What, How & When Do You Assess Financial Performance?

Do You Proactively Assess The Financial Performance Of Your Business?

Its 6 months after the year end, and the accountant has just completed your financial statements for a period of time that ended 6 months ago.

And even then, the financial statements provide mostly financial accounting information and very little management accounting information.  So performance assessment, while available,  is already dated and incomplete in terms of useful information that you can use to manage your business with.

For any small or medium sized business, assessment and measurement of performance activities typically do not take place in any meaningful way.

Why?  Its the typical reasons of not enough time or not a priority and so on.  So measurement is more based on money in the bank account or level of credit being utilized at any given point of time.

Ok, so maybe we can agree that there is room for improvement here and that better understanding of current financial performance of any business entity is of value in helping to profitably operate a business.  I don’t think any of the above is a stretch.

So what do you measure and how do you go about it?

In terms of what, there are numerous things to consider here which will depend on the specifics of each business, but in general the primary financial metrics are assessment of actual revenues and costs against budgets or projections.

Now while typical management accounting can be performed in house or through an accounting firm, the numbers by themselves only tell part of the story.

The benefit in review and assessment is to be critical of what you see and to relate financial performance back to your strategy, the market place you operate in, the initiatives you’ve undertaken, proposed future opportunities, and so on.

To get the most out of a financial performance assessment, many business owners will bring in an outside party periodically to sit down and go over the financial performance reports with the business owner  and managers to provide an unbiased opinion of the business enterprise and its current performance.

The third party needs to be someone who understands strategic planning, operational implementation and execution as well as financial measurement.  By default, the external business accountant tends to fill this role and in some cases, can can considerable value.  However, in many situations, accountants do have enough experience in strategy and operations to provide real value in these exercises regardless of how much they claim to know about management accounting.

Basically third party input can be very helpful, provided its from a knowledgeable source.

When To Assess

In my opinion, the minimum should be at least once a year, which in many cases is too long an interval.  Semi annual or quarterly assessments will yield more actionable results versus annual financial performance assessments that are still more historical in nature due to the amount of time being covered.

With everything going on in a business, it IS hard in most cases to create this type of assessment discipline.  But then you have to decide if you want to know if you’re heading for a cliff in time to make a course correction, or if you would rather just hope there are no cliffs ahead of you that can’t be easily seen.

If you’re business would like to improve this process and get solid third party input, send me an email and we can discuss it further.

The Balance Between Borrowing Money and Saving Taxes

Are You Saving Taxes And Destroying Your Borrowing Potential At The Same Time?

Business finance covers a lot of ground including accounting, taxation, foreign exchange, business analysis, and business financing to name the main groupings.

And while all these areas fall under the same umbrella, they don’t necessarily work in harmony, especially when some of these activities are outsourced to a third party accounting practice.

For small and medium sized businesses, a common example of this is the impact of annual financial statements and business tax returns on a businesses ability to borrow money.

Many business lenders follow fairly rigid criteria related to financial ratios including balance sheet leverage and payment coverage. These ratios and others can be directly impacted by the decisions business owners and managers make with their accountants with respect to tax strategies.

Most business owners and managers don’t necessarily understand the connection between taxation and financing and in some cases, believe it or not, neither does their accountant. The primary goal is to reduce taxes and therefore improve cash flow.

There is nothing wrong with this approach as long as you don’t require business financing to operate your business. If you do, then here’s a couple of things to be mindful of.

First, if you have a senior financing facility in place with a debt lender, there are likely financial covenants in place that require you to main certain ongoing levels of balance sheet leverage and income profitability that are relative to the amount you’re borrowing. Aggressive tax savings strategies can put you off side of these covenants which at the worst will get your loans called in and at the least will increase your cost of borrowing.

Second, if you try to secure new business financing capital with financial statements that are over leveraged and/or do not show enough debt servicing ability, there’s a very good chance that funding will not be available, or if it is, it will come at a higher cost.

