CategoryBusiness Advice Archives — Page 6 of 8 — C. Lynn Northrup, CPA, CPIM

Appetite for Risk

How much appetite for risk does an entity have relative to its pursuit of value? Each entity has to develop its own appetite for risk. This will depend on achieving an acceptable balance between growth, risk, and return and creating the proper relationship between risk appetite and strategy.

Effective risk management and execution of strategy requires appropriate alignment of people, processes, and the supporting infrastructure of the organization and process owners. Appetite is linked directly to strategy and is aligned with the desired level of value creation. Different strategic options will evolve based on the assessment of risk attached to each strategy. Therefore, management style and approaches to strategy will drive varying levels of appetite for risk-taking. When setting strategy, entities will vary in their approaches to risk. Qualitative approaches will categorize the entity’s appetite for risk as green, yellow, or red (high, medium, low). Entities that employ a quantitative approach will consider appropriate goals for growth, return, and risk. Risk management helps the management team choose strategies that blend with the organization’s goals for creating value.

There are a number of considerations that impact an organization’s appetite for risk. These factors will vary from business to business. It boils down to what risks the business wants or is willing to accept and what risks they want to avoid. The desired rate of return on initiatives is one of the factors that will influence risk appetite. Risk appetite will be affected by the current rate of return and the competitive need to accelerate growth. The strategic focus of the entity will directly impact whether a company has a high or a low appetite for accepting risk. Risk management needs to consider the organization’s appetite for risk and then guide management in selecting and balancing their decisions in their choice of initiatives and allocation of resources. The tolerance for entity-wide risk will then enter into the selection of objectives in the pursuit of its strategic vision.

Risk tolerance and appetite represents a balance that helps keep businesses and organizations on course and helps to avoid unnecessary and avoidable surprises. It is like walking a tightrope and then deciding how high you are willing to be, in case you fall.

Understanding Risk

The first thing to realize is that risk will evolve from either internal or external sources with the potential to affect strategy. Risk represents the possibility that some event will occur. Management’s job is to assess all the risks associated with implementing strategy and achieving the organization’s objectives. It boils down to considering the impact of all the underlying events that might have some impact. Enterprise Risk Management (ERM) is a framework for aligning risk appetite and strategy. Based on application of the framework, managing risk becomes a process of enhancing our risk management decisions. It is about reducing operational surprises and losses through a process of identifying and managing the entire multiple and cross-enterprise risks. It is more than avoiding losses; it is a process of seizing opportunities and looking for ways to improve the deployment of capital.

It is very closely linked to internal control in that is a process that is created and managed by people. It is, or should be, applied in a strategy setting and across the enterprise. It will only provide reasonable assurance and is geared to the achievement of objectives. When we say that risk management is applied in setting strategy is that it sets strategies and then considers risks relative to alternative strategies. It evaluates alternatives and helps decide on a course of action.

Risk management is applied across the entire enterprise and should consider the entire scope of activities at all levels of the organization. You need to consider special projects and new initiatives. Don’t apply the concept too narrowly because taking a portfolio of risks may override the occurrence of a single isolated event. Your assessment should consider both quantitative and qualitative factors in reaching judgments. Also, it is useful to group risks into categories so they can be effectively managed.

Now that we’ve got you started on the road to understanding risk management we will next take up risk appetite in our next post.

Rethinking Retirement

Everywhere you go the black cloud of the economy hangs over you like a constant drizzle telling you to crawl into a fox hole and don’t spend any money. Being of retirement age, this strikes home because we have worked hard all our lives. Now we’re working even harder and earning less.If we can’t retire, what are we going to do? My situation is a little different because I have consistently flunked retirement. I still relate to the issue since as a CPA advisor, I share everyone’s pain. People want answers and I’m frequently asked to provide them. These are tough answers because each situation is different.

One of the tough choices is with people who retired thinking their savings would carry them through their golden years. The first thing all retirees need to do is recalculate their budget and compare their current expenditure level to their retirement income. Most people took a hit on their investment portfolios and need assistance on how to invest the remainder. Most retirees should cut back on the fat and downsize where possible. There are a number of things that can be done to cut back on expenses. I’ll touch on some of these ideas in a future post. The key here is to match your retirement expenses to your retirement revenue as closely as possible.

Where can retirees get good unbiased advice? More CPAs will be shifting their focus to providing some level of financial advice. This is a good place to turn for people who have smaller portfolios. You should be looking for good practical advice on how to plan and budget for the future. It could be money well spent.

If you have a shortage of future revenue, you might want to explore getting a part-time job to narrow the difference. I realize this is neither why you retired nor what you had in mind when you retired. My advice is to deal with the world the way it is and not the way you wished it was. We all have to do what we have to do. One idea for part-time work is to link work with a hobby so it is more fun.

