Does Minimizing Taxes Maximize Cash Flow?

If you ask some business owners about income taxes, you often get the response that they do a lot of “work” at year-end to minimize their taxes.

Too often, they are advised that by minimizing their tax liability, they save money. That is the way many people generally think, so it must be true. Right?

Wrong.  From my experience, I have found that the key to growing a successful business is to pay taxes.

Why? Because those that pay the most taxes have the highest earnings. Those that have the highest earnings are strong and healthy. Those that are strong and healthy have the best relationship with the most cost effective source of financing that exists – a bank.

It is often counter intuitive to the way most people think.

Now I am all for good tax planning, but not to a fault. Many owners are advised (by some of their advisors) that if they keep their income down, they keep their taxes down. O r to pay out big bonuses at year end so they get into the lowest corporate tax bracket.  And even to draw on their credit line to make the bonus payments every year.

For most businesses, low income equals low bank credit. The reality is that banks lend money to businesses that can pay it back (or “service” their debt).  And businesses service their debt from their operating cash flow.  So the reality becomes that low income translates to low operating cash flow.

And as all business owners know, without a strong credit facility, it is very hard to grow your business.

So if your year-end financial statements or tax return show your business doesn’t make any money, don’t be surprised if your bank won’t give you much of a credit line.

What if you took the opposite approach – reported your income without all of the year-end “planning”?   Pushed your business to be as profitable as it could?  Maximized your profits and your earnings?

If your business is healthy, higher income will lead to higher credit facilities. And if credit facilities are used for good things and not for bad things – funding sales growth vs. overhead expenses, losses, capital equipment, year-end bonuses — really good things will happen for your business.

I know, I know. It is like the devil and the angel on your shoulder whispering in your ear what to do.  “Low taxes, low taxes”, shouts the devil in one ear.” In the other, the angel is saying, “If you have more income, you can get a better bank deal.”

I say, try listening to the angel and see what happens.

But what do you think? Let me know in the comments.

The Best CFO Article I Have Ever Read

I have read a lot of articles and blogs about CFOs.  There have been some great ones.  Most describe the various roles a CFO fills.  Everything from leadership to lending. From technical skills to turnaround strategies.  But never before have I seen one that truly captures the essence of how successful CFOs work in middle market and lower middle market companies than the one I came across last week.

I about fell out of my chair when I read it.

It starts off like this:

“…the new operational river running through the executive suite is dissolving the walls between the chief financial officer and chief operating officer offices. Today’s successful CFOs must have a strong operational focus. Today’s successful COOs must have a strong competency with numbers. And more and more frequently, businesses — particularly those with revenues under $100 million — are recognizing the cross-functional fluidity between these roles and moving to combine the CFO and COO positions, or adjusting each role to incorporate cross-functional attributes.”

Wow.

The article is by Thomas Bonney, the founder and managing director of CMF Associates and is entitled “The New Fluidity of COO and CFO Roles”.  Here are a few key points that Mr. Bonney brings out:

1.  “CFO and COO roles shifts are most frequently on the rise at companies where there is a weakness in leadership at either position.”

I have seen some CFOs excel in their careers.   I have seen others fail.  The ones that succeeded always did so repeatedly.  They were different.  They were involved in the business.  I mean really involved in the business.  Not just sitting in a few meetings.  They were involved!

The ones that failed often did so repeatedly.  This sums up why.

Gone are the days when the CFO is purely a numbers person.  I have often said that controllers sit at their PCs all day, but CFOs are involved in the business.  I once asked a CFO who was struggling if he could do his job without his PC.

CFO’s MUST be involved in every aspect of their businesses.  This includes operations, sales and finance.  To be effective as a CFO, you have to be a true business person.  If you work for a business owner, they will never respect your abilities unless you are walking the shop floor, attending production meetings, and helping the sales team.  Remember, you must be adding value in every one of these areas.

2. “CFO and COO role shifts are also occurring as entrepreneurs and family business owners increasingly realize they can’t have a hand in every functional role within their organization.”

This is so true.  I have personally spent many thousands of hours with entrepreneurs and business owners.  I am one myself.  The instinct of the entrepreneur is to do things themselves.  They are task oriented.  They put their head down, figure it out and get it done.  This is how they got to where they are today.  They had a vision, worked hard and made quick decisions.  But at some point they can’t do it all.

The business owner is usually the CEO, President and founder.  They spend much of their time with the people, with their customers and leading the company.  Too often they are functioning as the COO as well.  As the business grows, this is where things often start to bog down.

3.  “However, many [CEOs] are learning in the face of arduous conditions that their CEO role is a full-time position in its own right, and that they require the support of a very strong, operationally oriented “number two.”  With an integrated CFO/COO in the “number two” role, the founder/CEO can more effectively leverage his or her time to focus on revenue growth and strategic direction, which in the current environment is critical to long-term success.”

The reason these entrepreneurs have succeeded in their business (they are hands on), too often becomes the reason they struggle (they can’t let go).  Deep down, do they hope for a true “number two” to step up and take over many of the things that they have done for years?  Absolutely yes.

