbers shown in thousands. I’ve assumed a $200K line of credit (shown with a bright blue border). On Line 1 - Net Cash Flow, you can see the expected negative cash flow in the next three periods, of <$161,000>, <$75,000> and <$4,000>, respectively. [See the Sample Chart, below, to refer to these items. Line Numbers and Categories are bold-faced for easier reference. The numbers are shown in thousands.]

How much cash do we need?

If you look on Line 3 – Cash Required, you’ll see how much cash we’ll need in excess of our Opening Cash Balance for each period. Line 3 – Cash Required shows the money we need to pay our payroll and normal operating expenses on time. Line 4 – Line of Credit Used this Period, shows how much we’ll need to borrow in each period so that we have enough cash to cover those bills as well as the $150,000 Minimum Cash Balance we need to support out working capital needs. Below that is the new Line of Credit Balance (Line 5), and below that is our Remaining Availability to borrow against our line of credit.”

“Tom, I’m not following you.”

“Sorry, John. Take a look at Period 1 (marked with a bright red border) on Line 4 where you’ll see the borrowing of $96K, shown as Line of Credit Used This Period. The $96K on Line 3 - Cash Required represents the difference between the negative cash flow from our operations of <$161k> on Line 1 and our Opening Cash Balance of $65K in Period 1.

How much do we need to borrow to meet our needs?

Can we borrow enough at the right time?

“Thanks, Tom, I’m with you. It looks like you’ve set up the financial model to borrow enough money to cover our cash needs and to show what borrowing power we have left.”

“That’s right, John. You can see from Line 3 that we need to borrow $40,000 in Period 3 to meet our cash needs. However, you can see that we’ve maxed out our $200,000 line of credit by then (see Line 5 – Line of Credit Balance) so we can only only borrow $29,000. In theory, we’ll have a negative cash balance of $11,000 (Line 6 – Net Cash Balance), but we can probably manage that by deferring a few payables, but that’s not a sustainable policy.”

When does our cash flow return to positive?

“So, if I’m reading this right, the good news is that we return to positive cash flow in periods 4 & 5, our cash position starts improving again and we can even pay back some of our loan.”

“That’s right, John. It gets pretty close in period 3, but our borrowing capacity starts to grow after that. It improves because we expect to have a large, positive operating cash flow in the 5th period, when our receivables finally get collected.”

Do we qualify for a $200,000 line of credit?

“Tom, are we sure we can get a line of credit of $200,000? That’s your assumption, isn’t it?”

“Yes, I used a target line of credit of $200,000. In reality, our balance sheet is probably not strong enough to justify anything other than an asset-based loan. In that situation, the bank advances money as a percentage of our outstanding receivables and inventory. The line of credit will vary based on those balances each month, but it should be in that general ballpark.”

Do we need an Asset-Based Loan?

“Tom, I think I get the general idea but I do want the specifics. Can we reconvene this afternoon and go over the details? Maybe you could update this table to reflect how the loan availability changes based on inventory and receivables?

You can also teach me a little about an asset-based lending program and educate me about your concerns with our balance sheet. I really need to understand this. Can I check back you sometime after 3:00 p.m?”

“Sure, no problem, John. I’ll be waiting.”

What’s your experience? Do you have borrowing capacity to deal with unexpected cash shortfalls? Do you have an early warning system to let you know about a cash crunch that may be coming?

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TO BE CONTINUED …

This is Part 2 of a 12 part series called the “Big River“. The Big River signifies the growth path that so many companies follow, or are seeking, and the dangers that lurk along the shoreline as the Big River races forward trying to consume everything in its path. Next week you’ll learn how to begin to evaluate your bank borrowing capacity using an asset-based loan program. Make sure you sign up now so you receive every update in this practical series.

Business Finance | No Cash? Can we borrow what we need? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. Every Wednesday, we’re sharing a new Business Finance Tidbit specifically for those business executives who don’t have a finance background. You’ll get a head start by reading Warren Buffett’s letter to shareholders this year, and his comments about depreciation.

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“The importance of knowing accounting can not be underestimated, it’s the language of business. If you don’t know it, it’s like being in a foreign country without knowing the language.”

Warren E. Buffett, CEO of Berkshire Hathaway, Inc.

We’re making money … but we’re broke?

“We’re broke,” Tom mumbled to himself. Tom Sampson is the controller of Ace Business Stuff and was reviewing his latest calculations about their cash flow.

“What do you mean, we’re broke?” Tom looked up sheepishly to see John Wilson standing in his doorway. He fingered his collar and turned to address the company’s CEO. “We can’t be broke because business has never been better,” John said. “Our sales are up over 20% and we’ve even knocked a few percentage points from our costs so our margins are up, too. Our operating expenses are about where we expected, so we should be hitting the ball out of the park.”

How can we be out of cash?

“How can that be, Tom? We just agreed that we’ve having a record year.”

“John, we’ve discussed this before. Profits aren’t the same as cash. Profits are the excess of revenues over costs, measured when we deliver our products. Cash flow is the excess of what we collect from those sales, less what we use to run our business. They don’t always occur at the same time . . . or the right time.”

“But, Tom, if we have more revenue than costs, then we’ve got to have extra cash, particularly if we’re on our way to a great year. Something’s wrong here. Have you double-checked with the bank?”

