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Cash Flow Statement 101

Cash Flow Statement 101

By Mark Snyder

The cash flow statement is the most important and insightful financial statement for any organization. This financial statement shows how management is generating and spending the cash of an organization over time.

Unfortunately, most small companies do not have a good cash flow statement. The reason this key financial statement is missing is that generating an accurate cash flow statement is a manual process. All accounting systems are set up to automatically generate a balance sheet and income statement, on an accrual basis, based on the transactions that are entered, but not a cash flow statement. A good accountant can pull together an accurate cash flow statement, but it takes time, knowledge of the business, and access to the transactions within your balance sheet and income statement.

The cash flow statement is organized into three sections: Operating, Investing and Financing.

Operating

The Operating section takes the organization’s net income and adds back any large non-cash items, which is usually depreciation and amortization expense. The depreciation and amortization amounts are the costs of larger and long-life assets on your balance sheet [think property, plant, and equipment] that are being expensed over their useful lives. Additionally, the Operating section evaluates how your organization is managing their working capital, which is primarily their accounts receivable and accounts payable balances. This provides great insight in assessing the effectiveness of management, for example if Accounts Receivable shows as a negative amount, that means the organization has more cash tied up on their receivables than in previous periods. This could be indicative of future collectability issues or poor cash collection efforts of customer receivables. Ultimately the most important line is the “Net Cash provided by or (Used for) Operating Activities” as this demonstrates whether the operations are generating cash or consuming cash. 

Investing

The Investing section shows the money that the organization has put back into their business.  Normally you will see in this section the amount spent on large capital purchases such as buying new equipment or facilities. The investing section also shows if the company is liquidating any assets such as selling off equipment or land. This is especially important for those businesses that are very capital intensive and evaluating how management is maintaining or building their long-term property, plant, and equipment assets.

Financing

The Financing section shows what is happening in the business regarding their debts and investors. Organization’s will show all debt repayments as well as any new debt that was obtained during the period. Also, any payments to investors such as dividends, as well as any issuance or repurchase of company stock.

The total of the three sections (Operating, Investing, and Financing) will demonstrate the change in and organization’s cash balance during the period being evaluated.

The cash flow statement demonstrates how management is doing managing their working capital, the impact of their operations on cash, as well as the investments being made into the business along with how debt and investor activities are affecting cash. All these activities are critical in evaluating the status of the business and managements stewardship of the business’s resources. If I only had time to evaluate one financial statement for an organization, it would be the cash flow statement.

Mark Snyder is an Area President with FocusCFO based in Cleveland, OH.

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Balance Sheet 101

Balance Sheet 101

By Mark Snyder

Accounting is the language of business, but unfortunately, it’s confusing almost to the point of mystifying to the layperson. A company’s balance sheet is one of the most important financial statements, yet many people don’t understand the “how” and “why” behind its purpose and structure.

The purpose of the balance sheet is simple, it is merely a summary, at a point in time, of what a company owns [assets], owes [liabilities] and net worth [equity]. Why is it organized in such a weird way where the total Assets equals the total of Liabilities plus Equity? Wouldn’t it make more sense to have your Assets less your Liabilities equal your Equity? Accounting is based on the key concept of double entry bookkeeping in which debits have to equal credits. This key principle of balancing debits and credits hews well to the concept of a balance sheet and makes perfect sense to an accounting professional.

Assets and Liability

The asset and liability portions of the balance sheet are organized between current and non- current sections. Anything in the current section is something that will impact cash in 12 months or less. For example, accounts receivable is considered a current asset as it should be collected as cash within 12 months. Conversely accounts payable is considered a current liability as the amount will be paid to the vendor out of the company’s cash balance within the next 12 months.

Working Capital

The essence of the balance sheet is highlighting the working capital of a company. Working capital is merely taking the company’s current assets and subtracting the current liabilities. The concept of working capital is evaluating if an organization has enough liquid assets to cover debts coming due in the next twelve months. If there is significant working capital, this is indicative of a company being able to meet all near-term obligations along with providing funding for investments in their business or possibly returning funds to owners. If working capital is negative it means the company owes more that than they can pay over the next twelve months and the organization will need to seek other financing sources or else the viability of the company may be at risk.

Non-current Assets and Liabilities

Non-current assets and liabilities provides a view of the longer-term resources and debts of a company. A layperson should take note of the amount of property, plant and equipment that a company owns and is this a business with a lot of asset investments that may require significant upkeep in the future. Additionally, pay careful attention to the long-term debt of the company that will be due in future years therefore possibly putting significant pressure on the organization in the future.

Summary

There are a lot of ratios and other indicators that financial professionals use when evaluating a company’s balance sheet, but most of the time its as simple as making sure what a company owns is more than what is owes and ensuring the organization has the liquidity in the short term to pay their debts coming due. It really does not need to be much more complicated than that.

Mark is an Area President for FocusCFO based in Cleveland.

