Financial Modeling is an Art, not a Science

Financial Modeling of proforma returns is a task that should be performed by every business, annually.  It is the act of quantifying the anticipated revenues and expenses, associated with implementing your business strategy.  While the expected outcome of a Balance Sheet or Statement of Cash Flow can be completed, the statement modeled will most likely be the Income Statement.

The primary driver of the success of this process is related to the quality of the assumptions used, i.e. data based estimate vs. a gut guestimate.   The ease of choosing assumptions is directly related to the age of your company –

  • Established businesses within a mature industry – The assumptions used will be mainly based on the history of your company, but slightly modified to take into account your strategy.  The model output would be an annual budget.
  •  New businesses within an established industry – The assumptions used will be based on the activities of competitors, whose business model closely match yours, but slightly modified to take into account your strategy.  The model output should be a three to five year plan.
  • New business for a new or young industry – Assumptions chosen should be conservative assumptions provided by senior managers of your company, i.e. the experts.  The model output should be a three to five year plan.

The first model produced is your expected scenario.  Now produce two more models, i.e. run the model for revenues 25% greater than previously expected and 50% lower than expected.  This process is valuable to understand what you will do if actual results differ from your first model projection.  If your company is 25% more profitable than expected, what will you do with the enhanced revenue?  If your company is 50% less profitable than expected, will you survive the next 12 months of Operations?

Once the model(s) are completed, the iterative analysis process should begin.  Understand the drivers of revenues and expenses.  What adjustments can be made to cost inputs and revenue strategies that could create different results?  What Risk components (opportunity, threats) alter this cost vs. revenue relationship.   Adjust the model accordingly and re-analyze.

The process discussed can be completed by any experienced modeler using a spreadsheet program, to predict the economic outcome of any business, new product or service.  A more in-depth analysis can be performed (Monte Carlo Methods/Simulations) using a statistical package or spreadsheet “add-in” that can model the probability of different events occurring, based on changing variables.

The last and final step – document the model.  Document the assumptions you employed so monthly you can compare actual results to plan results.  This documentation will help you understand the cause if a variance exists.

What is your experience?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Rules are Changing

The market turmoil of 2008 changed the business landscape dramatically.  In addition to integrating new rules into the business, today’s CFO, must keep up to date on rules still yet to be implemented.

Following are some of the federal rules affecting Human Resources, Finance, Accounting and Financial Management.  This list is in no way exhaustive.  There may be additional rules specific to your industry or at the state/local level that require your attention.

2012 Regulation Table

Note – it is not unusual for implementation dates to be delayed for various reasons.

It is true, currently, that depending on the size of your company, implementation of these rules may be delayed, if even required at all.  But keeping up to date on the latest regulations can only benefit you and your company.

If these rules must be integrated, my suggested implementation approach is as follows –

  • Review the requirements with your General Counsel;
  • Identify the items that will impact your company;
  • Collect data from your industry affinity organization i.e. how are competitors integrating these rules; and,
  • Develop a plan to implement the rules within your company – implementation, monitoring effectiveness, altering policies & procedures…

Caution – new rules have the immediate impact of increasing your expense base either through new processes, requiring additional headcount and/or training staff on the new requirements.

What has worked for your company?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Emotions and Economics

You have a great idea and you want to start a business.  Regardless if you are creating a new product/service category or you are entering a segment with established competitors, there are some basic “Best Practices” that you should adopt.  Following are the top three –

Set a plan – The cash flow of any business is critical to its survival.  Project for the next twelve months when you will recognize revenues vs. incur expenses.   This matching of revenues and expenses may be slightly complicated if consumers are not paying for your product or service immediately, i.e. you extend credit.  Now re-set your plan if your revenue expectations are 50% lower than what you expect.  Can you adjust the rate at which you incur expenses or will your cash be tied up in supplies?

Staff your business top down – You have strengths and more than likely, your business is linked to those strengths.  But it is unlikely that you are a specialist in all disciplines required to run a business efficiently.  For example, if you need a Finance resource, hire an experienced executive for your management team that can add value in multiple areas.  Just as important, a specialist can provide you with objective feedback required to make you successful and avoid mistakes.  Along the same lines, as soon as possible distribute responsibilities.  One person should not be responsible for Sales and Compliance.  Strategies in one area may contradict strategies in the other.

Draft your Policies and Procedures as you develop – If you make a decision, document it.  Now look at it from all sides, i.e. what risk am I assuming, how will this decision impact the customer experience, is this policy the most efficient.  Regardless of the size of your company, a document that defines how the organization will act in a specific situation is critical to avoid confusion and reduce risk.