You’ve probably heard a version of this somewhere

This conversation, in many forms, takes place every day in conference rooms and hallways across America. You may have been in a few. Business is starting to grow again; the company is ready to start investing in people as well as property, plant and equipment. It’s expanding operations, adding product lines and serving customers. Business is prospering . . . but there is a limited understanding of the accounting and cash flow implications of those plans.

Have you double-checked with our bank?

“John, I don’t need to check with our bank. There are no missing deposits and we’ve reconciled all of our accounts. The problem is that we’ve invested all of our cash in the business and we’re not going to be able to meet payroll.”

“Didn’t you see this coming, Tom? You said we’re on top of the bank stuff and our accounts are clean. Why didn’t we see this sooner?”

“John, we’re lucky we’re even seeing it now. It was only when I saw our receivables climbing faster than our revenue that I knew something was off. It was Jody who told me that the salesmen got approval to extend our payment terms from N/30 days to N/60 days.”

“We had to do that, Tom. Our customers have expanded their purchases from us because we’re able to offer more generous terms than our competitors. That’s what’s fueling our growth.”

There are lots of ways to run out of cash

“Which is exactly why we’re out of cash, John. We’ve got all of these extra sales but we haven’t collected any cash from them yet because we’ve given the customers longer to pay. Nobody told me, or our purchasing manager, so we didn’t have a chance to reach a similar deal with our own vendors. So, we’re stuck with having to pay them on time, plus with the people we’ve added, our payroll is up and we have to pay that every 2 weeks no matter what.”

We love the Big River … but it consumes everything in its path

What John Wilson, CEO, is painfully discovering in this simplified example is that the flow of profits and the flow of cash are asynchronous, that is, they don’t follow the same pattern. The kind of accelerated growth that ranges at or above 15% per year is what I call the “Big River”, and the bigger the river, the greater its impact on everything in its path. It’s indiscriminate as it absorbs the cash faster than the profits can keep up.

In the conversation between Tom and his CEO, the Big River is consuming all of the company’s liquid assets. Managing the growth rate of your business is critical because the growth rate is the engine that drives so many of the issues critical to our business success. DilutionA reduction in earning per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities. … LeverageLeverage can mean several things. 1) The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment, or 2) The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.. … ValuationThe process of determining the current worth of a company. An analyst valuing a company may look at the company's management, the composition of its capital structure, prospect of future earnings, and market value of assets. Judging the contributions of a company's management would be more subjective, while calculating intrinsic value based on future earnings would be an objective technique. … LiquidityThe ability to convert an asset to cash quickly. Also known as 'marketability'. There is no specific liquidity formula, however liquidity is often calculated by using liquidity ratios. . . . . and more.

What’s the best way to evaluate the impact of growth?

“Great, Tom, the sooner the better. I’m thanking my lucky stars that I invested what I did when we started this business. Otherwise, we’d be even further in the hole.”

Where is all that cash going?

“It’s not as bad as all that, John. I think we’ve got a good story to take to the bank. We’ve got solid receivables and inventory, so we should be able to borrow enough working capital to get through this period, collect our receivables and better align our terms with our vendors and our customers.

“You were right, John. This is a good time to call our bank.”

What’s your experience? Have you run out of cash just as you thought your business was picking up?

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What’s next?

This is the first part of a 12 part series called the “Big River”. For me, Big River signifies the growth path that so many companies follow, or are seeking, and the dangers that lurk along the shoreline as the Big River races forward trying to consume everything in its path. Next week you’ll learn how to begin to evaluate your bank borrowing capacity.

Business Finance | We’re Making Money. Why Are We Broke? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background.

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Depreciation = Cash? Why do we care?

We’ve kinda been on a Warren Buffett tear lately, and last week I encouraged you to read his recent 2010 Annual Report to Berkshire Hathaway shareholders.

I want to plant another seed this week about an often misunderstood concept: DEPRECIATIONIn accounting, an expense recorded to allocate a tangible asset's cost over its useful life. Because depreciation is a non-cash expense, it increases free cash flow while decreasing reported earning. It is used in accounting to try to match the expense of an asset to the income that the asset helps the company earn. For example, if a company buys a piece of equipment for $1 million and expects it to have a useful life of 10 years, it will be depreciated over 10 years. Every accounting year, the company will expense $100,000 (assuming straight-line depreciation), which will be matched with the money that the equipment helps to make each year.. (You can see the definition by placing your cursor over the term.)

How is Depreciation Relevant to EBITDA?

Today, let’s just think about it in terms of EBITDA. In Does EBITDA Bury Its Own Dead?, I wrote about the perils of treating EBITDA as a placeholder for cash flow, and Buffett couldn’t agree more.

In his Annual Letter to Shareholders, 2002, Buffet describes how depreciation is viewed by those devoted EBITDA followers … as a non-cash item that is unimportant to cash flow as part of the EBITDA cash flow legend

In future columns, we’ll address the way the depreciation is viewed, the conflicting signals it sends and the issues it conceals. In the meantime, Buffett goes on in his 2002 letter to further attack the concept that depreciation isn’t a real expense, which he calls “nonsense”.

Consider this Analogy … Depreciate Your People?

Buffett offers an interesting analogy that I hadn’t considered, but it’s a poignant way of looking at depreciation as a most deceiving member of this EBITDA tribe:

“In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business. Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a “non-cash” expense – a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?”

