Driving Your Company's Value

Progress Report: Readership Up and Recognition Growing

After six months the DYCV blog is showing signs of long term success:

1. We have hit the 600 readers a month level. This is solid growth for a business blog, which will never reach the readership levels of the larger blogs addressing the needs of a much larger consumer based  marketplace.

2. We recently were shown an article that will soon be run in a publication of a  large professional association (over 300,000 members) recommending their members should encourage their clients to read DYCV Blog regularly.

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Understanding Your Financial Statements – Part 11: Long Term Liabilities

Long term liabilities represent the debts of the company which will not have to be paid within the next twelve months.  These liabilities commonly include:  bank debt, loans from stockholders or related entities and contingent liabilities.  The portion of the liability that has to be paid within the next twelve months is recorded in the financial statements as part of Current Liabilities (See Part 10). 

Financial statement analysis questions that should be asked related to the company’s long term liabilities include:

1. Are your long term liabilities increasing or decreasing as compared to the prior period or previous year?  What are the factors that caused the change?
2. Long term liabilities represent what percentage of total assets (long term liabilities divided by total assets)?  How does it compare to the prior period or prior year?  How does this compare to industry comparative data?
3. Do you have a good relationship with your banker and other creditors?
4. Should you consider restructuring your interest bearing debt to change lengthening your repayment schedule?
5. Should you consider repaying your debt sooner to lower your future interest expenses?
6. What is percent of your payments or principle versus interest?
7. Can you accelerate your principle payments without having a significant negative impact on your operations?
8. Have you set goals for the level of debt you desire to maintain?
9. Do you plan to repay debt from related parties (stockholders or other related parties) or is it really a form of equity (long term debt without FMV interest being paid)?  If so, should the debt be reclassified to equity?
10. Are there any balloon payments that need to be paid in the next two to three years?

10 Ways to Enhance Cash Flow

One of the things that separates well managed companies from others is the management of cash flow. And in these more turbulent times, managing cash flow is more important than ever. Here are 10 ways to enhance your company's cash flow:

1. Assess customer credit risks up front. If you sell on terms, you are extending credit to your customers and have the risk of not getting paid for services provided or products sold. Make sure you clearly establish and communicate your billing procedures and payment schedules. Also consider credit checks on new customers before offering credit carte blanche.
2. Bill immediately. You can't get paid for what hasn't been billed yet. My experience is that there is almost always room for improvement in billing procedures...you can't bill soon enough. I worked with one client whose policy was to have billing done by the end of the month for the previous month. Instead of billing at the beginning of the month and having cash in the bank, the client had a line of credit outstanding all year to finance unpaid receivables.
3. Bill thoroughly. Make sure your bills are clear and your customers can understand them. Unclear billing is an excuse for a customer not to pay immediately. Related, be sure to stick to your billing policies. One professional services client I worked with had more than a year's worth unbilled work on the books...they worked for free for a year!
4. Collect your bills. One of the greatest potentials for loss of cash flow flows from uncollectible accounts receivable and the older the A/R gets, the less likely it is to get paid. Establish a collection policy and stick to it.
5. Make paying your invoices easier. If you don't already, consider accepting credit cards, offering pre-authorized debits, billing electronically, and/or providing postage paid return envelopes with your bills.
6. Time your own payments carefully. Review payment terms on your payables and use them to your advantage.
7. Cut unnecessary expenses. Good times covers a multitude of sins that are exposed in bad times. Is your insurance coverage current? Do you have any policies or controls on employee expenditures? Who manages inventory purchasing? Etc.
8. Consider extending payroll periods. If you are paying weekly, bi-weekly or monthly payroll periods may defer payroll tax deposits and add to cash flow.
9. Make sure your receipts are deposited as quickly as possible. Cash in the register or checks in the drawer do nothing for your cashflow.
10. Plan ahead. Take advantage of volume purchasing, purchase discounts, and other cash management and budgeting techniques that will give you a leg up in managing cash flow.

Ratio Analysis, Part 9 – Accounts Receivable Turnover Ratio (cont)

I previously reviewed the A/R turnover ratio, as well as the related average collection period. Let’s digress just a little…

Most of my discussion regarding financial ratio analysis has been oriented towards spotting trends or issues. Typically, financial ratio analysis is performed after-the-fact, or on historical financial performance. Therefore it is easy to assume that financial ratio analysis is merely diagnostic in nature…it is used to look for a problem to fix or to keep a problem from occurring.