Bottom line, there is a balance between minimizing business taxes and maximizing borrowing capacity. Failure to maintain or keep track of this balance can be very costly in the long run.

How To Cut To The Chase When Securing Capital – Part II

Here is The Next Installment in How To Increase Your Odds Of Securing Capital From The Outset

In the last installment, we discussed the importance of starting off your initial  meeting with a prospective lender or investor by cutting to the chase and quantifying exactly what you’re looking for in terms of financing and what it will be used for.

Once you’ve given the lender or investor enough information to initially qualify their potential interest in the deal, you’re either going to get a quick No, or they’re ready to hear more.

Focusing on the later, you now want to continue your presentation.

The second area the lender or investor wants to understand is your future projected financials (cash flow, income statement, balance sheet) and the related assumptions that drive the numbers.

As an example, virtually everything in the business can be associated with a time frame and cost, so the financial statements become a powerful means to convey the business story you’re trying to tell.

The quantification of market size, competitors, market share, price, margin, operating costs, and so on, all impact the financial statements directly or indirectly.

And lets face it, this whole process is all about money and making more of it, so its important to show your potential source of capital funding how they will get their money back, over what time, and the potential return they can expect.

When you can quickly show how you have quantified all the relevant information into income, balance sheet, and cash flow, it gives the lenders and investors something concrete to wrap their heads around while proactively answering a lot of the questions they will have before they even ask them.

This information can be highly summarized.  Its just important that its covered off to maximize the interest level of those involved.

Too often, the business owner or entrepreneur is so completely focused on their sales pitch of what they’re trying to accomplish that the underlying financials are either glossed over, or not really addressed at all.

Remember that the more you can relate what you have to present back to dollars and cents, well quantified and supported assumptions, and realistic time lines, the more seriously you’re likely to be taken.

There is definitely a balance to be had between the marketing side of a presentation and financial projections.  Just make sure you know your numbers cold so that where ever the discussion goes, you will have the answer on the tip of your tongue.

Cut To The Chase When Securing Capital For Your Business

Be Direct And Specific When Trying To Secure Business Financing

Before you speak to a debt financier or equity investor about securing capital, you should have gone through the process of pre-qualifying them to some extent to make sure they are relevant to your business financing requirements.

When you go to speak to a source of business capital, its their turn to qualify you and the sooner you allow this to take place, the faster you’ll get their serious attention.

Too often, business owners and managers start off their initial discussion with lenders or investors with a long winded explanation of their business opportunity or business potential, trying to impress the capital provider with what they view is the best approach to securing capital.

Instead of creating a good first impression, they are more likely to put the capital provider to sleep as the provider impatiently waits for the business owner to disclose the pertinent initial information they require to perform their initial assessment of the business financing opportunity.

Seeking business capital is a marketing exercise and like any marketing approach, the goal is to provide the target audience with the information they are interested, not the information you feel they should be interested in.

So here’s the best way to get off on the right foot with a debt or equity financier.   This approach may also get you a fast No as your audience will be able to qualify you faster, but at least you won’t be wasting your time pitching a lost cause.

Start off by stating exactly how much capital you’re looking for, why its required, and how exactly it will be applied in your business.  While this may seem obvious, its rarely the beginning point of business owner presenting to a lender or investor.  The primary reason being that human nature seems to think that if a compelling enough business case can be created right off the bat, then the amount of funds requested and the application will be secondary in nature.

In reality, by not being able to immediately describe in financial terms what capital you seek and why, you’re more likely to leave the impression that you don’t have a buttoned down plan of action that has been summarized in financial detail, regardless of the raw potential of the proposed investment.

When you lead with a detailed summary of your financial requirements, you’re not only allowing the capital provider to see if you fit into their current criteria, but you’re demonstrating to them that you have gotten a well thought out plan of action that can be accurately described in terms of numbers.