What do you think? Are you staring at your EBITDA numbers every month? Can we help you understand it better?

Business Finance | Warren Buffett | Should We Depreciate Our People? is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tip every Wednesday specifically for those business executives who don’t have a finance background.

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Read Warren Buffett’s Letter to Berkshire Hathaway Shareholders

In most fields of endeavor, the more we learn, the more we realize how much we have to learn. It’s certainly no different in the world of business finance, so for non-finance executives, it’s never easy to know where to start.

So, why not  jump into the deep end right now by reading Warren Buffett’s Letter to Berkshire Hathaway shareholders for 2010. The publication of Berkshire Hathaway’s annual report is closely watched in the national media, as well as in homes and offices across the country … and for good reason.

Business Finance is about much more than finance

I’ve said before that leaders don’t have the luxury of confining their interests to just a few things. Building a Business is not just about strategy, finance and leadership. It’s about much more … and nothing brought that home more clearly than choosing the categories and tags for this article … because it’s about so much more than business finance … and yet, it’s related directly to business finance.

A great example of the Art of Communication

Warren Buffett’s letter is a great example in the art of communication … about complex financial issues as well as organizational development, culture, recruitment, succession planning, ethics, stewardship … it’s a long list that will satiate any appetite for those of you interested in understanding how all of it fits together. On the subject of communication, you may find the Communication Action Plan a valuable tool to jumpstart your own communication plan, which we just published as part of our Nothing but Leadership series.

What do you think?

In his annual letter, Buffett discusses the many financial challenges within the companies and industries under Berkshire Hathaway’s broad umbrella. What’s so engaging is not just his avuncular style but the rich tapestry of issues and challenges that come together in the assessment of business performance.

Is there a particular issue that you’re curious about? Growth? Liquidity? Metrics? Leverage? Valuation? Productivity? It’s all there … with Buffett’s personal interpretations, his issues with analysts, his challenges to accepted valuation and financial metrics standards.

How does Buffett’s letter serve as a communication device for shareholders? Too much information? Not enough? Where should we start to help you with your business finance education?

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How our Weekly Business Finance series will help you

Most non-finance executives have picked up a few tidbits … from a class, from a financial colleague or friend, a banker, an accountant … and have assimilated a variety of random fragments that are probably more like a messy collage than a well-drawn portrait. Is it enough to get by? Maybe … but if you’ll take ownership of your own financial education, we’ll help you. Dig in, challenge what you read, add your comments or questions and we’ll answer them right here … every time … and we’ll get this conversation started. Are you with me?

Business Finance | Why you should read Warren Buffett’s Letter is a post from: Sword Tips – the Exkalibur blog

“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tip every Wednesday specifically for those business executives who don’t have a finance background.

Most non-finance executives have picked up a few tidbits … from a class, from a financial colleague or friend, a banker, an accountant … and have assimilated a variety of random fragments that are probably more like a messy collage than a well-drawn portrait. Is it enough to get by? Maybe … but if you’ll take ownership of your own financial education, we’ll help you. Dig in, challenge what you read, add your comments or questions and we’ll answer them right here … every time … and we’ll get this conversation started. Are you with me?

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“Make everything as simple as possible, but not simpler.”

Albert Einstein

If it were only that simple ….

If you’ve ever exercised by lifting weights, you know that the amount of the weight on the bar is only one variable that needs to be considered for a particular exercise. If you’re doing a bench press, you can add more weight because your chest and shoulder muscles help your arms to lift the weight. But if you put 50% of that total weight on each of two dumbbells, you can’t lift either one. You’ve probably also learned that you can’t use the same weight for curls as you do for bench presses.

How much weight can you really lift?

Likewise, if you’re going to do only one repetition, you can handle more weight than if you’re going to lift it ten times. If you are lying flat, you can do more than if you’re lying on an angled bench. And if you’re going to do more than one set, you’ll probably have to reduce the weight further so you’ll still be able lift it when you’re in the third set. Are you trying to build strength or develop endurance? Are you trying to lose weight or improve your golf game? All of these variables make a difference.

How do we balance all of the financial variables?

Now, consider this list of variables. DilutionA reduction in earning per share of common stock that occurs through the issuance of additional shares or the conversion of convertible securities. Ownership. Growth RateThe amount of increase that a specific variable has gained within a specific period and context. This typically represents the compounded annualized rate of growth of a company's revenues, earnings, dividends. Expected forward-looking or trailing growth rates are two common kinds of growth rates used for analysis.. Borrowing Capacity. Valuation. ROIReturn on Investment. A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.. Interest Rate. Profitability. LeverageLeverage can mean several things. 1) The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment, or 2) The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged..

You’ve probably encountered some of these forces at one time or another. You may have discovered that they are closely linked, so that as some of them change, others change even more dramatically.

Maybe you don’t have the time or expertise to understand or evaluate all of this in a comprehensive way. Yet, these critical variables demand your attention because they will trip you up every time, and usually at the wrong time … when you’re running out of cash, the buyer doesn’t think your company is worth much, your banker wants to call your loan. That’s when the dumbbells start to get a little too heavy.

Yes, you CAN learn these business finance principles

These issues are the ones that usually come up in the most important decisions that a company must make. Should we borrow more money to fuel the growth opportunities in front of us … or, do we increase the cash we pay to our shareholders? Is it worth giving up some equity to outside investors to achieve our accelerated growth plan … or is the dilution too damaging to our existing investors?