Let me make just two comments:

1. Financial ratio analysis can, and should be applied to financial forecasting. Doing so provides a ‘sanity check’ as to the reasonableness of the forecast. For example, if your company has had a historical gross profit margin of 35 percent and your forecast shows a 45 percent gross profit margin, you better have a damn good explanation for the dramatic change…otherwise both you and your banker will be disappointed.
2. Don’t let the tail wag the dog. What I mean is that financial ratios are a tool to help you manage and direct the business, not shackles that keep you from doing what you need to do to accomplish your business and personal goals.

Regarding the second point, the average collection period is a great example. My prior discussion identified the reasons, or effects, of changing average collection periods. However, one way to grow revenues (and hopefully profits) is to loosen credit standards – providing more generous payment terms to your customers will (1) allow existing customers to purchase more from you, and allow new customers with poorer credit history to purchase from you. That’s not necessarily bad…as long as you understand the risks involved.

This type of risk (credit risk) is what bankers deal with every day, usually very effectively, but sometimes not too well, as the current subprime mortgage mess illustrates.

There is a cost to you to purposefully allow the average collection period to grow. You diminish your cash by allowing customers to pay later and you risk greater levels of non-payment by having customer with poorer paying records. You may even have to borrow to finance your receivables to do so. You need to recognize this fact and you measure and track it.

So, if you put this all together, you can be proactive in your receivables management and possibly grow your business through use of credit terms. However, you should do so only if you can estimate the cost of doing so and you carefully and constantly measure and track your strategy, in part, through the use of both historical and prospective financial ratio analysis.

Ratio Analysis, Part 8 – Accounts Receivable Turnover Ratio (cont)

The traditional formula to calculate the A/R turnover ratio is:

Sales ÷ Accounts Receivable

Accounts Receivable can be measured either at period end, or an average over the sales period.

We can convert the A/R turnover ratio to an A/R collection period or Average Collection Period as follows:

Average Collection Period = 360 ÷ A/R Turnover Ratio

How do we interpret this ratio?

Implications of an increase in Average Collection Period:
• Company’s customers might be in trouble
• Possibility for an increase in write-offs
• Reduction in cash on hand

Implications of a decrease in Average Collection Period:
• Increase in cash on hand
• Increase in operating cash flow and free cash flow
• Increase in Return on Equity

Implications of a high Average Collection Period:
• High cost in extending credit to customers
• Loose credit policy
• Less cash on hand

Implications of a low Average Collection Period:
• Tight credit policy
• More cash on hand

Ratio Analysis, Part 7 – Accounts Receivable Turnover Ratio

I have been reviewing turnover ratios. Turnover ratios can be used to measure efficiency of operations and management. In addition to considering total asset turnover, we can measure and evaluate efficiency of any single asset or group of assets. We looked at the inventory turnover ratio. Now let’s look at the accounts receivable turnover ratio (or A/R turnover ratio).

The traditional formula to calculate the A/R turnover ratio is:

Sales ÷ Accounts Receivable

You could also use “average” accounts receivable, similar to how we previously calculated the average inventory turnover ratio.

What does the A/R turnover ratio tell us? How quickly a company gets paid by its customers. So, if a Company as an A/R turnover ratio of “12,” that implies the company is paid by its customers in 30 days, on average. This leads to an expansion of the formula, converting the A/R turnover ratio to an A/R collection period or average collection period.

Average collection period is calculated as follows:

Average Collection Period = 360 ÷ A/R Turnover Ratio
     Note: You could also 365 days

So let’s assume a company has $4.2 million in annual sales and $525 thousand in accounts receivable at year-end. That calculates to an A/R turnover ratio of 8 times (or 4,200,000 ÷ 525,000). The average collection period is 45 (or 360 ÷ 8)

It should be obvious that the more quickly a Company gets paid on its credit sales (the higher the higher the A/R turnover ratio and the lower the days sales outstanding), the more cash is available to it. Next time, we’ll talk about how to interpret and use the A/R turnover ratio.

Managing Capital Expenditures in Slower Economy

There are five important considerations / ways to manage your capital expenditures in a slower economy

1. Align your capital and business strategies closely and do not be destracted by a short term focus.

2. Track ROI on every capital expenditure regularly.

3. Use outsourcing wherever possible to keep capital expenditure lean

4. When buying software, time the purchase to occur just before the end of a quarter, as vendors will be more likely to offer discounts in an effort to make their numbers better.

5. Summarize and keep track of capital expenses reviewing regularly to verify the expense is still justified and that the reasons and assumptions are still valid.