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Transparency of Profitability

Transparency of Profitability

By Mark Snyder

The pinnacle of profitability reporting is understanding your item and customer profitability metrics for organizations selling goods. We’ve seen many times that either the organization’s system cannot capture this data, or the way the system was deployed did not enable both an item and customer profitability view. Depending on the business, they may have either item profitability or customer profitability, but rarely do they have both.

Often an investment into a business analytics system are necessary in order to pull your organization’s data and parse out profitability by item and customer. You really need to understand the customer profitability view and then be able to do a deeper dive into the items that customer is buying, and which are profitable or not.

An organization was selling products through retailers to the end consumer. They were approached by a partner company to supply ingredients to the partner’s products in the same retail channel that were complementary and not competitive. The new industrial supply business would require minimal capital with some bulk load out capability expansion. On the face this looked like a great opportunity to increase the utilization of their manufacturing facilities and enable the industrial business to share in the plant and corporate overhead that was solely borne by the retail business. The organization was forward thinking and set up this business up as its own business unit and therefore leveraged their system to track profitability for these industrial customers and unique items separately from their core retail items.

What happened over time is a testament to the power of customer and item profitability. At the start of this new venture the gross profit margins and operating profit were comparable to the organization’s retail sales. But as time went on and the venture expanded to other partners, the gross profit of the industrial business began to erode, which was readily apparent via the separate industrial business item and customer profitability metrics.

Two things happened to the industrial business over the years. The partners expectations were constantly being raised with regards to quality and timeliness of supply. The requirements became so onerous that significant product rework and waste was created due to these ever-tightening specifications. Additionally, the partners treated the organization as merely a supplier and upon every contract renewal there were heated negotiations on price and ultimately concessions to maintain the industrial volume.

Finally, after many years of supplying product to their industrial partners the organization found that this business was becoming a significant drag to the organization’s profits and was a hindrance to their retail aspirations. If the profitability of the industrial business had been buried into the overall business, it would have taken a lot longer to find, diagnose and socialize the issue. Even with clarity into the industrial business profitability it was still a significant paradigm shift as whole teams had been built around this business therefore creating a lot of angst within the organization.

Ultimately the organization discontinued the industrial business and was able to sell parts of this business to another organization that was strategically focused on the industrial supply chain. This move freed up precious resources that allowed for expansion of their retail line as well as mergers and acquisitions to bolster their retail presence.

This positive outcome highlights the critical need for transparency into your customer as well at item profitability.

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Little Things Matter

Little Things Matter

By Mark Snyder

A Standford psychologist, Philip Zimbardo, performed social science experiments back in 1969 that provides some key insights into the human condition and how people respond to their environment. Zimbardo performed experiments involving what is now referred to as the broken windows theory.

Zimbardo took two similar cars and parked one in the Bronx, NY and one in Palo Alto, CA. The car in the Bronx did not have a license plate and the hood was propped open. In less than ten minutes people began to remove parts from the car and in less than 24 hours all valuable parts had been removed and the car was stripped and virtually destroyed. Conversely in Palo Alto no one touched the car and it was left alone for about a week. Zimbardo then made one change to the Palo Alto car, he smashed part of the car with a sledge hammer and all of a sudden the same thing began to happen to the Palo Alto car as had happened in the Bronx, it was stripped of all its valuable parts in less than 24 hours.

What’s the lesson of this experiment?

Little things matter!

When people perceive that something is not being cared for, they begin to take liberties and do things that would not normally do in certain circumstances or in a certain environment.

Rudy Giuliani famously applied the broken windows theory to the tactics of the NYPD to clean up the streets of New York City. He flipped the script and instead of just focusing police efforts on major crimes, such as rape, murder, assault etc. he focused on cleaning up the streets literally. Giulani cleaned up the graffiti and trash, focused efforts on removing the drunk, disorderly, pan handlers and prostitutes from the streets. He literally cleaned up the streets and what happened? Overall crime incidents began to drop, people took pride in their city and he literally created an environment that rivaled crime rates in much smaller cities and turned around the urban decay in NYC.

So, you’re thinking, this is a great discussion regarding how to combat urban decay or improving police tactics, what does it have to do with business?

As a leader in your organization or as a business owner does the state of your organization reflect that all things matter? What is the cleanliness of your operation? Are things broken and take a long time to fix? Do you and your employees pick up the trash as they are walking the operation?

If as a leader you’re not taking care of the little things, can you expect any more from your staff?

Take the time to show that your operation is important and invest in the cleanliness and functionality of all parts of the business. You’ll find your acts will be contagious and will drive a higher level of pride and ownership within your organization.