As an entrepreneur, you are emotionally invested.    This emotion is the critical ingredient needed to make you successful.  Your creativity will separate you from your competition and will hopefully bring customers.  The purpose of the aforementioned Tips is to control that emotion.

Nothing destroys economics more than emotions.  I learned this concept in school, but have seen it played out with the 30+ small and mid-size companies I have managed, as their financial support.  If actual results do not follow your expectations, your Plan, People and Policies and Procedures will help you get them back on track quickly.

These tips are not just for companies starting out, but should be adopted by companies of all sizes.

What is your experience?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

A PEO is not a “Set it and Forget it Process”

A Professional Employer Organization (PEO) is a co-employment arrangement where a Business hires the PEO as the employer of record. The employees are referred to as leased employees.  For a fee, usually a percent of payroll, the PEO will perform a portion of your Personnel & Payroll activities; while the Business performs others —

Task Business PEO
On-boarding Recruit and process new employees. Provides benefits package.
Compensation Designs plan. No involvement.
Payroll Process payroll instructions bi-weekly, i.e. salary, draws, commissions. Business distributes the Commission statements. Pay wages per Business directions.
Taxes No involvement. Pay and report all employment taxes to state and federal authorities, as required.
Unemploy and W/C claims No involvement. Administers and manages all claims.
Benefits No involvement. Makes benefits available per contract.
Employee Support Respond to day-to-day questions based on Policies and Procedures. Involvement reactionary.
Employee Training Coordinates job training. Coordinates harassment/ discrimination training.
Performance Reviews Administers. No involvement.
Warning Process Administers. Involvement reactionary.
Record Maintenance Maintains employee file. Maintains employee file “of record.”

If you are a small business and do not have the resources to hire a full payroll and human resources staff, the PEO approach should be considered.  This recommendation is further supported when you consider the HR changes that are “on deck” for implementation, i.e. W2 reporting, 401k disclosure, HSA management, health care regulations.  Keeping track of the changes and when they will be implemented may be better handled by a specialist, i.e. the PEO.

If managed correctly, these relationships are fantastic.    Following are a few suggestions for your consideration –

  • Spend extra time ensuring the payroll you submit for payment, to the PEO is correct.  Out of cycle payments are usually expensive.
  • Maintain a complete copy of the employee records.  Do not be in a situation where the vendor has all of the information for your employees and you have none, i.e. giving up total control.
  • Annually, review what you pay for PEO services vs. what it would cost if you maintained in-house support.  Depending on your business, there will be a point where bringing the process in house makes sense.
  • Conduct meetings with the PEO, on a set schedule, to ensure the quick resolution of issues, as they materialize.

My personal experience with PEO’s occurred between 2000 and 2006, where I was responsible for managing payroll activities for 30 joint venture companies, i.e. 250+ employees.

What is your experience?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

An Approach to Compare Actual to Plan

It is February 16th.  By now you should be finalizing your January 2012 P&L.  What matters now, is what you do with the information.   While one month should not cause you to make changes to your business plan, it is a data point in an evolving trend.  Following are recommended activities —

Measure

Compare actual results to your planned results.   In theory, these plans have only been around for 45 to 60 days.  The actual for the month of January should be the closest to your plan than any single month in 2012.  How do your January Actual Revenues compare to your 2012 January Planned Revenues compared to your 2011 January Actual Revenues?  Complete this type of comparison for all p&l line items.   Compute the numerical variance and distribute the data to the appropriate cost center manager.

Variance Analysis

The most productive process I participated in, included monthly meetings where cost center managers discussed revenues and expenses achieved in the current month, compared to the plan they developed, with the responsible executive manager.  This approach was vital in creating an environment of accountability.  The purpose of the meeting was not to brow beat the manager, but to understand if the budget created was unrealistic or a situation where subpar performance needed to be addressed.  The greatest value in this process was to gather information from the point of sale, i.e. what was working vs. what was not working.

Forecast

In some instances, a production shortfall in the current month will be made up in a later month.  But sometimes that will not occur.  After the first quarter, monthly reports should show four different comparison points, i.e. actual vs. plan vs. variance vs. forecast.  This last value will provide executive management and the board with an accurate representation of what to expect in the current full year, financially.