How do I measure and evaluate all of that? Conversely, how fast can I grow my business without outside capital? For family businesses, it’s a classic conundrum: How do I fund the transition of retiring family members when the business needs that capital to grow?

How do I start to evaluate these issues?

There are a lot of perspectives from which to consider these challenges. Your company’s “Strategery” is part of that process as you seek to prioritize the Company’s opportunities to make the most powerful strategic choices to drive future performance. Being clear about your goals and objectives and what you need to accomplish is the centerpiece upon which the evaluation of these issues must rest.

Allocating your limited resources is one of the toughest decisions of all

Of course, these variables are also influential as you make your “capital allocation” decisions, a fancy term for “we don’t have enough money to go around” … so how do we decide how to allocate our limited resources?

These issues become problematic when they’re not managed, and always surface when a company does not prepare a longer-term forecast that allows it to anticipate trends and future results. Many companies ignore this process, usually with a statement that sounds something like “I don’t know what’s going to happen tomorrow, much less next year, so why should I bother trying to forecast the future”?

Ignore Forecasting at your peril

It’s certain that forecasting future results is more art than science, but it’s also true that we can do a lot to “get in the ballpark” of future expectations. Even if you’re going to “SWAG’ an estimate of future sales, you can evaluate the sales cycle, inventory turns, collection periods and other metrics to better understand the range of likely outcomes. If you’re off by even 10-20%, you can still get a pretty good idea of the general direction of the discretionary cash flows available to meet some of your goals.

Cash flow is the lifeblood of business and you’ll have the opportunity to become a Cash Flow Knight if you stick with us.

We’re going to make this as simple as possible

What these issues have in common with weight lifting is as simple as it is complex. While the iterative nature of the weight lifting routines is pretty obvious – there are a lot of variables that affect each other, and when one is changed, it changes the other – the failure to embrace those differences can lead to serious and permanent injury.

We’ve started a video finance library that will also help you understand these critical issues. You might start with our Follow the Money video primer that will give you a simple but solid overview of cash flow in about 6 minutes or so.

You can’t ignore how these issues interact

It’s clear that when companies fail to consider the interaction of variables like growth rates, leverage, dilution and valuation, unseen currents of conflict gain strength. The longer these issues linger, the more expensive and difficult they are to resolve.

Let’s get started together

In our Business Finance series for Non-Finance Executives, we’re going to explore these concepts, their relationship to each other and the impact they have on your business. These are some of the most important concepts you need to understand. We’re going to build a comprehensive framework that will help you think about them … act on them … and literally save your business.

Why not subscribe now so you don’t miss any of these articles? The Sword Tips blog will also help you learn to become a better leader, boost your personal productivity and even encourage  a little fun along the way.

Thanks for checking in. I hope we’ll see more of you around here.

Business Finance | Are You Ready for an Injection of Financial Adrenaline? is a post from: Sword Tips – the Exkalibur blog

‘Always ask why.  Dig deeper.  Get the facts.’ Avoid crowd mentality

“Ask Why” was their motto. “Wheel Out,” “Fat Boy” “Death Star” and “Get Shorty” were some of the nicknames applied to their strategies. Confirmation letters of successful trades were addressed to names like “Mr. M. Yass and “Mr. M. Smart” … and I think you can parse the underlying contempt. “Rank & Yank” described their people performance system, “Pump and Dump” their trading strategy. About $70 billion of market value was destroyed, more than 20,000 employees lost their jobs and pension funds worth $3.2 billion were destroyed, more than two thirds of which belonged to retirees with little chance to rebuild.

I had always intended to watch “The Smartest Guys in the Room,” the 2005 movie based on a book by the same name from co-authors Peter Elking and Bethany McLean, but it got lost in the shuffle until last week. It chronicles the Enron cataclysm, whose meteoric ascent was violently terminated with its bankruptcy on Dec. 3, 2001.

“Be like Enron” is still an ignominious curse

It’s hard to believe this happened almost 10 years ago since to be “like Enron” still reverberates as an ignominious curse. It’s really more like a viral infection, though, because so many of the forces that drove its destruction have cleaved similar fissures in scandals from the Ponzi schemes of Bernie Madoff to the financial meltdown that brought our economy to its knees in 2008.

We won’t recount the history of Enron’s demise except as it relates to the flaws that still besmirch corners of our financial system. In summary, Enron took 16 years to grow from $10 billion to $65 billion in assets and only 24 days to become what was then the largest bankruptcy in American history. It rose to a $70 billion valuation before its stock tanked at 40¢ a share. California lost $30 billion playing in its energy casino, and Gov. Schwarzenegger rode into office as a result.

Enron is instructive on so many levels that it’s too much for one column. The lessons are both fundamental and monumental, and like most scandals, born of the character flaws and human failings that have been chronicled from Homer to Shakespeare. Businesses remain susceptible to some of these insidious “Smartest Guy” forces, so heed these warning signs to keep these varmints from burrowing into your organization.

Due diligence may be boring … but skip it at your peril

In What’s the Difference between a Lightning Bolt and a Bright Idea, we explored the bedrock value of doing your due diligence. It’s pretty clear from the Enron debacle that banks and regulators, as well as law and accounting firms … and analysts and journalists … were sucking on the Enron popsicles and ended up as facilitators instead of independent parties.