This is a great way to get serious attention from a debt or equity provider who are inundated with dreamers and entrepreneurs either weak at or uninterested in the underlining financials and corresponding stewardship that goes hand in hand with gaining access to someone elses money.

Once you’ve established what you want and why, the lender or investor will be able to make their initial assessment and either give you a fast no that you would have gotten anyway, or start moving forward in their seats with a higher level of interest.

We will address the next phase of the your initial discussion in tomorrow’s post.

How To Sell Your Business For A Higher Price

Creating Optimal Cash Flow Trends Can Significantly Increase The Value Of Your Business Sale

When you list your business for sale, the bids and eventual proceeds you can expect to receive will be largely influenced by historical cash flow results. Your focus cash flow in the period prior to sale, can significantly increase the profit you realize.

Buyers will tend to look at a business sale price as a multiple of the expected future net cash flow. The multiple will vary based on industry and also future expected growth. The best way to increase the multiple in your favor is to focus on optimizing the cash flow base that will be multiplied.

The ideal financial picture would show 3 to 5 years of past financial statements that show steady and even exponential growth in both earnings and cash flow. Alternatively, there are three other historical cash flow and earnings trends: 1) declining cash flow, 2) cash flow that trends up and down, 3) steady or near flat cash flow results.

If your business is experiencing declining cash flow or eradicate cashflow, the cash flow base and the multiplier will likely be reduced due to future uncertainty. Steady cash flow results will not likely impact the base, but the multiplier will not be high due to absence of growth potential.

Lets look at a few different scenarios to give you a better idea of how these different cash flow trends impact a business sale.

Scenario #1. Mature business sale where the business has been in flat to slight decline. This is a very typical situation where the business owner(s) have held the business for a long period of time, are no longer investing in growth, and are at or near retirement age. To prepare for sale, there may be a final push to show better results from selling off assets and optimizing accounting statements. But the long term historical trend will show that the cash flow improvement occurred immediately prior to sale and will not likely stop the base and multiplier from being discounted.

Scenario #2. Business showing steady cash flow results where growth has been siphoned off to the owners. Because the actual financial results do not show growth, there will likely be no increase to the multiplier. If a typical multiplier was 3 to 4, a growth based multiplier could be 5 to 10, potentially making a significant difference to the proceeds the business owner can expect to receive. Yes, the financial statements can be recast to build back in the funds taken out by the owners. But recasting can be imperfect based on the convoluted ways owners extract funds from their businesses. Plus, unless the recast is done by a third party with significant review, its not likely to be assigned much value by potential buyers.

The key takeaway here is to start planning your exit strategy and future business sale well in advance. By investing in growth 3 to 5 years prior to listing the business for sale and generating financial statements that drive results to the bottom line, business owners are more likely to garner premium returns in the market. The extra work and effort could generate a huge payday by potentially increasing both the base and the multiplier.

Where To Go To Secure Capital For A Start Up?

How Do You Secure Capital For A Startup?

The first thing to discuss is where not to look when you’re trying to secure capital for startups, which is in the most obvious places.

Unless there is a government sponsored loan program administered by the major banks, the lenders that you see on the television every day have absolutely no intention of lending you any money for a start up business venture.

Yet because of our branded conditioning, it tends to be the first place everyone goes and the first place they get turned down too.

Once you have maximized your personal financing potential and taken full advantage of you family and friends, you have to start thinking outside the box whereby the box being walking into a bank and applying for a loan.

First, focus regionally.  Wherever you are, there is going to be local, regional, and national business development programs that are designed to increase the business tax base and maintain or add jobs to the economy.  These business development programs are designed largely for businesses that are not yet “bankable” but have a sound basis for commerce and intend to hire employees.  And while many of these types of support programs tend to focus on small dollar loans,  there are exceptions.

More specifically, I’ve seen some regional development programs that will shell out millions in loans and guarantees for the creation of industry and jobs in certain areas.  This of course is area specific, so if you want to get access to the funds, you have to be willing to relocate to the area that has the money.