But I can tell you from firsthand experience, you don’t get the job because of your resume or your past successes.  You get it because you understand where in the business money is made, and you jump in with both feet.

Trust is earned, not given.

4.  “CFOs without operational acumen lack the intellectual horsepower and breadth of experience to understand and implement these organizational changes, which if done properly can yield significant competitive advantages.”

I can’t add anything to that statement.  It says it all.

For the full article, check out the link below:

http://www.thedeal.com/newsweekly/community/the-new-fluidity-of-cfo-and-coo-roles.php

Working with Small and Medium Size Business (SMB) Owners

I love entrepreneurs.

Generally speaking, they are usually Type A personalities; they make quick decisions; they are passionate about what they do.

In the late 90’s, while I was a member of Corporate America, I was walking through a very large automotive production facility.  My good friend (who was an SMB owner) pointed to a guy at a workshop in the corner of the plant and said “you see that guy, he makes $300,000+ a year running his own business”.

To me he looked like a regular guy.  In reality he was.  My friend followed up with, “there are lots of ways to make money.  You just have to find a niche and be really, really good at it.”

So in 2001, after 18 years of corporate America, I decided I wanted to be one of those guys.  The ones who found a niche and were really good at it.  I started my own CFO practice in 2001 at the age of 40.

During those first 18 years of my career, I had the opportunity to work mostly in public companies that were growth oriented.   After taking a company public in 1996, we did 17 acquisitions in 3 years.  They were mostly of companies with revenues between $2 million and $15 million.

My job was to perform the “due diligence”, to find out how they worked before we bought them.  Then, once we acquired them, I worked with these former business owners, now employees, to be integrated into our larger corporation.  During that time I learned a lot about entrepreneurs.

Watching them shift from running their own business to being part of a large organization was always fascinating to me.  It was interesting to see the former-SMB owner, who was usually self-employed for a reason – i.e., they didn’t like to work for anyone else – be faced with being part of a larger company.

Before they sold, they had sensed what they felt was the value of being part of a larger company.  On their own they often struggled with access to capital, good employee benefit programs and having someone else worry about most of the administrative issues.  Too often they could no longer get their hands around the numbers side of their business.

For many, these challenges had begun to make their entrepreneurial life miserable, or at least really, really hard.  They were essentially on their own facing the reality of being a business owner, and it was lonely.  They simply wished they could spend more time on what they loved – usually their customers and bringing in more sales.  But they were stuck in the administrative grind.

Once we bought them and the deal was complete, I worked with them to get them up to speed on things we did every day in running public companies.  I was the integration guy.  I helped then learn how to do things like three-month rolling operating forecasts, weekly revenue pipeline reports, developing budgets, and then review their monthly results versus budget.

Most often, they had never seen any of those before.  But they certainly found them more than helpful to have when the phone call came from the Company President every Monday afternoon asking “how are things going”.  Once they had them, they looked back and asked how they ran their business without them.

A few weeks after we closed on one of the deals, one former owner said to me, “Brad, if I had know someone like you before all of this started, I would not have sold my company. “

That stuck with me.  In fact, I have never forgotten it.  That is where the idea formed in my mind that a few years later led me to walk away from the world of corporate America and start a CFO Services practice in 2001.

I didn’t want SMB owners to feel they had to sell their company to get help with these issues.  I wanted them to be able to focus on what they were really, really good at.

Next: We will talk about some of these challenges and how CFOs help tackle them.

Grab Your Piece of a $2.2 Trillion Market

We are frequently asked by CFOs and CPAs for advice on how they can achieve more predictable, repeatable growth for their firm or practice. For those of you who have attended any of our training sessions or coaching calls you know our advice is always the same. You have to pick a core market that over time you can ‘own’. Is a $2.2 billion market too big? Probably. But could you capture the small piece of this market that exists in your city or town? In the United States, between 2011 and 2029, over 800,000 businesses with an estimated value of $3.3 trillion dollars will be disposed of by the Baby Boomers who own them. According to a Trendsetter Barometer Survey published by Price Waterhouse, 65% of these businesses will be sold – with an estimated value of $2.2 trillion. 99% of these transactions will be small businesses of $1 million or more in revenue. Their owners will be at or around 65 years of age, and if they are prepared they will do what most other ‘business sellers’ never do – they will realize maximum value for their business thanks to the work done with their own permanent, part-time CFO over the prior 3-5 years. What are your plans for your business? Do you speak with your clients and prospects about their long-term goals? Unfortunately, with history as our guide, we can be confident that most of the liquidity events that will occur over the next 18 years will be executed at valuations far below the expectations of their owners. Not because the businesses or their markets lack potential, but because their business owners did not plan ahead. Professional CFOs who are prepared have the ability to build value in their client businesses not only by assuring the business’ health but by enabling growth – working both sides of the cash flow equation. (see post: Build a Cash Flow Factory) Next time you are speaking with a business owner or referral partner, ask them how much of their retirement or estate is wrapped up in the future value of their or their client’s business. Consider the glut of businesses that will be for sale over the next two decades, and consider what you can do make this market a core component of your practice’s or firm’s go to market strategy.