Fortune magazine listed Enron for six years running as one of the Most Admired companies in the country. According to the authors, Enron was spending $1 million/week with Arthur Andersen, and nearly as much with their law firm, extraordinary largesse that frequently spawns conflicts of interest. In Watchdogs … Or Lapdogs, I referred to the unusual arrangement that allows companies to hire their own “independent auditors.” It’s not much different for the security ratings agencies, either, which became apparent in the Wall Street meltdown I described in Is Anyone Really Independent. Were these organizations, as the movie described them, what Lenin meant by the term “useful idiots”?

In short? Always ask why. Dig deeper. Get the facts. Do your due diligence with even greater fervor when you’re offered the last seat on the bandwagon.

Get a full set of financial statements EVERY TIME

I’m constantly reminding clients to make sure they get a full set of financial statements every month, including an income, balance sheet and cash flow statement. Without all of them, the information presented is misleading and open to errors of omission as well as commission. More importantly, you can’t understand cash flow, the lifeblood of business, without all of them.

For inexplicable reasons, Enron was the only financial institution that only published an income statement. They didn’t provide a balance sheet or cash flow statement … to shareholders or analysts … and got away with it until the end.

Need I say more?

There’s no room for extreme personalities

Mr. Skilling was known as someone who liked “men on bikes” and burnished the company’s affection for extreme personalities. The trading desks, in particular, favored these leadership styles and as they began to dominate the company’s business, their extreme personalities convulsed into brilliant gamblers run amuck.

One of the division presidents was infamous for his love of “money and strippers.” He later left the company, sold his stock before the fall for over $250 million to settle his divorce … and then ran away with his stripper girlfriend who was carrying his child.

His division showed losses in excess of $1 billion.

Extreme personalities rarely excel in an organization whose leadership style emphasizes a collaborative environment. If you’ve got any, make sure you’re enforcing adequate safeguards … or better yet, get rid of them.

Hubris is the root of most evil

Hubris is defined as excessive arrogance, and has a nefarious classical history. It was considered a crime in classical Athens and thought to be the greatest crime of the ancient Greek world. According to Wikipedia, the ancient Greek Word, Atë, describes the action leading to the protagonist’s downfall as “ruin, folly or delusion”, a matched set that nicely covers the misconduct of many Enron executives.

When hubris is inflamed by greed, any spark can start a conflagration. Enron may be a distant memory … until we think Madoff, Lehman Brothers, AIG … and then these inglorious strains of humanity are resurrected like characters in a Shakespeare tragedy.

In many ways, it comes down to the simplest of propositions. If it’s too good to be true, it probably is.

•••

Lary Kirchenbauer is the president of Exkalibur Advisors, providing practical business strategies for family and other privately owned businesses in the middle market. Exkalibur works closely with senior executives and their businesses in the wine and other industries, and hosts the Exkalibur Leadership Forum for leaders of middle market companies in the North Bay. Please visit Exkalibur.com for a library of valuable resources, articles and insights or connect on Twitter, LinkedIN or the Exkalibur fan page on Facebook.

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The North Bay Business Journal, a publication of the New York Times, is a weekly business newspaper which I have served as a regular columnist for over three years. The Business Journal covers the North Bay area of San Francisco – from the Golden Gate bridge north, including the Wine Country of Sonoma and Napa counties.

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Article published as Vol. 82 on February 14, 2010: The electronic version of this article, as published by the North Bay Business Journal, may be found here. ******************************

Any related materials or articles referenced in the published column, or otherwise applicable, are referenced in this digital version of the article.

Leadership Styles: The Smartest Guys in the Room can kill you! is a post from: Sword Tips – the Exkalibur blog

For many business executives, wrestling naked with alligators isn’t much different than wrestling with cash flow every day, particularly in the last 24 months. A lot of focus may be on the actual fighting just to stay alive  … but a lot of it is trying to be sure you know where the alligator is … kind of like trying to “follow the money” as it ripples through your business. You’re certain the alligator went somewhere, but it’s kinda important to know where. Likewise, you’re very clear that there’s cash ON the balance sheet but how it flows THROUGH the balance sheet isn’t so clear.

Why wouldn’t you want to understand cash flow?

With positive cash flow serving as THE CORNERSTONE OF BUSINESS SUCCESS, why don’t we take more time to understand it? When we look at financial statements, we spend about 85% of our time looking at the income statement. It’s easier to understand … revenues come in, expenses go out, profits are left over … but why those profits don’t convert to an equal amount of cash … and why so much of it disappears as it flows through the balance sheet … is an enigma wrapped in mystery tucked inside a conundrum for most business executives. Yet, without the balance sheet, it’s impossible to know where your cash is being invested or what levers to pull to get more of it.

Follow the Money video finally makes it possible to understand cash flow

That’s why I’m excited to be able to share this video with you … we call it Follow the Money … but it could easily be subtitled, What is Cash Flow … Really?We’ve been looking for a powerful visual way to explain Comprehensive Cash Flow … in simple terms and without financial jargon … so that you can drive improved business performance by focusing on what Warren Buffett calls the “lifeblood of business”. All you really need is a simple, visual way to see how cash flows through your business and where it ends up.