Second, government grants and loans are out there and can be secured.  However, most government grants and loans are in place because there is a lack of some service or product that they are trying to draw business owners towards.  So if you want to take advantage of government funding, then you may want to research what they are supporting before you choose your business venture otherwise there may not be anything available for what you choose.

Third, other related businesses that want a certain type of product or service, but can’t readily access it and don’t have the time to create a related business themselves.   What could be better than having a major customer right off the bat that also has a financial stake in your business and is therefore motivated to help you succeed?

Fourth, there are equity investors that are on the look out for businesses they can buy into.  Just remember that this can be a very demanding form of capital that is typically looking for high profit potential and experienced partners that know what they’re doing and have a track record to prove it.

If you want to start a venture that requires capital, then you need to work backwards from the available capital sources.  That may sound counter intuitive but its not if you think about it.  From a marketing point of view, you are always taught to work backwards from established market needs and wants instead of forcing something new on the market or guessing at what will make you money.

When business financing for startup capital is involved, you have to work double time and work back from the market and from funding sources.

In reality, there are four scenarios that evolve out of the someone wanting to start a new business.  1) You want to start up a business providing things that not enough people want and there are no sources of financing for that type of business available to you. 2) You want to start up a business providing things that not enough people want, but there is some available sources of financing.  3) You want to start a business that has high customer demand, but no sources of financing.  4) High demand, and money available.

Too many people choose 1, 2, or 3, and get nowhere fast.  But even if you do your homework and focus on #4, there is no guarantee of success, but you’ve increased your probability of a profitable outcome just by not swimming against the current.

Bottom line, there is no magical place that provides start up money for any type of start up.

But there is also an infinite sea of money always looking for a home.  When you focus on a real market need that you can tap into where there is available money to scale the business, then you’re on the right track.

Securing any type of capital is always about having something to leverage.  If  you have a great business idea that the market is hungry for or just needs more of what you want to deliver, and you have a solid plan to move forward with, that’s a great start.  But take a hard look at potential sources of capital as well that are motivated in some way by what you’re trying to do.

If you can put market demand and money availability together, then you’ve got something to secure capital with.

If you’re looking for more specifics,  I don’t have any.  Each scenario has its own set of variables (market, individual skills, geography, economy, competition, industry, etc, etc, etc.)

Where to look for start up capital has everything to do with understanding the relevant variables which will help point you in the right direction.

How Do You Secure Purchase Order Financing?

How To Get Purchase Order Financing For Your Business?

Purchase order financing is a form of asset based business financing that business owners and managers utilize to cash flow profit earning opportunities.

A basic overview has the borrower holding a purchase order for delivery of goods to a customer and requires a financing advance against the purchase order to secure and potentially complete the finished goods in question.

In order know if your business could be eligible for purchase order financing, here are some generic requirements to consider.

1.  The purchase order needs to be for a commodity good that has an easily identifiable market in terms of asset liquidation pathway and value.  The best liquidation plan for most purchase order financiers is the customer list of the borrower.  Existing customers are already buying the product from the source so its reasonable to presume that this would be the fastest and easiest way to move the product, especially if a discount was provided.

2. The issuer of the purchase order must be a credit worthy entity capable of honoring the purchase order if it is properly fulfilled.  Some lenders will even go so far as having the issuer qualify for accounts receivable insurance before approving financing.

3.  The product to be sold must have a profit margin of 20% or higher.  In the event of any transactional or repayment issues, the lender will step in and liquidate its security for repayment and because the assets will be forced liquidated, there needs to be some margin in the product to allow for a likely discount under conditions of a forced sale.  The second reason that a solid margin is required is to cover the cost of financing.  Purchase order financing is not cheap and can range from 2% a month to upwards of 4% a month plus administration fees.

4.  If raw material needs to be turned into finished goods, the amount of work required needs to be minor in nature.  Lenders don’t want a bunch of money sunk into work in progress that may not be in a sale able form.