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5 Tips to Bulletproof your Travel Expenses Policy

5 Tips to Bulletproof your Travel Expenses Policy

By Mark Snyder

At a previous company that I worked for, the expense report submitted by one of our technicians revealed some surprising and troubling entries such as a receipt for luggage as well as dog boarding costs. Upon further investigation this was an employee who had never traveled for work before and was unfamiliar with our standards. The employee explained that he was traveling the same week as his wife was also away from home, he had to buy an additional set of luggage as they only had one set. Additionally, they needed pet boarding services for their dogs in their absence. As managers we were really to blame as we had done a poor job informing the employee of the expectations and properly documenting our policy.

Here are five guidelines that will help craft a bulletproof employee expense policy:

1. Principle Based 

Ensure that the policy is based on common sense principles such as “Spend the Company’s money as if it was your own” and “All employees are expected to behave in an honest and responsible way in relation to the Company’s expense policy”.  When people understand the over-riding principles, they tend to take the policy more seriously and comply with the guidelines.

2. Provide Examples

Your policy cannot possibly have a listing of every acceptable or unacceptable charge, but you should provide some common examples of allowable items as well as items that are not reimbursed. For example, baggage fees, parking, and hotel internet charges are allowable items, but movies, mini-bar, childcare and pet care will not be reimbursed. Some short lists will go a long way in helping your employees understand the logic regarding what is acceptable and what is not allowed.

3. Timely

Make sure to provide a timeliness expectation for submitting expenses, such as a completed expense report and related receipts should be submitted within 30 days. I can still remember certain employees who would wait all year long without submitting any expenses and then at the end of the year submit an expense report for the entire year that would be in the multiple thousands of dollars. This was always an unwelcome surprise to our year-end earnings as well as the burden on our cash flow and staff to process all these reports.

 

4. Win/Win

Create a policy that benefits the employee as well as the Company. For example, we’ve seen a lot of success with meal per diems. You could provide each employee a $50 per day allowance for meals, that way if they spend less, they get to keep the extra money. This is a great incentive for the employee to be very conscious of what they spend. In addition, it keeps the record keeping burden to a minimum and makes submitting expenses easier for the employee as well as your accounting team. A good place to start to get an idea of acceptable per-diems is the following website — https://www.gsa.gov/travel/plan-book/per-diem-rates

5. Exceptions

Make sure to consider any customer events that may fall outside of the standard guidelines and ensure your employees understand the process to get those exceptions approved and reimbursed.

Overall make sure to communicate your expectations especially when welcoming new employees to your team. Clear communication has a way of heading off issues before they arise.

Mark is a Principal with FocusCFO based out of Cleveland, OH.

855-236-0600

Product Costing Horror Story

Product Costing Horror Story

By Mark Snyder

I still remember the look on our General Manager’s face as we explained that our new product costing analysis had revealed that his biggest product line in the foodservice industry was being undercharged plant overhead to the tune of almost $3 million per year, and these costs were incorrectly being borne by our retail product line. As you can image that meeting ended with emotions running high and feelings of disbelief and shock.

How did we end up in this situation? For so many years our manufacturing plants would build a detailed budget by area of responsibility such as production, maintenance, quality control and sanitation based on the projected pounds of product to run through the plant. We would then simply apply the overhead rate per pound based on the weight of each case.

This method was “close enough” when we were a smaller company and the plant’s products and processes were somewhat similar across the board.

As our company grew over many years, we added new product lines and new stock keeping units (SKU) and ended up with facilities that had lines running retail containers at weights of 2 and 3 pounds and foodservice lines running small portion pack SKUs of only 0.5-ounce product. We also acquired businesses and brands over time that continued to increase the complexity of our operation and we determined we were woefully behind in properly assigning costs.

We internally developed a straight-forward methodology of spreading the costs for our manufacturing areas of responsibility [i.e. production, maintenance etc.] across separately identified packing lines and production processing activities to provide a view of what it cost to run a specific line or process each year. We then determined how many hours of production were required during the year based upon our volume forecast and how long it took to manufacture each SKU based on the throughput of that line. Ultimately, we ended up with an accurate cost per hour to run a production line or process and applied this hourly cost to each SKU based on the volume that would run through that process per hour.

The clarity and transparency that this new information provided was breathtaking. We not only had a better cost build per line and process, but also within each production line the items that were slower running, due to small batch runs and frequent changeovers, were less profitable than we thought. This provided a roadmap to trimming our product portfolio based on the new clarity into product profitability.

How does the story end? The General Manager explained that his Foodservice division could not absorb such a large cost increase, and price for it in the marketplace, based merely on an “accounting change”. Fortunately, we were a few years away from consolidating three manufacturing sites into a new greenfield site that would provide significant manufacturing savings. We waited to officially institute the new costing methodology until the new site was up and running. This allowed the Foodservice division to basically retain a similar cost structure in the new facility and our retail division received all the savings associated with the investment in automation.

The moral of the story is to seek clarity of in your product costs, this will lead to a stronger business and a better approach to the marketplace.

Mark Snyder is a Principal with FocusCFO, based out of Cleveland, OH.

855-236-0600