Corrective Actions

If results vary widely from what was expected, the conversations during the cost center manager meetings gravitated to “what can be done to fix the shortfall” or “how do we prepare for the unexpected increased business we are experiencing, to ensure customer service does not suffer.”  Many constructive ideas were borne out of these meetings.

After following this process for a few months, you should see a slight change.  Managers will  understand they are accountable for their respective cost center; and that process corrections are being implemented quickly and efficiently.  Most importantly, executive management will be in the communication loop monthly.

Please share your thoughts.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Bad Debt Strategies

If you extend credit to your customers, which is required for almost all businesses, a certain amount of bad debt will result.  Resolving this bad debt efficiently and quickly, while not disrupting the possibility of future business from the customer takes tact and experience.

Following are a few strategies that will help with this situation:

30 days Past Due

  • Analyze the customer history.  Fully understand the relationship to date.
  • Contact the client, as soon as the bill becomes past due.  Do not leave a voice mail message.  The first call should always be administrative in nature to understand if there are any issues with billing or the service provided, i.e. missing or lost invoice; waiting for approval…  During this call, ask directly when you should expect to receive the past due payment.
  • Send a letter to the client with the agreed upon new terms.

60 days Past DueIf the issue is not resolved, follow-up will be required.

  • Contact the client, as soon as the newly established commitment date lapses.  Do not leave a voice mail message.  This call should be considered the initial Collections Call.  If not discussed in the first call, try to understand the reason for the bad debt, i.e. cash flow problems; default due to being out of business, bankruptcy; or other serious problem.  During this call, ask directly when you should expect to receive the past due payment.
  • Discontinue service until the outstanding debt is satisfied.
  • Send a letter to the client with the agreed upon new terms.

90 days Past Due – If the issue is not resolved, follow-up will be required.

  • Prior to this call the Collections Manager should speak with the responsible Executive to discuss options that include legal actions.
  • Contact the client, as soon as the second established commitment date lapses.  Do not leave a voice mail message.  Try to understand what new situation occurred that justifies the missing of this second day.  Advise the client of the actions you will be taking to try and collect the debt.
  • Send a letter to the client with the agreed upon resolutions discussed.

Every customer interaction should be documented and maintained in the client file, as part of their history.

Bad debt should be tracked via a Scorecard that includes dollars delinquent, for each of the following time periods – 30, 60, 90, 120, 180 days.

Prior to a bad debt situation –

  • Document your collections policy, to ensure the customer experience is consistent.
  • Make sure your credit application and policies are compliant based on state guidelines.  Engaging a Collections Attorney to review your application and approach is a worthwhile expense.
  • Audit your client files to make sure that you have a current credit application, signed by an individual with the authority to enter agreements; as well as the contact information for your customer’s Accounts Payable contact.

Please let me know your experiences.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Employment Status Determines Tax Liability

According to the IRS –

“Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.”

Originally the IRS determined if an individual was an employee or an independent contractor, based on a “Twenty Factor” test.  But in January 2006 the process was simplified.  Factors considered now fall into one of three categories, i.e. behavioral control, financial control, type of relationship.

IRS Test Category Employee (W-2) Independent Contractor (1099)
Behavior Control Location On premises Off premises
Behavior Control Work Time Co determined – standard Contractor determined – non-standard
Behavior Control Staffing Resources Co determined Contractor determined
Behavior Control Direction Provided Direct work process and output Direct work output only
Behavior Control Training Co provided Contractor responsibility
Behavior Control Supplies and Equipment Company provided Contractor provided
Financial Control Business Expenses Generally  Reimbursed Generally Unreimbursed
Financial Control Investment in Process Insignificant Significant
Financial Control Degree of Availability Co is sole customer Multiple Co customers
Financial Control Pay Consistent Not consistent
Financial Control Profit or Loss No p&l outcome p&l outcome
Type of Relationship Contract Describing Relationship What parties call it What parties call it
Type of Relationship Benefits Eligible Yes No
Type of Relationship Degree of Permanence Permanent work Temporary work
Type of Relationship Importance of Services Performed Business critical Non-business critical

If after reviewing the IRS established testing you cannot determine the employment  status, you have the option of completing and filing a form SS-8, requesting an IRS ruling on the status.

As you can see, in some circumstances employees fall clearly in one or the other camp.  However, there can be a very large grey area.

In 2000, the Department of Labor investigated the degree at which mis-classifications occurred.  At that time it was determined that 30% of firms mis-classified employees and independent contractors.