5. The supplier of the material that will likely be receiving proceeds directly from the purchase order financing lender, needs to be well established in terms of reputation and financial stability.  Typically, a lender will want to see the borrower have some prior dealings with the supplier in question.

6. The issuer of the purchase order must be prepared to pay the lender directly once the goods written in the purchase order have been received by the P.O. issuer.  The lender must be paid directly by the borrower’s customer, which is quite standard in asset based lending due to the high levels of leverage and risk involved.

7.  If the supplier of goods is from another country, the lender may require a third party inspector to inspect the product during production and loading and have the borrower bear the cost of this activity.

These are just some basic things to consider with purchase order financing. There can be numerous variations to above but this provides a basic overview of what you need to have in place to be able to secure purchase order financing.

What’s The Most Important Criteria For Equity Financing?

What do investors value most when considering equity financing proposals?

Lets make a slight qualification to this post before going any further. Obviously, investors will focus their attention on opportunities that meet their criteria for industry, technology, profit potential, and so on. But after they pre-qualify the opportunity to be in the ball park so to speak, what is the most significant criteria there after that most equity investors and their advisors will apply against potential opportunities?

Answer… Strength of the management team.

And even to get more specific, the presence of some one or a team of some ones that has been involved with a similar opportunity in a similar industry with at least one other company at a similar stage in its life cycle, and successfully led these past organizations to not only meet the expectations after capital investment, but also were able to orchestrate a profitable exit strategy.

Most investors are looking to get in and get out in 5 years or less and at least double their money in the process to provide the minimum return expectation. So not only do they want someone at the controls that knows how to get things done right off the start, but also someone who knows how to cash out profitably in a reasonable amount of time.

So basically, investors are looking for a tangible financial score card that clearly shows what the key personnel have delivered in the past, and hopefully delivered more than once. Sure, holding high senior positions in profitable companies and having an impressive set of academic and professional credentials can help build the case for competent management, but if there isn’t proof of making things happen and delivering returns directly from their leadership efforts, then investors are likely to pass.

There are a number of reasons why this makes a lot of sense.

First, there are all kinds of senior managers out there that may be highly skilled at what they’re area of expertise is, but have no real experience of managing in a more raw and non linear start up or growth environment. And the business landscape is littered with all kinds of examples of high priced executives that flamed out on ventures funded with other peoples money.

Second, there is a definite learning curve to managing a fast moving venture with high expectations and lots of moving parts that have to come together quickly or fall apart. There are many executives that are capable of moving into an existing position and improve upon it or take it to the next level. But its not the same experience as building something from nothing.

And here’s something else to consider. Not only is the past management track record the most important equity financing criteria, but in many cases its at least 70% of an investors decision to proceed with the opportunity or not.

So before you spice up your presentation for the next group of equity investors you want to get an audience with, make sure that you’ve got someone you can bring along that has the type of track record to close the deal.

Business Loans Come In Many Forms

What Are The Different Types And Forms of Business Loans?

First of all, what is our working definition of a business loan.  For the purposes of this post, I will define it as a debt instrument with a stated rate of interest and defined period of repayment.

Any business loan is further defined by the purpose of its use, the security involved, and the timing of the related cash flow stream tagged for repayment of the principal and interest.

When the purpose is for working capital, business loans or debt instruments will come in forms that are short term in nature and are predominantly secured by short term assets like accounts receivable, inventory, and potentially equipment.

Working capital instruments for low leverage balance sheets and strong credit profiles will include lines of credit and term loans of 5 years of less.  Lines of credit will rise and fall with the cash requirements of the business, while term loans will have a fixed repayment term, drawing money out of cash flow for structured principal repayment.

For higher leveraged balance sheets and/or weaker credit, working capital can be provided through asset based business loans, inventory financing, accounts receivable factoring, and purchase order financing.

