Make Sure Your’s Is The Optimum Backlog

I look very carefully at sales order backlogs as a temporary CFO. Given the current economy, I get that having long back logs hasn’t been the problem you’ve likely been focused on, none the less it’s still a point of discussion. Let me say first of all that the time frames of healthy backlogs will be different for different industries. Depending on the industry, if participants don’t have a six to twelve month backlog, it’s considered unhealthy. Customers at some industries expect a backlog. What I’m asking in this article is for business owners to assess their own backlog taking into account their industry and what is considered healthy there.

Backlogs have their place keeping the business owner in a state of harmony. They minimize layoffs by keeping employees busy. They can be a solution to cash flow problems (by increasing production, staff, or capacity to cut into itself and accelerate the customer’s receipt of cash) or indicative of demand or the customer’s propensity to buy. If you accelerate sales and cut into the backlog you will increase production thereby decreasing fixed overhead, have faster inventory and sales turnover and make more money. Of course, even the backlog has its limits—it can’t get too long. Customers are kept waiting longer for the product or service they are owed the longer the backlog gets. Usually a longer backlog also means a longer cash cycle due to inventory and labor being needed well in advance of the delivery of products and services. Basically, even though backlogs can be great to solve cash flow problems, they can end up causing cash flow problems if they get too long.

The CFO and business owner need to collaborate on making a point of assessing the backlog, an assessment which should include:

Determining if there is currently a cash flow problem.

Determining what cash flow and profits were like when there was a shorter backlog and faster turn over.
Determining what the staffing availability is.
Determining what the general customer’s patience level is.

If the CFO prepares a business and cash flow forecast for the business owner, these problems and more can be discovered and solved with greater, more organized ease.

There are optimum inventory levels and optimum employee levels just the same as there are optimum Backlog periods. Of course backlogs are great, but you need to determine an optimum backlog, and that depends on the industry you’re in.

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Accrual Versus Cash Reporting

What the difference is between accrual basis and cash basis accounting is something I am often questioned about as a part time CFO. QuickBooks users know that by clicking QuickBooks’ “modify report” button, the user is presented with the choice of reporting their financial statements under a either a cash or accrual reporting basis. Depending on their choice, my clients notice a significant discrepancy in their profit and wonder why. Explaining the differences between a cash and accrual reporting basis is one of my CFO services.

Revenues are recognized under the accrual reporting basis whether the cash on the sale is received or not in the month the product is sold or the service is performed. For example, if you ship computers to the customers you sell them to with 60 day terms in the month of May, the sale will be recognized in May (not 60 days later in July when the cash will actually be received) under the accrual basis. Expenses are recognized when they are incurred, not when they’re paid under the Accrual Reporting Basis. Going back to the example, if part of your cost producing those computers was hiring outside contracted labor with 30 day terms the expense would be recorded in May (even though you paid for it in June).

Revenues are recognized in the same month the product is paid for by the customer, not the month its shipped under the Cash Reporting Basis. Returning to the example, say the computer is shipped to the customer in the month of May with 60 day terms. The sale will be recognized in July when it was paid for under the cash basis, not May when it was shipped. Expenses under the cash reporting basis are recognized when they are paid, not when they’re incurred. For example, if part of your cost to produce the computers you built and shipped in May were to hire outside contracted labor with 30 day terms the expense would be recorded when you paid the expense in June and not when you incurred the expense in May.

How do you know which is better than the other? Is one better than the other? Both are allowed for income tax purposes, and an income tax professional should be consulted to figure out which is best for you. For management purposes, the accrual basis is, in my personal opinion, a much better choice because it provides a more accurate matching of expenses with revenues. Taking a look at the computer company example under the Accrual method the product is shipped in May and revenue is recognized. The expense associated with the product (outside contractors) is recognized in May when incurred. This is a perfect match of revenues with the expenses that produced that revenue. Now take a look at the same example under the cash basis. The revenue would be recognized when paid in July and the expense would be recognized when paid in June. There you have an obvious mismatching of revenues and expenses.

Through utilization of the accrual basis and the proper matching of revenues with expenses more useable management reports are available and in turn better decision making. Certainly the CFO as well as the business owner will be able to better utilize and make more effective judgments with the accrual basis of accounting. As previously mentioned the IRS allows for both methods of accounting however under GAAP (Generally Accepted Accounting Principles) only the accrual reporting basis of accounting is allowed.

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So you Want to Sell your Business to your Employee(s)

I’m often involved in exit planning and the execution of the finished plans as part of my CFO duties. I’m here now to give you a preliminary checklist to keep in mind if you really want to sell your company to employees, although also keep in mind that doing so is not normally advisable. The reasons for that being employees don’t usually possess the financial resources needed to make a significant enough down payment, or even the credit capacity to assume personal guarantees that may be outstanding. Despite all this, some business owners significantly trust their long-time employees, or want to reward extremely loyal employees, and are willing to assume the additional risks in order to sell their business to them.

Here’s that check list I promised:

• Is the employee/potential buyer on the same skill level as you? Are they capable of thinking like a business owner and not just as an employee?

• What skill sets do you have that will need to be filled when you retire?

• Will your potential new owner be able to fill the need for those skill sets?

• If the answer is no, what is the best means you have to find someone with your skill sets, and should you hire them before you sell or retire in order to break them in, or leave it to your company to sort out after you leave?

• When should your employee/new owner’s closing date be?
The timing is important, and when that date should be depends on many factors such as if you’re selling the business in the slow season or going into peak season. It’s not recommended to sell during the slow season because it gets your new owner off on the wrong foot.

• On a retirement date, is the stock ownership to employees all at once or gradual, and what are the income tax ramifications of either situation?

• How do you transfer personal liability?

• If you want to sell your company to multiple employees, will they make good partners and work well together? If the answer is no, then you probably realize that spells disaster for your company.

• Today, how much is your business worth?

• On your planned retirement date, how much will your business likely be worth then?

• From the business in total, how much money do you need?

• What form can this payment take? Do you need, for instance, a lump sum or would per
year for a number of years you need to specify work for you? It’s likely that you’ll need to take a note for any part of the purchase price, so what is the credit worth of your new owner?

• After retirement, how much money do you need to live on?

• Of that retirement amount, how much must come from the
proceeds of the sale of your business?

Please consider these points carefully if you are seriously considering selling your company to an employee. This list is something I usually hand to my clients who are at the first stages of thinking about selling their company to an employee, as it starts them out thinking in the right direction. Multiple factors not mentioned in this post also need to be considered carefully before diving head first into this process. Make sure that if you’re doing this, you get a team of professionals to help you through.

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