You can learn this in 4 slides and barely 6 minutes

In Vol. 4 of our Financial Adrenaline video series, we’ve included 4 slides that I think will help to unlock some of these mysteries and explain the essential elements of cash flow. You’ll see why EBITDAEarnings before Interest, Taxes, Depreciation and Amortization is a terrible placeholder for cash flow, why the balance sheet is so integral to understanding cash flow, and why Comprehensive Cash Flow is the best measure to fully grasp all the elements of cash flow in your business.

What happens if you’re not paying attention to Comprehensive Cash Flow?

Recently, I was working with a middle market distributor whose company had been using a secured credit line for 30+ years. While the company’s assets were pledged to support the line of credit, there were never any guidelines or covenants that required minimum asset levels to support the line of credit. The company had experienced a good run of prosperous years and it was never a problem … until the recession struck some 24 months ago, their business began to falter, inventories were extended, receivables were slow to come in and the bank began to evaluate the underlying collateral they expected to support their loan.

The company had never paid much attention to their balance sheet. They had a few bank covenants to monitor like minimum working capital and net worth, but they didn’t pay any attention to the change in working capital assets … inventory and receivables … or ever compare it to the size of the line of credit. They got into a deep hole and could only survive the bank’s heightened concern by investing precious personal resources back into the business. Even a rudimentary understanding … and regular monitoring of Comprehensive Cash Flow … could have prevented these unexpected events.

You CAN learn the principles of business finance

To further support your commitment to learn these concepts, you’ll find a few additional resources in our Sword Tips blog, including Don’t gamble with your balance sheet, which describes the fate of those that ignore it, and Death to EBITDA. You’ll also find other information by visiting our Financial Adrenaline  page which exclusively deals with business finance issues for middle market companies. The growing Financial Adrenaline video library also contains valuable resources.

Don’t miss the next episode of Financial Adrenaline

Why not subscribe to our Sword Tips blog so you don’t miss any future episodes of our Financial Adrenaline video series. Our Sword Tips blog also contains everything we provide including regular blog posts, my newspaper column and other published articles as well as our entire video and podcast library.

Be sure to add your comments to this blog post and let us know if this video helped you, if not, why not … and what we can do to improve it. Tell us what else we can do to enhance your understanding of basic business finance principles. Go ahead. We can take it.

Follow the Money to Find Your Cash is a post from: Sword Tips – the Exkalibur blog

You can’t sustain excellence without business finance

“There comes a moment when you have to stop revving up the car and shove it into gear.”  — David Mahoney

“Cheery little column,” my editor said recently when he read of the rampage of Pestilence and War, the first two horsemen of the Apocalypse. Yet, it’s no exaggeration that middle market business leaders pay little attention to business finance. You may say that’s not true – “I look at my monthly financial statements” … “I know what they say” … “We’re on top of things.” Maybe, but I have seen little evidence that executives have worked nearly as hard to unleash the power of business finance as they have to learn more about marketing programs or social media or lean manufacturing techniques.

If your first inclination is to run toward the exits when business finance is mentioned, it’s only because you’ve been led to believe that these principles are understandable only by seasoned and studied financial professionals. Hogwash.

Yes, you’ll have to devote some time and attention to it, but these principles are very accessible and you can learn them, certainly well enough to work closely with your financial team to make sure everyone’s paying attention to the right things. If you’re going to be a successful business executive, you can’t ignore these principles … and if you keep reading, you’ll see that I’m willing to help you.

Why does the Third Horseman of the Apocalypse ride a Black Horse?

So, yes, the Four Horsemen are still tearing across the landscape. Last time, I noted that there are four occasions when the lack of attention to business finance slaps us upside the head, too late, of course. Pestilence bears the plague of unexpected cash shortfalls that often appear just before payroll is due. War breaks out when you’re trying to grow without adequate cash resources.

The Black Horse travels in third position among the Horsemen, representing Famine, and it’s a famine of great proportion when you can’t access external financing resources.

For our purposes, we’re mostly talking about bank financing, although in some cases, outside equity financing may be required. Even if the carnage wrought by Pestilence and War drives your soldiers to the battlements, somebody still needs to plow the fields. Famine intensifies the plague because the company can’t access outside financing, which often results from inattention in another area … that dastardly balance sheet.

I understand the P&L. Do I really need to understand the balance sheet, too?

Most business owners spend about 85 percent of their time on the income statement and pay little attention to the balance sheet. They understand the concept of the P&L – revenues come in, expenses go out, profits are left over – but where they’ve gone and why they don’t result in an equivalent amount of cash or net worth on the balance sheet  is a riddle wrapped in a mystery inside an enigma for most executives.

So, it’s exasperating when your banker asks about the balance sheet because for most executives, the importance of debt coverage, or debt/equity and liquidity ratios, is bewildering. What do they mean? Doesn’t most everything happen on the P&L and the balance sheet is just the result of that activity?  (Is that why the horseman astride the black stallion carries balancing scales?)

You have more control over the balance sheet than the P&L

Savvy financial folks understand that you have more control over your balance sheet than your income statement. They also understand that cash flow is generated primarily by changes on the balance sheet, and managing it is one key to accessing the credit facilities required to fuel your plans.

