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Small Business

Thinking of expanding? Not so fast

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The driving force in many expansion plans is to generate higher sales, with the hope that profits, too, will rise.

But before making moves to buy new equipment, expand your plant or implement a new business idea, you need to grasp the profit angle.

In some cases, an expansion plan boosts sales but not profits. You wind up working longer and harder for nothing. You may think, “If we lose a little bit on each deal, we can make it up on volume.” That sounds good in theory, but may prove difficult in reality. To prevent problems, here’s a step-by-step guide.

  1. Fixed and variable costs. Break down your costs as either fixed or variable. Fixed costs don’t change over any reasonable time period while variable costs are related to sales. (The more sales, the more variable costs.)
  2. Contribution margin. This is what remains from sales after you deduct the variable costs. So if your product sells for $10 and your variable costs run $8, your contribution margin is $2. From that margin, you cover fixed costs and add to your profits.
  3. Breakeven. This is the amount of dollars and time it takes the contribution margin to match fixed costs. To calculate it, divide fixed costs by contribution margin. You don’t realize a profit until the contribution margin exceeds fixed costs. Until then, you’re in the red.

Once you calculate these factors, you’re ready to analyze the impact of expansion. Let’s say your company makes Belgian chocolates and sells them in quarter-pound boxes at $10 a piece. Your variable costs are $8, giving you a contribution margin of $2 on each box to cover fixed costs and provide a profit. Your fixed costs are $100,000, so you need to sell 50,000 boxes to break even.

If you expand, and fixed costs rise to $125,000, your contribution margin stays the same. Using the breakeven formula (fixed costs divided by contribution margin), you now have to sell 12,500 more boxes, or 62,500 total.

Have your numbers calculated? It’s a good idea to talk to your accountant about how cash flow, liquidity and profitability could change, depending on business conditions. But fundamentally, a solid grasp on these factors is critical to deciding whether you’re better off keeping the status quo or charging ahead with an expansion.

Why your business absolutely needs a budget

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Most business owners view a budget with utter disdain. They’ll use any excuse to not prepare a budget. Some of the excuses I have heard over my career:

“Who has time for that?”

“Our annual earnings don’t really change from year to year.”

“Sales are flat, why bother?”

Most business owners run their business based on the business’ history and the owner’s experience. Sometimes this works well, other times not so much. Remember the credit crisis of 2008? Our business clients who weathered the storm were the ones who had transparency into their business via a budget. They could model the effect it would have on their profitability and cash flow using their existing budget and adjusting their expenses or payroll accordingly.

So, why prepare a budget? As previously discussed, transparency into the effects business conditions have on cash flow and profitability. Another reason is to plan for growth, organic or merger. Growth creates its own challenges such as the need for financing. A merger needs to be modeled to attract possible financing. Yet another reason to create a budget is to see how pricing changes affect profitability.

What is a budget?

A budget is simply your estimated income and expenses for your business year, a pro forma document, meaning you’re using your knowledge to estimate the how you will see the year.  A budget typically reflects how your company expects to spend money in the future.

Let me say it again, it is your spend, meaning you have built into the budget hiring for growth, a new or larger facility, etc.  It will change as you move through the year and must be updated. I like to update each month of the budget with actual results, so trends can be spotted and profit and cash flow projections more accurate with the known adjustments. This is especially useful when communicating with a bank or investors.

How do I prepare one?

Depending on the size of the business the budget process can begin as early as August or September. If your business has a sales team, it is imperative you start with them. Have each sales person develop their sales budget by month and by customer. Do not just accept the numbers provided challenge them based on your expectation of reality, against their previous sales and the current economic environment. This will form the foundation of the entire budget.

Next, review your historical gross margin, listen to your sales team as to pricing pressures and project the gross margin. Finally, estimate your general and administrative expenses such as administrative salaries (accounting, HR, executives) insurance, utilities, rent, travel and entertainment.

Here again, you’ll reference history and change in operations and possible hiring patterns to estimate the expenses by month.  This becomes your plan for the year and if sales are not being obtained, or margin is lower than obtained, then changes will need to be made in personnel or expenses.

Of course, if you are satisfied with the ultimate operating margin, maybe nothing needs to be changed. The important thing to remember is this will hold your employees accountable to the plan, if you hold yourself accountable to developing, monitoring and taking action against it.

Where to start? Your accountant is a great place. Don’t have one? Fix that now and call Magone & Company at (973) 301-2300.

Employee non-compete agreements: Enforceable or not?

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No employer wants to find themselves competing with a former employee. Nor do you want valuable inside information, strategic plans or trade secrets shared with a rival company. So, how do you craft a non-compete agreement that’s both effective and enforceable?

It’s all about the word “reasonable”
Courts have long attempted to balance the interests of employers and departing employees in deciding whether a non-compete agreement should be upheld. There are commonly three factors a court will examine when hearing a non-compete case:

1) Time. You obviously can’t restrict a former employee from competing forever. The period considered reasonable typically ranges from one to three years, depending on the industry. For example, in high-tech businesses where information changes so quickly, the length of a non-compete contract is often on the shorter side.