While all of the above are technically asset based loans, lets discuss each one separately.  The standard asset based loan provides working capital funds as a percentage of the liquidation value of accounts receivable, inventory, and equipment value, similar to a line of credit.  Unlike a line of credit, the leverage tends to be higher and is more closely managed by the lender through the lender collecting all the customer proceeds due to business and then continually adjusting the loan outstanding according to the current security value.  With a line of credit, there are balance sheet ratios that need to be maintained and reported on a monthly basis, but the cash is collected and managed by the business as long as the business owners and manager stay within the stated covenants.

Accounts receivable factoring is extended as a business loan on the strength of the customer that owes the receivable and provides the lender with rights against the receivable that’s outstanding.  There are many different forms of factoring and the rates can vary tremendously.

Inventory financing provides a business loan for the purchase of inventory and uses the inventory for security.  Some inventory financing models have the lender control the inventory in third party warehouses to protect their interest in the inventory while other inventory financing models will allow the inventory to remain on the business owner’s premise if the facilities and control systems can provide the lender with sufficient comfort.

Purchase order financing provides business loans based on an advance against the value of a customer purchase order.  The credit rating of the customer, the nature of the order, and the time period required to complete the transaction will determine the amount of purchase order financing.  For instance, most purchase orders are provided on the purchase of commodity goods that have an active market and can be readily liquidated by the lender to get their advanced funds back if required.  Inventory financing is also primarily provided on commodity type goods for the same reasons.  Both inventory financing and purchase order financing command higher rates of interest than traditional forms of working capital related business loans

Other forms of short term debt can be subordinate debt financing where a business loan is provided against assets that already have debt registered against them, but with sufficient security value available to secure additional capital in a second security position.  Because of the second position, the cost of these funds will be higher than the first position debt.

For intermediate term lending on the acquisition of assets with a useful life of 2 to 10 years, business loans come in the form of term loans or demand loans for equipment.  A demand loan can demand repayment at any time while a term loan cannot.  Equipment can also be financed through leasing which is different from a business loan in that the lease company retains the ownership of the assets acquired and/or provided as security while in the case of a business loan, the assets are owned by the business with security registered to the lender.

Longer term business loans for longer term life assets such as buildings and real estate are typically financed by commercial mortgage instruments.

There are still other forms of business loans such as convertible debentures and mezzanine financing that are more elaborate in nature and tend to be utilized when loan amounts are in the millions of dollars and more complex business enterprises are involved.

There are so many variations around all these forms of business loans, that each would require a separate discussion.

The point here is to remember that if the business has something of value than can be readily sold or liquidated in the market place for a predictable amount, then there is potentially a form of business loan available to that particular business.

How Important Is Personal Credit To Business Financing?

What Type Of Impact Does Business Credit And Personal Credit Have On Business Financing Decisions?

First of all, business financing decisions for debt capital tend to limit credit assessments to business credit if there are no personal guarantees required by business owners, shareholders, or third parties.  However, this is not an absolute rule, and in many cases, personal credit still creeps into the decision making process.

Why?

Because personal credit is a form of character assessment, reflecting how an individual carries through on the commitments he or she makes.

There may be ample financial support for debt financing, but a poor personal credit track record of a major owner of a business can still lead to an application decline.

In cases where the security offered by a business and any required covenants are not sufficient to secure the lender, then personal credit becomes even more of a major factor in credit decisions.

The third scenario when personal credit comes into play with business financing is when the business itself has very little or no established credit.  This can be very common with businesses under 3 years in existence and also in older businesses that work with smaller suppliers than don’t report their results to credit reporting agencies.

While I can follow the logic of utilizing personal credit reports when assessing business financing requests, the practice is far from reliable due to inaccuracies in personal credit reports.  Remember that the personal credit reporting agencies do verify the information placed in your credit report, so any errors can potentially impact a business financing credit decision for a business loan you may apply for.

This is yet another reason to regularly check you credit report for errors and take the time to make it as accurate as possible.