It’s surprising how many companies suffer paroxysms of pain in their gut when they get that unwelcome phone call from their banker. Why don’t more companies pay closer attention to their bank covenants and call their banker when they see that a potential default is on the horizon to work out an appropriate arrangement? Most bankers appreciate that their borrower is paying attention and will work overtime to be accommodating. Of course, if Pestilence hasn’t inspired the cash flow forecasting that will prevent the deathly plague, you won’t see the default coming and the Famine could finish you off.

Yes, the Fourth Horseman riding the Pale Horse is just over the horizon

Maybe I’m being a bit dramatic but not by much. I see this every day. I’m thrilled when I see a business paying close attention to these principles and I’m happy to call many of them clients. But I’m equally frustrated to see so many good businesses with a solid value proposition struggle because they haven’t paid enough attention to the core principles of business finance.

Oh, how I wish the Black Horse was the last of its kind, but alas, the Pale Horse is bringing up the rear, as we’ll examine next time. In the meantime, don’t sail past the last exit before Armageddon. Pull over and make sure you’re incorporating finance into your everyday business decision-making.

(P.S. I’m willing to help you advance your business finance experience … at no cost and with no obligation. Be one of the first 5 business owners to comment on this post and we’ll provide a FREE Business Ferret 5-Year Analysis … AND spend an hour in an online meeting with you to help you understand the specific strategic finance concepts that apply to your business.)

KBO.

•••

Lary Kirchenbauer is the president of Exkalibur Advisors, Inc., providing practical business strategies for family and other privately owned businesses in the middle market. Exkalibur works closely with senior executives and their businesses at the intersection of leadership and business strategy and uses the Business Ferret™ framework to help companies use strategic finance to drive improved business performance. Lary also hosts the Exkalibur Leadership Forum for leaders of middle market companies in the North Bay. Please visit www.Exkalibur.com for a library of valuable resources, articles and insights or join the Exkalibur fan page on Facebook.

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The North Bay Business Journal, a publication of the New York Times, is a weekly business newspaper which I have served as a regular columnist for about three years. The Business Journal covers the North Bay area of San Francisco – from the Golden Gate bridge north, including the Wine Country of Sonoma and Napa counties.

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Article published – October 25, 2010: The electronic version of this article, as published by the North Bay Business Journal, may be found here. ******************************

Any related materials or articles referenced in the published column, or otherwise applicable, are referenced in this digital version of the article.

Vol. 75: Don’t gamble with your balance sheet! is a post from: Sword Tips – the Exkalibur blog

Then, to provide more graphic and visual insights about the principles of business finance, we’ve created  a Financial Adrenaline video library … all of it free to everyone … to help you advance your own understanding of business finance principles.

Now, we’ve come up with an easy-to-understand postcard-style PDF to summarize the features and benefits of our Financial Advisory services using the proven tools of the Business Ferret™.

So, why not download our Financial Adrenaline postcard to keep as a handy summary of the features and benefits of these powerful business finance tools, and how they can help you help you integrate business finance into your everyday business decision making?

The hidden treasures in your financial statements is a post from: Sword Tips – the Exkalibur blog

“Speed, for lack of a better term, is good”.

That’s not quite what Gordon Gekko said in the original Wall Street movie, but it’s close enough for our purposes.

So, who’s complaining about the super-fastest fiber-cable ever? Nobody that I know of, but here’s what caught my attention. It isn’t just the extraordinary speed extolled in Forbes’s recent article, Wall Street’s Speed War. Sure, it cost about $300 million to bury a one-inch underground cable over the 825 mile distance between New York and Chicago. Yes, it’s been done in stealth mode so no one would find out and build one even faster, and yes, it’s about to go live.

Big deal? Apparently so … but here’s the thing. The only reason this cable got built was … grab your abacus … to save 3 MILLISECONDS off the previous route for such cable traffic. That’s equal to THREE 1/1000 OF A SECOND!

What for? Here’s a few of the effusive remarks that Forbes quoted: ‘That’s close to an eternity in automated trading” … or “Anybody pinging both markets has to be on this line, or they’re dead.” Yes, this cable line is “required” to accelerate the automated trading by Wall Street houses that use “algorithms to make lightning-fast trades”. In that world, phenomenal speed is the differentiator and 3/1000 of a second is a lifetime.

Is it just me … and I’m the last guy any one would call a Luddite … I don’t think I’m out of touch or old-fashioned, am I?  … but isn’t there something eerily disturbing about this plan by Spread Networks? Aren’t we simply adding rocket fuel to a raging fire that is increasingly out of control and most recently, threatened to burn down our entire financial system?

Remember the old adage … “Speed, Quality, Price – Pick Two!” I kinda wished we’d pick the last two when it comes to Wall Street.

What about you?

Warning: Speed may not be good for our health! is a post from: Sword Tips – the Exkalibur blog

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Why is this so hard? We find ourselves entrenched in the quagmire of a lingering and painful recession … more companies than ever need stronger financial management … and yet so many of them remain painfully slow to recognize it. Sure, many have trimmed costs and are paying closer attention to nickels and dimes, but few of them have a comprehensive financial strategy.

Business Finance? Meet the Wine Industry!