Also consider how long the worker was employed by your organization. According to attorney Barry Kozyra of Kozyra & Hartz in Livingston, NJ, “It’s unreasonable to take somebody out of the workplace for one or two years if they only worked at your business for a month. You would have to demonstrate that you have very fragile intellectual property or confidential information that could be stolen.”

2) Geography. You can make restrictions where your company does business, but probably not nationwide or worldwide. One exception is internet or software companies that operate internationally, where courts have found broader geographical restrictions to be reasonable.

Explains Kozyra, “We routinely see situations where an employer wants to restrict someone from working anywhere on the planet because the company has such wide-ranging reach. While it’s not commonplace, it can hold up in a court if the company has very unusual intellectual property, or information that can be disseminated without recourse to another country or continent.”

3) Scope. No non-compete agreement can strip an employee of the right to earn a living. An agreement can restrict certain core functions, but it can’t prevent an employee from using skills they’ve acquired over the course of their career.
Restrictions must normally be limited to the job the employee performed for the employer. For example, a software engineer for one automaker can’t be restricted from taking a sales job at another manufacturer’s showroom.

Interestingly, non-competes are enforceable in NJ against all employees except attorneys. Adds Kozyra, “Some states also don’t allow non-competes for doctors, because there’s a shortage in many areas of the country, and the need for medical care and specialists can have a huge impact on public health and safety.”

Know your state’s requirements
Non-compete agreements are subject to the laws of the state in which they’re written. Some states don’t recognize them at all. Others stipulate timing, for example that employees must enter into an agreement upon hiring rather than after they give notice to quit a job.

If you’re a multi-state entity, be sure to choose your terms wisely and put them in writing, Kozyra advises. “If you do business in more than one state, you’re able to designate the law of one state and the jurisdiction of one court to apply to the contract.” Most organizations, he says, will choose the state with terms that favor the employer over the employee.

Remember — employees will come and go. But you can take steps now to prevent your valuable intellectual property or your clients from walking out the door with them. The information above should not be considered legal advice, so be sure to consult with your legal advisor for assistance in drafting a non-compete agreement, or if you feel a former employee’s conduct is in violation of your current agreement.

Accepting checks? Proceed with caution

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Check fraud costs individuals, businesses and financial institutions as much as $50 billion annually, according to one estimate.

Forged checks have always been a problem, but with inexpensive laser printers and easily accessible paper, check fraud is more prevalent than ever before. Victims include financial institutions, businesses that accept and issue checks, and of course consumers. In most cases, these crimes begin with the theft of a financial document — stealing a blank check from your business, home or vehicle during a burglary, searching for a canceled or old check in the trash, or removing a check from your mailbox.

If your business accepts checks, a little knowledge of the payment system and a good eye can help you distinguish bad from good.

Look for alterations

Checks contain a nine-digit routing number in the bottom left-hand corner. The first two digits indicate the Federal Reserve Bank that will handle the check. A favorite trick of forgers is to change the routing number.

By knowing the routing number of your closest Federal Reserve Bank, you can quickly tell if there’s a problem with the number on a “local” check. If the routing number appears to be altered, there’s a good chance the check is bad. A quick scan can also spot discoloration, which is an indication of check alteration.

Another sign of a potentially fraudulent check: No perforated edge on one side. Checks made on a home printer are typically smooth on all edges.

Sometimes the checks themselves are legitimate, but the person trying to use them isn’t. Payroll and other checks are routinely stolen. That’s one reason why the federal government started electronically depositing Social Security checks.

Inspect signatures

If you’re a retail-type business, consider implementing a policy of matching the check’s signature to a piece of ID like a driver’s license. Instruct employees to not to pay attention to the appearance of the check writer, but rather the appearance of the check itself.

Consider “checks and balances”

Companies issuing checks are at risk, as well. Company executives should examine check stock and account balances regularly to look for discrepancies. The right financial controls can also help deter internal fraud. For example, make sure the same person doesn’t write checks and reconcile bank accounts. Limiting the number of people authorized to write corporate checks reduces the chances of fraud.

Get professional help

An experienced accounting firm can perform an internal control study and recommend ways to minimize employee fraud and theft. In addition, your financial institution may offer fraud deterrent methods like watermarked check stock. Payroll cards, on which the company loads electronic payments, are also gaining in popularity.

Remember that the best defense against the danger of check fraud is a proactive approach that prevents — rather than detects — the crime.

Keeping your firm’s debt in check

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Paying your company’s bills is just as important as collecting your own receivables — and they need just as much management. The good thing is, you have a surprising amount of control over how and when your company’s debts are paid and that provides several advantages.