How to Build a Cash Flow Factory

At a high level we can think of cash flow as the movement of cash in and out of a business. At a practical level cash flow is the single best measure of the current value of your client’s business. The objective being the creation of a business model that produces far more cash than it requires to operate – having more money flow “in” at any one time than flows “out”.

Managing cash flow is a critical business function that requires daily analysis and adjustment; it assumes even greater significance during economic slowdown when ensuring liquidity, access to working capital, and minimizing risk associated with various projects become important business considerations.

The CFOs job is to manage a business’ value by steering it through times of riches and recession; generating the cash required to make the most of a stagnant economy as well as to fuel times of economic growth.

In this post we explore the first three parts of a concept we call the Cash Flow Factory; a new way of looking at cash flow as a truly proactive operating discipline enabled by the partnership between CFO and client.

Part 1 – Cash vs. Cash Flow

There are only three places to get cash: an investor, a bank, and a business. When your clients are looking for cash do they consider all of their options?

They can look to short term options like an investor who will trade cash for equity, or a banker who will trade cash for a note. Or, they can look to the long term option of creating a sustained operational capability to generate cash from within their own business.

As our clients eventually discover, no matter where they start looking for cash, they eventually reach the realization that their focus must be on cash flow. And that means their focus must be on advancing their own internal financial and operational disciplines with the help of a CFO.

Are you helping your clients think about cash or cash flow?

1. What cash or cash flow alternatives are your clients considering today?
2. What challenges do you and your clients face with each alternative?
3. Do you know how to optimize your client’s ability to create cash flow, how to track progress, and where to adjust?

Part 2 – Health & Growth (next week)

Getting Your Arms Around Your Numbers – and Your Business

When my son went away to college, he said he learned a valuable lesson being on his own. He said, “Although money isn’t the most important thing in life, making sure you have enough is really important.”

We all know times are tough these days. Many businesses are struggling. The news is discouraging. People are worried.

The key to success can often circle back to focusing on the right things so your business generates positive cash flow. It is amazing how many good things start to happen when your business makes a profit and generates cash.

Here’s what we tell our clients at FocusCFO:

1. Focus on cash flow first. There is a big difference between the bottom line on your income statement and your cash flow. While net income is important, cash flow is more important. How many people have said “I don’t get it; my financial statement always shows a profit, but I never have any cash?” Understand the difference – it is critical.

2. Understand profitability. The key in business is not sales, but profitable sales. Remember, profitability is based on more than just the direct costs. It also includes indirect costs and overhead. When all of your sales add up to a poor performance at the bottom line, something has to change.

3. The No. 1 strategy. I spoke to a small business owner once who told me he wanted to focus on strategy. I looked at his financial statements and the business was losing money. My response was “Right now, there is only one strategy – your business has to be profitable and generate cash flow. After that is fixed, we can talk about different strategies.”

4. Know your numbers. How much profit did your business make yesterday? How about today? How much will you make tomorrow, next week, next month? In today’s business world, all of your successful competitors can answer these questions. You must be able to as well. Too often business owners reach for last year’s tax return or an old financial statement to gauge how they are doing. That’s not the right place to be looking.

5. Find the key drivers in your business and focus on them. Every business is similar in that there are three or four things that when they happen, the result is positive. Figure out what they are, track them, aggressively manage them, and watch what happens.

6. Know where cash hides. Often it is in inventory or receivables. Find out what inventory is not turning, has low margin or both. Sell it at cost or below cost if you have to. Take the cash from selling the bad stuff and buy something you can sell and make money. Then do it again and again. On receivables, get your invoices out quick and manage collections.

7. Understand the difference between fixed costs and variable costs. Fixed costs are the same most every month and include things like rent, office costs, fixed salaries and benefits. Variable costs change based on revenues. Minimize your fixed costs and manage your variable costs.

8. Don’t confuse your accounting system with your operating system. Accounting systems are great at measuring the past, but profits are made today. Operating systems don’t have to be complex, elaborate or expensive. They can be simple and still get the job done.

9. Make sure your internal accounting is accurate. Unreconciled accounts, sloppy bookkeeping, and a confusing chart of accounts – all of these lead to bad financial  information. Bad information is usually worse than no information. And while you are at it, fix your internal processes. There is no sense in making the same mistakes over an over.

10. Over-communicate. With your banker, your CPA, your insurance agents and your attorney. They are experts in these areas and are your business partners. Don’t keep them in the dark.

There are only three places to get cash: from an equity investor, from your bank, and from the business being protable. Investors can be challenging and complex and many business owners either don’t want, or will never be able to find the right investor for their business. So set that option aside for now. What is left? Just the banks, and your business.

Instead of going to a bank with your hand out, make your business profitable and ensure you can generate positive cash flow. Then go to your bank and tell them what you need. Too often, it is approached the opposite way. The business doesn’t generate a profit or sufficient cash flow so they want the bank to give them funding to operate.

The days of banks loaning money to businesses that can’t make a profit and generate cash flow are long gone.

Dig in, run your business the right way and get people around you who can help you do it. These are the keys to true long-term success!