So, in some misguided way, I guess it feels good to have some company … because the need for financial discipline was a common refrain among wine industry cognoscenti at this year’s Symposium, Competing in a Rapidly Changing Global Wine Market. The economic shock waves of the last 24 months have rocked the wine industry, dragging many of its members, in some cases kicking and screaming … into an era where professional management and greater financial discipline are demanding front row seats alongside the entrepreneurs and artisans that have reigned over the California wine industry

Building a bridge between the financial community and the wine industry is one of the founding precepts of the Wine Industry Financial Symposium formed in 1992. Last Monday, I was privileged to lead a 90 minute workshop devoted to Practical Strategies to Improve Cash Flow, in which I shared a few “diamonds in the rough” about how to get more juice into your bank account … and how the California wine businesses can integrate Strategic Finance into their everyday business decision making.

Wine, Wisdom and Stronger Finance. Drink up!

During the preceding From Survival to Prosperity – Strategies for Transition session, Jeff Gutsch, a partner who leads the Wine Industry practice at Moss Adams, LLP, moderated a panel of experienced wine industry professionals who got the afternoon workshops off to a great start. The panel discussed a variety of strategies for success in the wine industry, and while extolling the entrepreneurial spirit that spawned the wine industry in Northern California, frequently returned to the need for more professional management … explaining that the industry needed to “grow up” to succeed in the increasingly competitive global wine market.

Tim Allen, an industry veteran who served in senior finance capacities for 4 wineries that were sold during his career, and now runs his own boutique accounting service in Napa, emphasized many of the same themes that I discussed in my workshop … that sound financial principles are a critical component of success in the wine industry. Keith Wesselchmidt of Bacchus Capital Management and Mark Brody of Umpqua Bank echoed those observations, calling for business owners to develop stronger financial controls and rely upon strong professional relationships to build their businesses.

Do you think your business needs a stronger financial foundation … and if so, what are you doing about it?

Warning: Sell Wine? Ignore Cash? Adios! is a post from: Sword Tips – the Exkalibur blog

Volume 3 provides the foundation for the Financial Adrenaline series, and its powerful visual tools enable business leaders to enhance their understanding of Strategic Finance.

In this episode, we provide an overview of the Framework of the Business Ferret™ and show you the Scorecard that benchmarks over 1,000 variables over 5 years, 15 categories and 4 themes. We introduce some of the tools to measure Operating Performance, and illustrate some of the issues around Bank Financing and Covenant Compliance. We show you how to measure whether you’re Creating or Destroying Value, why Free Cash Flow is the cornerstone of business performance and why Scenario Planning tools can help you assess the likelihood of future success. This video sets the stage for a more detailed evaluation of each of these subjects in the continuing Financial Adrenaline series.

Business Finance: Vol. 3 – The Reinvention of the Financial Statement is a post from: Sword Tips – the Exkalibur blog

So What? It’s a $30B bill so it sounds like a lot of money … but so did the TARP $750B number when it was announced … and it’s still a long way from fully invested. The NYT claims it will help “credit-starved businesses” … says who? Read Uncertainty is killing business – NOT credit in which I review why credit availability is NOT what’s killing small business. If you’re uncertain about what uncertainty we’re certain about … read the WSJ verbatim quote to be reminded of the painful litany of  the economic and regulatory  quicksand on the road to recovery.

Sure, there may be qualified businesses struggling to get credit. It is tougher out there, the underwriting standards are less flexible … but will the economy recover when credit is extended to small and middle-market businesses? No, the economy will recover when small and middle-market businesses NEED credit to support the growing demand for their products and services.

We haven’t been through such a traumatic time in our economy in several generations. The issues are plentiful, but the most insidious is the lingering Double V – my expression for the deadly duo of Big Volatility and Little Visibility. Until demand is spurred by confidence in the economy driven by VISIBILITY AND PREDICTABILITY, this bill will provide little help.

Is your business starved for credit … or for customers? Is it all about politics?

Small Business Finance Bill passes – So What? is a post from: Sword Tips – the Exkalibur blog

A recent WSJ opinion piece nicely summarizes the quagmire of uncertainty that plagues American business. I’m pretty tired of all of the “credit-starved businesses” stories presented like medieval alchemy … fix this and you’ve found gold … because most of them based on a few unproven anecdotes. The real issue is UNCERTAINTY … so I’m forced to resurrect my own design that tells the story that really underlies the lack of job growth and investment … the Double V – my expression for the deadly duo of Big Volatility and Little Visibility.

Here’s the WSJ verbatim quote that underlies much of the UNCERTAINTY that plagues American business:

Do you think the lack of customers … or the lack of credit … is killing American business? What’s affecting you the most?

Uncertainty is killing business – NOT credit! is a post from: Sword Tips – the Exkalibur blog

This year, I will be conducting a 90 minute workshop to help companies in the wine industry revitalize their free cash flow. Here’s the exact title of the workshop scheduled for Monday, September 20, 2010 at 3:30 p.m. You can find the program and registration details here.

For the wine industry, this event is the kickoff for our Financial Adrenaline series, a program designed to educate business executives in the middle market about the power and value of Strategic Finance. FINANCIAL ADRENALINE relies upon the Business Ferret™ program for many of its insights. The Business Ferret™ is a proprietary product that provides powerful visual and and action-oriented plans to 1] Increase Cash Flow, 2] Optimize Financial Resources and 3] Enhance Marketable Value.

Stay tuned for new videos, podcasts and commentary in our Financial Adrenaline series to help you integrate Strategic Finance into your everyday business decision making.

Business Finance workshop at the Wine Industry Financial Symposium is a post from: Sword Tips – the Exkalibur blog