Start inside the business…

First, adopt good internal controls for the payment of your bills. You need to reconcile both:

  • Purchase orders with the invoices and statements your vendors send
  • Accounts payable subsidiary ledgers with the general accounts payable ledger

Once you have those controls working, consider these ways to effectively manage your company’s debts and maximize your cash flow:

  • Keep interest-earning cashin the bank for as long as possible, but not too long. If you don’t already have an interest-earning account, talk to your banker about a money market or some other interest-bearing vehicle. Consider using cash to pay down your lines of credit.
  • Periodically provide your banker with updated cash-flow projections. An improved cash-flow picture might result in better terms on any open lines of credit. On the other hand, if the projection is less than robust, your banker might increase your line of credit with no bump in the interest rate, depending on your firm’s overall financial condition.
  • Consider borrowing against the cash values of executive life insurance policies. This can reduce your net interest cost, because life insurance loan rates are generally lower than bank rates.

Then work your way out…

Of course, you should be using your suppliers to help finance purchases, as well as freeing up some operating capital, by taking advantage of favorable payment terms.

The more business you give to suppliers, the better the payment terms you should obtain. The goal is to widen the spread between sales revenue and payments, allowing you to maximize your cash balances at very low cost. To that end:

  • Use every possible discount. Have your accounts payable department maintain a calendar-style schedule to ensure payments are made within discount periods.
  • Stretch payments to their latest date.
  • Negotiate extended terms when possible and appropriate.If you’ve been a good customer you might be surprised at what your vendors will agree to.

By implementing smart debt management practices, you’ll streamline your debt payment plan and gain more control over your bottom line.

The connection between PR & profitability: How a proactive strategy can help your bottom line

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Sometimes how leaders react during a business crisis can have more of an impact than the crisis itself.

Remember when Equifax announced that the personal information of over 143 million Americans was compromised in a huge cybersecurity breach? The company claimed they learned about the attack in July 2017, but didn’t share that information with the public until September. They caught flak for not only failing to alert customers, but for a lack transparency in general — the result of a reactive, poorly executed public relations strategy.

So why are CPAs blogging about public relations? Ask Equifax CEO Richard Smith, who stepped down after 12 years at the helm. Shares of Equifax declined more than 23%, and the company logged over $87 million in costs related to the privacy breach.

PR is too often viewed as “feel good” marketing fluff. But when bad news hits the fan, a well-crafted PR strategy can help mitigate its impact on your bottom line — very much the purview of a CFO.

Not convinced? Here are four ways that first-rate PR can help protect your reputation as well as your earnings:

1. Managing media relations during a crisis. Let’s say your company is responsible for an accident that pollutes a local waterway. Now imagine that you’re in the middle of negotiating a major deal when the news breaks. The accident can hurt your company and put the deal in jeopardy. What can you do?

A skilled PR person — whether an employee of your organization or outside counsel from an established public relations firm — knows how to mitigate the potential damage to your brand and assist your organization in properly taking responsibility in a manner that engenders trust, restores brand confidence, stems sales attrition and re-establishes good will.

The problem? Many organizations first contact a PR firm in the midst (or the immediate aftermath) of a crisis, when significant brand damage has already occurred and public trust has eroded, according to Kathleen McMorrow, principal at The Communications Optic, a strategic communications and media advisory firm based in Chatham, NJ.

“The midpoint of a crisis is certainly not the ideal time to onboard a PR firm,” says McMorrow. “A far better strategy is to have established a relationship before a problem even occurs. That way, the firm can be a true partner to your organization, performing at an optimal level to contain the damaging effect of a negative incident far better than someone who just received your panicked call and knows nothing about your company.”

2. Overseeing relationships during litigation. Some types of legal actions, like those involving insurance coverage, for example, are between companies that have ongoing, profitable business relationships. A skilled professional can help balance your lawyer’s strong advocacy on your behalf with sensitivity to the business relationships that keep your company financially healthy.

Here’s where having an established relationship with a PR pro can also pay dividends, according to McMorrow. “When your PR firm is already your trusted advisor, fully engaged with your business strategy and market position, they’ll understand the nuances of your other business relationships and will act to protect them, along with your public image.”

3. Boosting employee morale during tough times. Sometimes, reaching out to the media can help with employee morale. Here’s an example: Your company is forced to make cutbacks, and remaining employees are losing confidence in their future with the firm.

Of course, establishing or maintaining professional development or other performance incentive programs can help keep staff engaged and productive. But think how much more effective your effort would be if a PR professional helped you relay this positive story to the media. Impartial media coverage would go a long way toward reassuring current employees and helping to attract talented candidates in the future. In addition, your strategic partners and vendors might have greater confidence and enthusiasm in their dealings with your organization.

4. Presenting a consistently positive image of your company. The court of public opinion is a powerful force in today’s justice system. Crisis management strategies can be enhanced by a consistently positive image of your company.

We’ve all seen the trend toward frivolous lawsuits and noticed the skepticism toward corporations in light of well-publicized abuses by a few firms. If people see that a company is investing in the community, giving back at charitable events or providing generous volunteer opportunities for employees, they might be less likely to sue for minor injuries or infractions. At the very least, they may accept a reasonable settlement if offered.

CFOs can’t afford to ignore reputation management in today’s litigious world. Rather than viewing a strategic PR plan as fluff, you might want to huddle with your marketing team and learn about the relationships and resources they have in place to prevent bad news from turning into a bottom-line nightmare.