The person contemplating retirement also has tough choices. One of the main questions to ask is how long do I continue to work? I always try to have people develop a retirement strategy to gain a sense of what they want to do and where do they want to live during retirement. Based on personal experience, living in a retirement community can make it difficult for retirees to find acceptable work since there are a lot of people competing for a limited number of jobs. This is where developing a careful and thorough strategic plan for retirement really can make a difference.

When my wife and I considered moving to Montrose, Colorado as our last move, I developed a strategic plan similar to what I would do for a business client. We evaluated the pros and cons in addition to developing a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis of how we were going to spend our retirement years. This removed the guess work from our decision process. We rented for a year until our house in North Carolina sold. I have seen a number of people saddled with two homes because they failed to think through all of the available options. Another mistake is buying a house prior to living in a community for a period of time. After they realized it wasn’t for them they were stuck with a house they couldn’t sell.

Retirement involves lots of choices and many difficult decisions. I will regularly include blog posts dealing with many of these issues. I welcome comments and questions. Since I have experienced many of these same challenges, I think I can help.

Recession – So What Do We Do Now?

Now that we have a new President many people will think that his recovery program will have us back on track in a few months. I’m not so optimistic. My advice is to prepare for a longer term period of slow economic activity, maybe as long as two to three years. This isn’t what you want to hear, but it could well be reality. Assuming such a dismal projection, it is important for us to develop a survival strategy – perhaps strategies.Your strategy needs to include a thorough understanding your competition and markets. You will need to be aggressive and radically different to gain the necessary market penetration. Don’t think your sales volume will be like prior years. It’s probably going to be lower and with reduced profit margins. The world is different now. Keep reworking your strategy almost on a daily basis to make sure you’re on track. Agility is the key to survival.

Developing a budget is essential. The budget needs to include revenue projections together with generation of cash flow. This means managing how you invoice, manage accounts receivable, manage inventories, and manage accounts payable. Maintaining an effective and effective cash conversion cycle is the most critical measurement indicator that you can monitor. When projecting your expenses you need to reduce them to various levels to match the level of revenue projected. Your expenditure budget needs to include survival level outlays representing the minimum level of expenses possible. When you understand how low you can go then you can adjust to revenue levels appropriately.

A component of the budgeting exercise should draw you into analysis of your business processes to understand where there are opportunities to improve these processes. In the new business environment improvement of business process flow will be the key to attaining a competitive advantage. One of the best opportunities to improve business processes will be in reducing paper work and improving accounting efficiencies. We have forgotten the back office which represents huge opportunities.

Many CPAs are too focused on taxes and financial statements and fail to provide the business advice that clients need. This will change as businesses will seek out the advice they need to survive the recession. If businesses fail to receive what they need from their CPA then they should seek a professional who has the expertise to guide them through the tough times ahead and will be responsive to their needs and requirements.

My advice is to be flexible, disciplined, patient, and focused. This is a time to think different because life will be different. The old rules aren’t going to work so you need to find new guidelines and ways to do business. Lower your expectations and hope for the best while preparing for the worst. While things look pretty dismal, this is a good time to look for opportunities to improve your competitive position and profitability.

From a CPA in Montrose, Colorado

My wife and I decided to move to Montrose, Colorado as our final step toward retirement. After realizing that I was flunking retirement, it was important to develop a working life style that would fit and also provide a vehicle to deliver years of experience to individuals, business owners and CPAs. Thus, the new web site became a reality. The web site was built at the same time we were building our new residence.One of my objectives was to provide other CPAs with the benefit of my consulting experience and training. Accordingly, the web site was developed to offer a variety of resources that would enable CPAs to deliver a wider range of business advisory services and support to their clients.

Most Montrose CPAs haven’t realized that I live in their community and that they have access to a wide variety of CPA resources. Since I believe in a team effort, these professionals can directly access my capability without any fear of losing clients. I only wish to provide support and help others in the community. Besides, I need a little time for golf and fly fishing.

Owner managed businesses in Montrose and throughout the western slope of Colorado also have new resources available to them without having to leave the area. My expertise can help these businesses achieve greater bottom-line profitability. Another area where I can help family-owned businesses is with succession planning.

Since my wife and I developed a life plan approach to retirement planning, I decided to offer our methodology to others contemplating and planning for retirement. In addition to pure estate and tax planning, my approach is to provide guidance in a wide range of areas from budgeting, life style decisions, where to live, and how to achieve your retirement goals and objectives.