In response, federal and state authorities are beefing up auditing to investigate these situations and levying fines against law breakers.  Please note the federal government’s newly re-introduced H.R. 3178; and California’s newly enacted SB459.

If it is determined that an employee was misclassified, the employing company will be assessed back taxes, penalties, interest, unpaid personal incomes taxes of the misclassified worker, overtime, benefits, leave entitlement, and other rights and protections due to employees.

If your company has any independent contractors, it may make sense to review the arrangements based on the criteria above.

Please let me know your experiences.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Activity Based Costing and Sales Management

Activity Based Costing (ABC) is a process by which you attempt to identify the discrete costs associated with a product, service or process.  Activity Based Management (ABM) is the process of using ABC derived information.  The primary uses for ABC include new product/process development and process improvement.

  •  New Product Development – Prior to implementing any new product or process you want to understand the costs of development and the expected returns.  Anyone that has experienced a major system conversion, understands that the true cost of the conversion is more than just the monthly licensing fee.  Some of the hidden costs include contract negotiations, compliance reviews, project staffing, testing…
  •  Process Improvement –In the ongoing quest to offer quality services at the lowest cost and remove non-value added expenses, ABC is a valuable tool.  Activities include – process mapping and validation, apportioning costs by activity, identifying areas of improvement to maximize revenues and minimize expenses.  This process is extensive and complicated.

The ABC process makes tremendous sense for these aforementioned uses.  However, the greatest drawback of ABC is that it cannot easily be utilized month-to-month, due to the extensive analysis required to allocate expenses.

In every p&l some items are obviously associated to a product or service sold, but others are not.  Items that are not as clear include HR, IT, Legal, Payroll.  For smaller companies these administrative services show up on the p&l and are tracked by themselves, as they are considered the cost of doing business.  But for larger companies, with multiple channels, these costs are a source of frustration, as they show up as a management fee or corporate allocation.  Lumping together and allocating is much easier to administer than an accurate monthly allocation of expenses.

So what can you do monthly?  ABC should be used monthly when reviewing Sales activities.  For each Sales person, the company should track the individual expenses associated with obtaining the sales generated, i.e. revenues less discounts, marketing dollars utilized, commissions paid.  Through this process you will better understand which sales managers are bringing you the most value vs. the sales managers that are not as profitable.  Once identified, these less profitable sales managers can be coached with the intention of bringing their profitability to parity with the rest of the sales force.

What has been your experience?

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Is Your Company maximizing Social Media?

Social media is a communications outlet that cannot be overlooked.  While current clients can be reached today via print, TV and through more traditional methods; future clients, individuals that were born after 2000, can be best reached via a social media platform.

If you are not engaged in the Social Media, following are some tips on how to get started —

Identify your strategy.  A strategy I have used before is as follows – “Build a relationship between your company and your consumers.   Reinforce your brand and your positioning.  Engage consumers or potential consumers to gain feedback on your products or services, i.e., positive testimonials, and willingness to recommend statements.”

Set-up a company page on a couple of social networks that reach your target customer.  Invite current/past users and potential customers to join your community.  Interact with the community on-line through product development suggestions, beta testing, targeted marketing campaigns.  Be true to your brand.  If your clients expect traditional content, now is not the time to become satirical.

Actively Market.  Respond to clients/customers.  It is terrible when a client makes an effort and comments, and their efforts do not receive any feedback.  If there is no response, they will never comment again, and may develop a negative impression of you.

Continue to post fresh material.  Successful usage of social media requires an effort.  It is not an afterthought.

Differentiate messaging across social media sites.  For example, you may wish to discuss seasonal promotions, special events or discounts on Twitter; but product information on Facebook.

However, in my experience, there are two primary reasons why some companies may wish to shy away from this communication medium –

Negative Comments – If you provide individuals an opportunity to interact with your company via social media, be prepared to read bad comments; as well as good comments.  Keep in mind that messaging on the internet is “forever” at the current time.  These negative comments will never go away.  But, in my opinion, any information that helps you understand what your clients are thinking adds value.  Just be prepared.

Legal Significance – Often times, social media is discussed as just a different type of advertising, similar to print and TV spots.  There does seem to be one very big difference.  Any company communication, prior to the use of print or TV, is vetted through legal departments to ensure there are no statements that could be considered by reasonable people as misleading.  It may not make much sense economically to constantly run 170+ words by your legal department.

But regardless of the two caveats discussed, I believe the benefits of engaging in social media outweigh the risks.  Just be thoughtful and true to your brand and strategy.

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Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.