In this current economic environment, which will last for some time, individuals and businesses will need a different level of service and guidance to help them navigate these difficult times. CPAs are uniquely suited to provide this guidance. CPAs can no longer just prepare tax returns and financial statements. They will need to learn other skills such as strategy and operational management. It is interesting to view the proposed format of the Uniform CPA Exam to see the emphasis that will be placed on these areas. This is all about helping businesses become leaner and do more with less.

I am looking forward to providing my contribution to the re-education process. My wife and I also look forward to working together with our neighbors and contributing to the Montrose, Colorado community.

Recession Proof Your Business with EVA

EVA^TM stands for economic value added. It is an economic value-based model to measure performance. It is a metric that holds businesses accountable for the cost of capital used in the business and determines whether or not real value has been created for the owners. The calculation is determined by subtracting a charge for the full cost of capital which includes the equity and debt from the net operating profit after taxes. The method adjusts for accounting distortions such as intangibles and gets back to a cash basis or an economic model of profitability. This is important because it focuses on what is really critical in this economy in contrast to GAAP accounting-based measurement.

If EVA^TM is a better measurement of value creation, why is it better? The underlying principle of any business is that it must provide a profit that is great enough to justify the cost of capital used in the business. In other words, a business needs to create a surplus of profit after covering all of its costs. Until a business has earned an economic profit, it has not really generated a profit. When the net economic profit of the business exceeds its cost of capital employed, positive value is created. If net economic profit is zero or negative, then value is lost.

In its simplest sense, there are only three ways to increase economic value:
1. Increase operating efficiency
2. Only undertake investments that add value
3. Get your capital out of investment activities that don’t add value
By simplifying your focus, one develops a much better grasp of how value is being created or not created.

All too frequently managers are making decisions without considering the cost of capital in making their investment decision. They also think they are making a profit, when in fact; they are losing value by not covering the total cost of capital.

It is critical understand the reality of whether or not you are making an economic profit. If you can’t earn economic, cash based, profit, then why pursue the investment or continue the business?

A New Beginning

Well 2009 is here. Now we have a chance to put the trauma of 2008 behind us and move forward to new beginnings. I already have. My goals are set and I’m moving on to where my dreams are going to take me. 2008 was a pretty good year for us. First and foremost was creating the new look to my web site and this blog. That said, there’s even more to do now 2009 is under way.

My advice is always to be patient, focused, and disciplined because in the long run this type of thinking and action is what gets the job done. This motto combined with a habit of always set goals and objectives is crucial. Then you need to monitor your results and adjust as quickly as possible if things aren’t going the way you anticipated. It’s a process – and not a short one.

Some of the things we are pursuing for this New Year include actions in multiple areas. I want this blog and web site to be an authoritative resource for CPAs, family businesses, and retirees as they navigate the difficult journey ahead. My plans include new training programs, up to date information on the potential adoption of IFRS, solid support for building business value, and guidance for family-owned businesses seeking to develop succession and transition plans to a new future. Plus all the other material we have always provided.

A new mission will include retirees and those looking toward retirement. This will include a new book and lots of guidance on how to make the transition. I am flunking retirement, but have put ourselves into a place where I can play, work, and live like I always dreamed we would. I learned a lot in making our journey, so it’s time to share this knowledge and information with others. I hope you will enjoy and benefit from this initiative.

Well, Happy New Year and stay tuned as we move forward and enjoy! We’re looking forward to the challenge that lies ahead.

Recession Survival

How you do survive the worst economic downturn since the great depression? This is a big question. Many people never experienced the depression or even the big recession of 1981 and 1982. I was a controller of a large corporation back in 81-82. This got me thinking about how could I provide guidance to those who haven’t experienced such turbulence.

Based on my experiences I created a toolkit to package all the tips and techniques of how to get through the tough times. One of the key elements of the survival toolkit is developing a plan and a budget for recession survival. The toolkit contains a cash flow and budgeting template. The process of developing a plan should include an assessment of whether the business needs a tune up, a turnaround, or is in a state of crisis. When you can’t cover payroll, you’re in a crisis. This is why cash is king. If you don’t have adequate liquidity or access to cash, the chances for survival get pretty slim.

During a recession it is time to get aggressive with your sales and marketing. It isn’t always just pricing. Make sure you reach as many potential customers as possible. It’s a numbers game, and having more leads in the pipeline is crucial. Understanding your profit margins is another essential step so you can make price adjustments and at the right level to secure a greater share of the market.

The Recession Survival Toolkit  outlines tips and techniques for reducing costs on every facet of the business. Just reviewing all of the potential opportunities to reduce costs is a healthy process. Usually the first step in cutting back is reduction of headcount. There are numerous ways to control payroll costs without reducing headcount. Consider adjusting hours worked or vacations with out pay as a way of keeping your valuable employees.

Another opportunity is to use lean workflow techniques and paperless systems to streamline the office and accounting functions. Not only is it cheaper, but it speeds up data retrieval, improves accuracy and saves time. It also minimizes the cost of paper and storage space.

Getting financing and having a relationship with your banker is a key element of making it through tough times. When your bank is your partner, your survival chances get a lot better. The toolkit reveals the techniques used by banks to make loan decisions. When you understand what the bank wants, you are in a better position to get the necessary financing.

Having developed a recession survival toolkit for businesses, I am now motivated to provide more guidance for individuals and retirees. I think CPAs have a responsibility to help citizens achieve a higher level of financial fitness. The AICPA and the Virginia Society of CPAs have launched a website that offers a great deal of information and advice on financial management.

Remember, it took a while for us to get in this mess, and it is going to take focus, patience, and discipline for us to get healthy again.

Cash Conversion Efficiency

In these times, cash is king. Achieving better cash flow starts with sales and marketing. A tough economic environment means there are more businesses looking for the same customer. Taking a more aggressive approach to finding more sales leads that can be converted into sales is a critical component to increasing your cash flow. You might even have to shave the selling price to secure the sales, so knowing your profit margins is essential.

Once we secure the sales it is time to be firm on how and when you will get paid. This is one of the key areas where cash conversion efficiency begins. Get cash at the time of sale if possible. Most businesses sell on credit, typically with terms of payment in 30 days. The days accounts receivable are outstanding is one of components of the cash conversion efficiency ratio. The faster or fewer number of days sales outstanding, the better. This generates cash needed for the business.

You have to purchase materials or goods that are recorded in inventory before converting them into sales. Since you likely paid for these goods based on credit of 30 days net and perhaps a discount of 1 to 2 percent if paid sooner than the terms of credit. The more effectively you turn your inventory into sales by reducing cycle time is crucial. Likewise, use your vendors as a bank by adhering closely to the established terms of sale without losing the discount offered.

Your cash conversion is determined by combining the average number of days cash is tied up in accounts receivable plus the average number days cash is held in inventory less the average number of days of payables. The smaller the number of days contained in the cycle the better.

Some additional metrics that should be monitored include:
• Cash as a % of Sales
• Gross Margin %
• Selling, General, and Administrative Expense as a % of Sales
• Net Working Capital as a % of Sales

The faster your cycle time, the faster you will convert your sales into cash. A component in achieving faster cycle times is to reduce the number of days required to send out your sales invoices after goods have been shipped or services rendered.

A couple of good references on how cash conversion efficiency is used include Go with the Flow published on CFO.com and Cash Conversion Efficiency – A Great Outcome published by Management Mythbusters.

Focusing on these basics of accelerating cash flow will help keep your business healthy in these turbulent economic times.

The Reality of IFRS

I am sure many CPAs have seen IFRS and heard there was going to be a convergence from Generally Accepted Accounting Principles (GAAP) to international accounting standards. But how many of them realize the magnitude of what lies ahead? I was involved in teaching SOX and internal control standards under Section 404. This gives me a pretty good idea of the effort required to make the shift. Since this web site and blog is geared to providing current and cutting edge information for businesses and CPAs it made sense to get on the IFRS band wagon sooner rather than later.Why all the fuss? Well IFRS accounting standards have been adopted by 113 countries and by 2011 it will be the standard used by 150 countries. The United States is immersed in global business and investors need to have the ability to evaluate investments around the globe. This makes a pretty good cased for a single set of globally accepted accounting standards. As was the case with SOX, CPAs are not yet prepared to shift to IFRS. Because of the global implications, CPAs in the United States will need to be capable of preparing and interpreting financial statements using IFRS.

The education process will be massive. It will impact investors, CPAs, and other specialists such as actuaries, and professional associations. Comprehensive education programs will be needed across the board. The AICPA has launched an initiative to help educate and pave the way for 2010 when conversion will likely be a reality.

In drafting this post the potential impact of the transition became starkly real. Colleges and universities will need to revise their curricula to accommodate the new standards. The CPA exam will need to be revised. Many CPAs could find themselves in situations where clients will demand adoption of IFRS. Those CPAs who make the effort to educate themselves will be on the winning end of the conversion game. My prediction is there will be more unprepared accountants versus those who make the leap.

This post is just the beginning and a way of sounding the alarm. I will be busy in the months ahead developing training material. Plus, we will be offering regular and current information on this site to help with the education process.  I’m looking forward to the journey, so sign up for my RSS feed and newsletters.  Let’s saddle up and enjoy the ride.